One proceeding rule to rule them all. Arbitration clauses may be unenforceable in a receivership context: Ontario Court of Appeal

Parties often include arbitration clauses in their contracts on the expectation that their contractual disputes will be resolved through confidential arbitration in their preferred venue. The Ontario Court of Appeal’s recent Mundo Media Ltd. (Re), 2022 ONCA 607 (Mundo Media) decision demonstrates that this expectation is often misplaced. Where one counterparty enters insolvency proceedings—whether in bankruptcy, Companies’ Creditors Arrangement Act or receivership—the other party could find itself forced to attorn to the jurisdiction of the insolvency proceeding to resolve its contractual disputes, even if it does not advance a claim in the insolvency proceeding itself.

What you need to know

• The Ontario Court of Appeal held that a party was unable to rely on an arbitration clause in its contract with an insolvent debtor to force a contractual dispute into arbitration in New York under New York law. Because the dispute was of significant importance to the debtor’s other creditors, the Court instead affirmed that it must be pursued in the debtor’s receivership proceeding in the Ontario Superior Court of Justice.
• Enforcing the arbitration clause would have run afoul of the principles and objectives underlying insolvency law’s propensity to consolidate all claims against a debtor, and in some cases claims by a debtor, into a single proceeding.
• This “single proceeding” model of insolvency law may be further developed in the Supreme Court of Canada’s upcoming Petrowest Corporation v. Peace River Hydro Partners decision, expected later this year.

The details

Background

This case addresses a party’s ability to rely on a contractual arbitration clause and resolve its contractual disputes through foreign arbitration when the other party enters into insolvency proceedings.

Mundo Media Ltd. was an advertising technology company that provided online marketing services. Due to Mundo’s declining revenues, in 2019, the Ontario Superior Court of Justice appointed Ernst & Young Inc. as receiver (the Receiver). The Delaware bankruptcy court recognized the receivership order shortly thereafter.

The Receiver brought a motion for an order directing SPay Inc., a Texas-based company and Mundo’s largest debtor, to pay Mundo US$4,124,000 for a number of unpaid invoices pursuant to services contracts between the parties. SPay sought a stay of the Receiver’s motion on the basis that those contracts contained arbitration clauses that required all disputes to be resolved by arbitration in New York under New York law. SPay also maintained that Mundo itself owed SPay substantial amounts under the services contracts, and that SPay would be asserting those amounts through a set-off against the Receiver’s claim.

At first instance, the motion judge first held that the Ontario court, not a New York arbitrator, had jurisdiction to determine the appropriate forum because the Receiver was an officer of the court. Second, the motion judge dismissed SPay’s proposed arbitration stay. The Receiver’s claims were of fundamental importance to Mundo’s creditors; therefore, the effect of the Bankruptcy and Insolvency Act was to supplant the arbitration clause, requiring the Receiver to pursue its claim in the Ontario receivership proceeding.

SPay sought leave to appeal the motion judge’s decision.

Key issue

The key issue on appeal was whether a counterparty could rely on the New York arbitration clause in its contracts with its insolvent counterparty—subject to a court-ordered receivership—and force the debtor to pursue contractual claims in the foreign arbitration venue.

The Court of Appeal’s decision

The Court of Appeal denied SPay’s motion for leave to appeal.

The Court accepted the motion judge’s refusal to enforce the arbitration clause because of a fundamental tenet of insolvency law: the “single proceeding” model. By grouping all claims against a debtor—and in some cases, like here, claims by a debtor—into a single legal proceeding, insolvency law aims to place creditors on equal footing and to insulate creditors from the inefficiency and chaos that may ensue if they were left to fend for themselves in concurrent but separate legal proceedings.

In Mundo’s circumstances, the Court explained that addressing the Receiver’s claims in the Ontario receivership proceeding, instead of through foreign arbitration, would avoid the cost and complexity associated with the Receiver (and other stakeholders) having to “scurry to multiple jurisdictions” to resolve claims of fundamental importance to Mundo’s creditors.

However, the Court reiterated that the “single proceeding” approach to insolvency law is not absolute. Issues must be resolved in insolvency proceedings only to the extent that the relevant stakeholder is not a “stranger to the insolvency”. In turn, the stakeholder’s status as a stranger to the insolvency is determined by the degree of connection between the stakeholder’s dispute and the insolvency proceeding.

The Court of Appeal held that SPay was not a stranger to Mundo’s receivership for two principal reasons:

• Although SPay stated that it did not intend to assert a claim against Mundo in the receivership proceeding, it did intend to claim a set-off in respect of amounts it asserted against Mundo. SPay would inevitably act as a creditor of Mundo, whether through a claim or through a set-off. The Court rejected that there was a substantive difference between claim and set-off in this context.
• SPay was Mundo’s single largest debtor, and the Receiver’s claim was Mundo’s largest potential asset. The success and quantum of the Receiver’s claim—and therefore of SPay’s countervailing proposed set-off—would have significant implications for the size of Mundo’s estate (and therefore for creditor recoveries). The outcome of these issues affected all other creditors.

The Court of Appeal further rejected SPay’s argument that insolvency law only seeks to consolidate claims against the debtor and not those asserted by the debtor—that is, that “single proceeding” arguments can only be engaged as a “shield” and not as a “sword”. This argument failed to recognize the purpose of resolving claims in a single proceeding: promoting efficiency and maximizing returns for creditors. It was also inappropriate to permit a party to contract out of the insolvency proceeding where the issues seriously adversely affect all creditors.

Implications

The Court of Appeal’s guidance in Mundo Media illustrates that parties cannot always rely on arbitration clauses when the other party becomes insolvent. Insolvency law’s preference for consolidating claims into a single proceeding can provide strong grounds to instead require the dispute to be addressed in the jurisdiction of the insolvency. The effect of this is significant: a party can lose the protections of venue and confidentiality that it bargained for in an arbitration clause.

However, because the Court rendered its decision on the specific facts before it, its decision leaves some questions unanswered. For example, can a party rely on an arbitration clause in an insolvency context where its dispute involves less significant claims asserted by, or against, the debtor? Does the arbitration clause apply if the party merely challenges the merits of a contractual claim against it, but does not assert a set-off or counterclaim against the debtor? Can a party “contract out” of the insolvency proceedings with an arbitration clause where it would result in something less than a serious adverse effect on all creditors? Such questions may be answered in future cases.

Looking forward, Mundo Media will not be the final word on these “single proceeding” issues. The Supreme Court of Canada is expected to release its decision in Petrowest Corporation v. Peace River Hydro Partners, 2020 BCCA 339, 43 B.C.L.R. (6th) 8, appeal heard and reserved January 19, 2022, and address the approach taken by the British Columbia Court of Appeal to similar issues. The decision may be released before the year is out.