In Ismail v. First York Holdings Inc.,[1] the Court of Appeal for Ontario found that once it has been decided that the “main” contract is void ab initio the doctrine of separability is inapplicable because the arbitration agreement has nothing from which to “survive.”
Background
The individual parties, Mr. Ismail and Mr. Abied, agreed in 2014 to do business together through a company called First York Global Holdings Inc. (FYGH). To facilitate their share purchase, Mr. Ismail appointed Mr. Abied as his attorney with authority to sign agreements on his behalf. Three agreements were signed and executed by Mr. Abied on behalf of both parties: 1) a Purchase of Business Agreement (the FYGH Agreement); 2) a Shareholders’ Agreement regarding the purchase by Mr. Ismail of 20% of the shares of FYGH; 3) a Purchase of Business Agreement of 20% of the shares of another company, National Trade of Canada (National Trade”) by Mr. Ismail (the National Trade Agreement). That company was never incorporated. Mr. Ismail alleges it was represented to be part of the entire transaction but was structured to give Mr. Abied favourable tax treatment. Mr. Abied claims it was a separate business venture and that National Trade is a company to be incorporated. Mr. Ismail sued based in oppression.
The procedural history
Mr. Abied moved under section 7 of the Arbitration Act, 1991 for a stay of the claim in favour of mediation and, failing that, arbitration “as agreed by the parties.” The grounds for the motion referred to the two purchase agreements, one for the FYGH shares and the other for National Trade shares, and the identical arbitration agreements contained in those agreements.
Decision of the motion judge
In his decision, the motion judge referred only to the National Trade Agreement and not to the FYGH Agreement. He found that National Trade was never an incorporated entity, and so there had never been any shares to transfer. As such, there was no consideration for the National Trade Agreement, the contract failed for lack of consideration, and therefore, there was no arbitration agreement. Mr. Abied appealed.
Issues on the appeal
The first issue was whether section 7(6) of the Arbitration Act, 1991 precluded the appeal. That section provides that there is no appeal from a decision made under section 7. Relying on one of its recent decisions[2], the Court of Appeal found that where the decision to refuse a stay is based on a finding that there is no arbitration agreement, the decision to refuse a stay is not made under the Arbitration Act, 1991, such that s. 7(6) is not engaged.
The second issue was whether the motion judge had erred by failing to stay the action based on the arbitration clause contained in the FYGH Agreement.
Mr. Abied submitted that the question before the motion judge – whether there was an arbitration agreement – was not limited to the National Trade Agreement but extended to the FYGH Agreement. The existence of the arbitration agreement contained in the FYGH Agreement was never in dispute.
The Court found that the motion judge had accepted the respondent’s argument that the only agreement in issue had been the National Trade Agreement. This finding is somewhat curious given that the Court had also noted, at the outset of its decision, that “the grounds for the motion refer to the two purchase agreements, one for FYGH shares and the other for National Trade shares, and the identical mediation/arbitration clauses contained in those agreements” and that the motion judge had held that “the facts relating to both transactions are intertwined.”[3]
The third issue was whether the motion judge had erred in finding that the National Trade Agreement had failed for lack of consideration.
This engaged section 17(2) of the Arbitration Act, 1991, which is one expression of the “doctrine of separability.” It holds that if the arbitration agreement forms part of another agreement, it shall, for the purposes of a ruling on jurisdiction, be treated as an independent agreement that may survive even if the main agreement is found to be invalid.
The motion judge had applied the test articulated in Haas v. Gunasekaram[4], which requires the following analysis:
1) Is there an arbitration agreement?
2) What is the subject matter of the dispute?
3) What is the scope of the arbitration agreement?
4) Does the dispute arguably fall within the arbitration agreement?
5) Are there grounds on which the court should refuse to stay the action?
The Court of Appeal acknowledged in Husky Food Importers & Distributors Ltd v. JH Whittaker & Sons Limited, 2023 ONCA 260 that Haas had been overtaken by the framework adopted by the Supreme Court of Canada in Petrowest.[5]
The first part of the new framework requires the applicant seeking a stay to establish that an arbitration agreement exists; court proceedings have been commenced by a party to the arbitration agreement; the court proceedings are in respect of a matter that the parties agreed to submit to arbitration; and the party applying for a stay in favour of the arbitration does so before taking any step in the court proceedings.
The second part of the framework requires the court to grant a stay where the arbitration clause is not void, inoperative, or incapable of being performed. The majority in Petrowest held that an otherwise valid arbitration agreement may, in some circumstances, be inoperative or incapable of being performed, because it would compromise the integrity of court-ordered receiverships proceedings as in the case at bar.
According to the Petrowest framework, the burden of proof shifts between the first part and the second. Under the first part, the applicant for a stay in favour of arbitration must establish the technical prerequisites. If the applicant discharges this burden, then the party seeking to avoid arbitration must show that the arbitration agreement is void, inoperative or incapable of being performed. Otherwise, the court must grant a stay and cede jurisdiction to the arbitral tribunal. [6]
The Court of Appeal concluded that it had been open to the motion judge to find that the National Trade Agreement failed for lack of subject matter and consideration, and therefore never existed as a legally binding agreement. Commenting on the doctrine of separability, the court held that where an underlying agreement is breached and becomes unenforceable or invalid, this does not rescind the agreement to arbitrate and added that “to hold otherwise would undermine the intent and effect of including an arbitration clause in an agreement.”[7]
However, the court found that the agreement to arbitrate cannot “survive” where there was no contract to survive from. In those circumstances, the court concluded that section 17(2) has no application.
The doctrine of separability
In our previous post on Petrowest, we discussed the doctrine of separability. Also relevant here is the Supreme Court of Canada’s decision in Uber[8]. In her dissenting opinion in Uber, Justice Côté had indicated that “the doctrine of separability was ‘one of the conceptual and practical cornerstones’ of arbitration law which plays an important role in ensuring the efficacy and efficiency of the arbitration process.”[9]
To Justice Côté, in light of the separability doctrine, it is critical to distinguish between the validity of the underlying or “container” agreement and the validity of the arbitration agreement and a finding that the container agreement is invalid would not, on its own, render the arbitration agreement invalid because an arbitration agreement generally survives the invalidity of the underlying contract, or of a term therein.[10] As Justice Côté explained in Uber that “the separability doctrine ‘immunizes the arbitration clause, protecting it from flaws or defects’ in the underlying contract”[11] which means that the arbitration agreement is invalidated only by a defect relating specifically to the arbitration agreement itself. However, “there may be instances where the same circumstances which impugn the validity of the underlying contract also call the validity of the arbitration agreement into question.”[12]
The Court in Ismail, relying on MDG Kingston Inc. v. MDG Computers Canada Inc.[13] (from which leave to appeal to the SCC was refused), has now added a finding of failure to provide consideration to the list of circumstances that may impugn the validity of the arbitration agreement alongside the “container” contract. In MDG, the Ontario Court of Appeal had found that “in cases where the agreement was void ab initio because it was illegal, or where no agreement was ever reached, the arbitration clause will not apply because it was never validly agreed to.”[14]
Takeaways
There are questions raised in this decision, including around the finding that “the facts relating to both transactions are intertwined,” the finding that the National Trade Agreement was void ab initio and the Court’s decision to refuse to grant the stay, without seemingly ever fully considering whether a stay should nonetheless be granted in light of the FYGH Agreement, the validity of which never seemed to be in doubt. These circumstances suggest that questions about how separability will operate post-Petrowest will continue, and parties with multiple related agreements ought to take all available steps to confirm offer, acceptance and consideration for each relevant “container” agreement. Parties considering a stay should also be careful to plead all relevant arbitration agreements.
If you have any questions about this topic, please reach out to the authors, Michael Schafler, Rachel Howie and Ekin Cinar.
[1] Ismail v. First York Holdings Inc., 2023 ONCA 332, [Ismail] at para. 19.
[2] Toronto Standard Condominium Corporation No. 1628 v. Toronto Standard Condominium Corporation No. 1636, 2020 ONCA 612.
[3] Ismail, at paras. 17 and 22.
[4] Haas v. Gunasekaram, 2016 ONCA 744, 62 B.L.R. (5th) 1 [Haas], at para. 17.[3]., the Court of Appeal for Ontario confirmed that the Haas test had been. Though the Petrowest framework was made for domestic arbitration legislation, the Court of Appeal confirmed that the framework was equally applicable to international arbitrations. The Petrowest test requires the applicant for a stay to establish that an arbitration agreement exists; court proceedings have been commenced by a party to the arbitration agreement; the court proceedings are in respect of a matter that the parties agreed to submit to arbitration; and the party applying for a stay in favour of the arbitration does so before taking any step in the court proceedings.
[5] Peace River Hydro Partners v. Petrowest Corp., 2022 SCC 41 [Petrowest].
[6] Petrowest, at paras. 77 and 78.
[7] Ismail, at para. 45.
[8] Uber Technologies Inc. v. Heller, 2020 SCC 16 [Uber].
[9] Uber at para. 221.
[10] Uber at para. 277.
[11] Uber, at para. 224.
[12] Uber, at para. 224.
[13] MDG Kingston Inc. v MDG Computers Canada Inc., 2008 ONCA 656 [MDG].
[14] MDG, at para. 24.
