”Should I stay or should I go now?”– Enforceability of arbitration clauses / agreements in liquidation scenarios

The Supreme Court of Canada recently examined the clash between arbitration and insolvency law when Ernst & Young (EY), in its capacity as the appointed receiver and manager over a company placed under receivership, issued court papers in a civil claim for debt recovery on behalf of the company, notwithstanding the existence of arbitral dispute resolution clauses in the contracts entered into between the company and the alleged debtor.

8 Feb 2023 6 min read Business Rescue, Restructuring & Insolvency Newsletter Article

At a glance

  • The Supreme Court of Canada examined the conflict between arbitration and insolvency law in a case involving Ernst & Young (EY) as the receiver and manager of a company in receivership.
  • EY issued court papers for debt recovery on behalf of the company, despite the existence of arbitral dispute resolution clauses in the contracts with the alleged debtor.
  • The court ruled in favor of the receiver, allowing the debt recovery claim to proceed in court, but acknowledged that a receiver cannot simply avoid an arbitration agreement and should consider the principles of contract law, party autonomy, and the efficient resolution of the receivership.

Peace River Hydro Partners (Peace River) subcontracted work to Petrowest Corporation (Petrowest) and its affiliates to build a hydroelectric dam in North-eastern British Columbia. Petrowest then faced financial trouble and was placed under receivership in terms of section 243(1) of the Canadian Bankruptcy and Insolvency Act, R.S.C., 1985 (BIA), which is comparable to a company being placed in liquidation in terms of the Companies Act 71 of 2008 in South Africa.

EY (the receiver), following its duty to ensure that Petrowest’s receivership was resolved efficiently and in the best interests of its creditors, instituted a civil claim in the Alberta Court of Queen’s Bench against Peace River for the collection of funds it allegedly owed to Petrowest and its affiliates for subcontracted work.

However, the contracts that Peace River and Petrowest had concluded all provided that disputes between the parties should be resolved through arbitration. Accordingly, upon the receipt of the receiver’s civil claim, Peace River launched an application for a stay of proceedings in terms of section 15 of the Arbitration Act, R.S.B.C., 1996 (Arbitration Act), on the grounds that the arbitral clauses in the parties’ various agreements obliged the receiver to have instead initiated the recovery proceedings in terms of the contractual arbitration clauses. 

Canadian courts’ findings

The receiver opposed the stay application. It argued that the BIA authorised the court to assert centralised jurisdiction control over the matter rather than to send the receiver to multiple arbitral forums. This would allow, according to EY, a more efficient and orderly resolution of the receivership. The court of first instance dismissed Peace River’s application, as did the Appeal Court. Peace River appealed to the Supreme Court of Canada. The Supreme Court too found in favour of the receiver, ruling that the receiver should be allowed to proceed with its recovery claim through court proceedings and agreed not to stay the proceedings.

Notwithstanding the final outcome in this instance, the Supreme Court did hold that on a proper interpretation of section 15 of the Arbitration Act, a receiver could not simply avoid an arbitration agreement, as allowing a receiver to do so was inconsistent with the principles of contract law, party autonomy, and the court’s longstanding jurisprudence with respect to arbitration.

However, section 15(2) of the Arbitration Act requires a court to order the stay of legal proceedings if it finds an arbitration agreement is “void, inoperative or incapable of being performed”. On a balance of probabilities, the Supreme Court held that an otherwise valid arbitration agreement should be declared inoperative or incapable of being performed if those proceedings precluded the orderly and efficient resolution of the receivership.

The Supreme Court was explicit in cautioning that it is not a given that insolvency law will always stay and that arbitration law must go. In future, courts should consider this carefully and weigh up:

  • the effect of arbitration on the integrity of insolvency proceedings (which are by their very nature intended to minimise prejudice to creditors);
  • the relative prejudice to the parties to the arbitral agreement and the debtor’s stakeholders;
  • the urgency of resolving the dispute;
  • the effect of the stay of proceedings arising from bankruptcy or insolvency proceedings; and
  • any other material factors.

In other words, insolvency and receivership do not automatically exclude a receiver’s obligation to have a dispute resolved by contractually agreed arbitration proceedings.

Position in South Africa

Although our arbitration and insolvency legislation does not deal with a possible conflict between the two areas of law, it is likely that a South African court could come to a conclusion similar to that of the Canadian Supreme Court.

Section 5 of the South African Arbitration Act 42 of 1965 (South African Arbitration Act), provides that “unless the agreement otherwise provides, an arbitration agreement ... shall not be terminated by the winding-up of the corporate body”. Thereby confirming that the arbitral agreement is still alive and cannot be discarded by a liquidator just because they were not a direct “party” to the agreement.

However, subsection 3(2) of the South African Arbitration Act states that a “court may at any time on the application of any party to an arbitration agreement, on good cause shown:

  • set aside the arbitration agreement; or
  • order that any particular dispute referred to in the arbitration agreement shall not be referred to arbitration; or
  • order that the arbitration agreement shall cease to have effect with reference to any dispute referred.

Setting aside arbitration on good cause

In context, arbitration agreements are not automatically terminated as a result of the liquidation of a company and while the court has the discretion to, inter alia, set aside the arbitration agreement, it may only do so on good cause.

In De Lange v Presiding Bishop of the Methodist Church of Southern Africa for the Time Being and Another [2016] (1) BCLR 1 (CC) the Constitutional Court held that “good cause” only allows a court to set aside an arbitration agreement where a persuasive case has been made to do so. The court further held that it would not be ideal to define what precise circumstances would amount to being a persuasive case. It was reiterated that courts should be scrupulous when deliberating about whether to set aside arbitration agreements unless there was a compelling reason to do so. The goals of arbitration should be upheld unless good cause required otherwise.

This instils the position taken by the South African Supreme Court of Appeal in the case of Brisley v Drotsky [2002] (4) SA 1 (SCA). The court found that party autonomy must be respected, and only special circumstances should exist to deviate from the parties’ choice to resolve matters through the arbitration process. A compelling case must be made by the party seeking to diverge from the arbitration cause before a court will allow such divergence.

Therefore, for a liquidator to ignore an arbitration clause in a contractual dispute they would need to provide compelling reasons for not abiding by such clauses.

Most efficient route to resolving dispute in liquidation scenario

In the Canadian case there were numerous applicable arbitration clauses which, if enforced, would unduly complicate the dispute resolution process. As the purpose of receivership is to resolve matters as quickly as possibly for the best outcome of creditors, the court found that the complications created by the arbitration clauses made the clauses, in the circumstances, inoperative.

Whether a South African court may have reached a similar conclusion is dependent on the circumstances, in a South African context, and would involve weighing up the nature of the proceedings instituted (action or application) against the complications in the implementation of the arbitration clauses, and likelihood of the matter being resolved through the courts faster than through complicated arbitration proceedings. It is clear from the South African cases mentioned above that compelling reasons need to be shown for the courts to look past the arbitration clauses. This is no different in a liquidation scenario.

South Africa looks to other common law jurisdictions, such as Canada, for comparative case law and emerging legal precedent that might find application upon our shores. If the underlying dictum of this case is anything to go by, it is that expediency and efficiency will be key elements in deciding whether or not a court will set aside a valid and otherwise binding arbitration clause and that the timeous resolution of liquidation processes is paramount. These principles are generally universal in terms of insolvency proceedings, and the Supreme Court in Canada echoed this in its decision.

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