Archive for November, 2016

Response to a Recent Criticism of Arbitration Clauses

Monday, November 14th, 2016

I read earlier today an interesting commentary on a recent decision of the Ontario Court of Appeal in the Novatrax case.  Let’s start with the basic facts.  Novatrax had an exclusive sales agreement with a German company to sell industrial fans in Canada and the U.S.  Either side could terminate on the giving of 12 months’ notice or without notice in certain circumstances.  The German company terminated giving no notice and saying that it had just cause to terminate.  The plaintiff sued the German company in Ontario and also added as defendants the individual owners of the company along with a new Canadian company that had been set up to take over the sales in Canada and the U.S.  The agreement had a provision that said that the parties agreed that German law governed the relationship and that they would “settle any disputes by a binding arbitration … in Frankfurt.”  Because of this, the German company argued that the Ontario lawsuit should be stayed and that the matter should go back to Germany for determination there.  The motions judge agreed and then the majority of the Court of Appeal agreed.

The commentary that I read took issue with this decision and used it as an attack on arbitrations generally and cautioned readers to consider whether it just might be better off to not have arbitration clauses in the first place.  In doing so, several old chestnuts were thrown out to attack arbitrations.

The first attack was to say that this case showed that, even though there was a belief that there would be only arbitration (and, presumably, that this would reduce legal costs overall), the fact that it gave rise to a fight in the courts, in fact, greatly increased the ultimate costs because there would have to be the arbitration AND the costs of the court fight.  I do not doubt that that was (or will be), in fact, the situation at the end of the day.  But let’s consider two factors.  First, suppose that there was no arbitration requirement and that the clause only said “settle any disputes … in Frankfurt”.  Now we’re only talking about a choice between litigation in the Canadian courts and litigation in the German courts.  You can be guaranteed that the plaintiff would have done the exact same thing – sued in Ontario.  This doesn’t surprise me.  Why?  Because it’s a heck of a lot cheaper for someone in Ontario to sue in Ontario than to sue in Germany.  So the plaintiff would have sued in Ontario and the exact same motion would have been brought and the exact same result would have occurred – the court would have said that they agreed to settle their disputes in Germany, so off to the German courts they go.  And in that situation, whatever the cost of litigation would have been in Germany, it would be increased by the cost of the motion and the appeal in Ontario.  Therefore, whether it is litigation or arbitration, the result (and the increased costs) would have been the same.  So that complaint with respect to arbitration goes by the wayside.

The second factor, already alluded to, is that the plaintiff had the choice of dealing with the matter either in Canada or in Germany.  If the plaintiff had sued in Germany, then the plaintiff would have saved the costs of the fight over where to have the dispute resolved.  Beyond this, if the lawsuit had continued in Ontario, then each side would have had to hire German lawyers to give expert evidence as to what was the law of Germany that governed the dispute.  If the dispute was fought out in Germany, they wouldn’t have to pay for that cost because the German lawyers / judges / arbitrators would have known the law.  In addition, suppose that the plaintiff sued in Canada and won a judgment.  The plaintiff would then have a judgment against a Canadian company (which, presumably, could be wound up pretty quickly with little in terms of assets) and the result is that the plaintiff would have to go to Germany to enforce its judgment against the German parent company and the two German citizens.  I don’t know what the law in Germany is like for recognition of foreign judgments.  If it is like Canada, then an application has to be brought and the application could be fought and there can be an appeal.  Sounds like the same costs of the motion and appeal in this case.  If it is like the U.S., then the plaintiff could end up having to re-litigate the whole case again before the German courts.  In these circumstances (at least based on what has been set out in the case), I would have been inclined to tell the client to just sue everybody in Germany because it would be easier to enforce the judgment.  So, the position that arbitration isn’t cheaper and, in fact, could be more expensive isn’t supported by other factors that would have existed even if it were simply litigation and not arbitration.

The authors also question the result of the decision because the result was that the plaintiff was not able to proceed with its claim in Ontario against the Canadian subsidiary and the two German owners because any arbitration in Germany would have only been between the plaintiff and the German parent company.  As noted by the majority of the Court of Appeal, there was nothing to stop the German owners and the Canadian subsidiary from agreeing to be parties to the German arbitration.  (This is possible, but the only reasons I can quickly think of why they would want to do so would be to ensure that there were not inconsistent findings by different triers of fact – be it judges or arbitrators – and to keep the dispute confidential.)  Moreover, once the arbitration was done, the plaintiff could start again its lawsuit in Canada against the subsidiary and the German owners – if they didn’t settle based on the arbitral decision.  The authors suggest that somehow this taints arbitration because it could force either non-parties into the arbitration or else it creates a multiplicity of proceedings (separate arbitrations and lawsuits).  There are three responses.  The first response is that of the majority when they found that it was “very doubtful” that there was merit to the claims against the two German owners.  If that is the case, then the Court of Appeal did the plaintiff a favour by saving it from having to fight what was likely a losing case against the individual owners.  The second response is that the non-parties were not forced to join the arbitration, but if they did not, then they had to wait around (with interest on damages potentially increasing at a significant amount per year) to see what happens in the arbitration – but nobody was being forced to join the arbitration.  The third response is that all of this presumes that a different result would have been reached if there had been no arbitration.  Again, suppose that the clause only said “settle disputes … in Frankfurt”.  You can pretty much be guaranteed that if the court was sending the main lawsuit between the plaintiff and the German parent company back to Germany, it would have sent the claims against the two owners and the Canadian subsidiary over there as well.  Why?  Because of the concept of “forum non conveniens” – which means that the courts will send cases to where it is the most convenient for the parties.  It would make little sense to have one lawsuit in Germany and the second lawsuit – involving German nationals on basically the same facts – being tried in Canada.  That would be a bigger cost and waste to the parties (and to at least one court system) than to deal with everything in one country or the other.  So if this matter was dealt with as litigation instead of arbitration, the result would not necessarily have been any different – and thus it is not a valid reason to challenge the arbitration system.

The authors of the commentary then abandon discussion of the case and go on to complain that another problem with arbitration is that you can be stuck with 3 arbitrators.  While this may seem like a good idea at the beginning when there is a lot of money at stake, if the contract ends up being not worth a lot of money by the time that a dispute arises, then the parties are “stuck” having to pay for 3 arbitrators and the amount at stake doesn’t justify the cost.  That’s a fair comment.  It doesn’t mean, however, that it’s something that justifies doing away with arbitration clauses completely.  However the arbitration is commenced, there will eventually be some document that sets out what amount the plaintiff is seeking.  Some rules call it a Statement of Claim, some are called Terms of Reference, etc.  There is nothing to stop the parties from saying that any claims under $X shall be determined by one arbitrator and any claims over $X shall be determined by three arbitrators.  This alleviates the concern of the authors of the commentary.  Arbitration clauses shouldn’t be avoided.  However, companies (and their lawyers) should ensure that they give more thought to arbitration clauses than to simply stick in clauses like the following:  ”All disputes arising hereunder shall be resolved by arbitration pursuant to the Arbitrations Act, 1991.”  Being surprised that this doesn’t do the trick for you is like being surprised when somebody says “oh, you’re bleeding from both nostrils, both ears and both tear-ducts in your eyes, go see Billy Smith, the first year medical student, he ought to be able to patch you up” and that doesn’t do the trick for you.  If someone gets lazy with arbitration clauses and treats them as an after-thought in commercial agreements, don’t blame the entire system of arbitration that it cannot make a solution that works, just like the fact that Billy Smith not being able to fix your brain haemorrhage means that the entire medical system is faulty.

The ultimate suggestion of the authors of the commentary, as I have alluded, is therefore to simply scrap arbitration clauses.  Their view is that good litigation counsel can agree to an arbitration later on when the dispute arises.  That’s a lovely thought and I completely endorse it.  Now, back to reality.  Whether it is litigation or arbitration the result is the same: someone is going to win and someone is going to lose OR each side is going to win some issues and lose other issues.  If you have a party with a good lawyer who can tell it what are its chances of success – and if the lawyer says that the chances of success are not great – then no client will ever agree to an arbitration.  I had a case that was going to go to trial settle shortly before trial.  This was a case I never thought in a million years would have settled because the plaintiff and the other defendants (my client was a very minor player) were completely entrenched in their positions and the plaintiff wanted a ton of money and the other defendants were willing to put up something but nowhere near what the plaintiff wanted.  Suddenly, the plaintiff decided to settle.  Why?  We all learned out later on that it was because the main witness for the plaintiff had died.

While not guaranteed, as a general rule, litigation takes longer than arbitration to get the dispute determined.  If you are the defendant and you are likely to have to pay something to the plaintiff, do you want to pay that this year – and take the hit on this year’s profit and loss – or put it off to another year?  Moreover, there’s always the chance that a key witness might die / move / become ill / etc. and that affects the plaintiff’s case.  Litigation gives more than enough time for this to occur – certainly far more time than arbitration does.  In the U.S., the parties generally absorb their own costs regardless of the result of the dispute.  In Canada, the loser pays a portion of the winner’s legal costs.  In arbitration, the general rule is that the loser pays all or almost all of the winner’s costs.  So there’s a costs incentive towards litigation.  If you have parties in different countries, arbitral awards are relatively easy to enforce – while court judgments, as mentioned above, can be very problematic to enforce.

With these realities, how many defendants are going to want to go with arbitration over litigation?  Some, certainly, who might want confidentiality over their dispute.  But even that is not a guarantee.  I was at a conference a year or two ago and the head of the dispute department in the U.S. for either IBM or Kodak was speaking and she said that their view is that they absolutely never agree to arbitration and they only ever want to be before the courts.  That was just their policy.  If that’s the case, then it doesn’t matter how good, bad or otherwise counsel are, there will be no arbitration occurring once the dispute has arisen.

The authors suggest that arbitration clauses be scrapped.  I disagree.  They do go on, in a final sentence, to suggest that, at a minimum, one should consider more closely arbitration clauses.  With that I fully agree.  The more that an arbitration clause is not considered an “add-on” or a “throw away” clause and real consideration is given to what is to happen, the better the chances that the arbitration experience will not only be productive, but, in fact, more productive than litigation.

Something to think about.




Nowadays Assume an Arbitration will Proceed / Appointing Arbitrators

Tuesday, November 8th, 2016

I read today an interesting decision from the Ontario Court of Appeal a couple of weeks ago in Haas v. Gunasekaram.  Mr. Haas invested $200,000 in an Italian restaurant in Toronto that failed.  He then sued his co-owners for fraudulent misrepresentation saying that he was, in essence, duped into making his investment.  All of the co-owners were parties to a shareholders’ agreement and the other owners brought a motion to have the lawsuit stayed since there was an arbitration clause and they said that the dispute should go to arbitration.  The motions judge denied the motion and this was appealed to the Court of Appeal.  The Court of Appeal allowed the appeal and ruled that the dispute should go to arbitration.

In paragraphs 9 through 16, Justice Lauwers reiterates what has become fairly straightforward law nowadays that if there is an arbitration clause, the starting point is almost always to send it to arbitration and let the arbitrator(s) decide his/her/their jurisdiction (ie. ability) to decide the dispute.  Mr. Haas argued that only disputes related to the terms of the contract could be the subject of arbitration and that he was suing on the representations made to him that resulted in the shareholders’ agreement being created in the first place – so his dispute wasn’t covered by the arbitration clause.  The Court of Appeal disagreed and noted that the arbitration clause was broadly worded and, more importantly, did not exclude the type of claims that Mr. Haas was making.  As such, the dispute should go to the arbitrator(s) to let him/her/them decide if the dispute was within the arbitration clause.  The result isn’t particularly surprising since this does not really make any new law.

What is interesting, though, is the length to which the Court of Appeal was willing to give preference to arbitrations.  The arbitration procedure had a typical clause that provided that if the parties agreed on an arbitrator, then there would be one arbitrator.  However, if they didn’t agree, then the wording provided that “each party” would appoint their own arbitrator and then either those two arbitrators would appoint a third arbitrator or else (if they couldn’t agree) the Superior Court would appoint the third arbitrator.  Mr. Haas said that this was flawed since there were 4 parties.  As noted by Justice Lauwers at paragraph 49:

[49]        I agree with Mr. Haas that the arbitration agreement was designed for a bilateral agreement, not for an agreement with multiple partners, as this case presents, but that is not fatal. Mr. Haas argues: “If the clause is effective, Haas would immediately be outnumbered by arbitrators appointed by Gunam and Feng, stacking the arbitral panel against him.” There is a simple answer: if the parties cannot agree on a single arbitrator, then each side to the dispute will appoint an arbitrator to select a third arbitrator. If these arbitrators do not appoint a third arbitrator, then under the agreement a Superior Court judge will appoint one. There is nothing inoperable about the arbitration agreement.

For this particular case, and for this particular moment in time, the decision is fine.  As it stood on October 13, 2016 (when the decision was released), we have Mr. Haas on one side and the other three shareholders / owners on the other side.  No problem.  But what happens if two, or all three, of the other shareholders / owners start to fight among themselves.  Now we no longer have only two “sides” but could have either three or four sides.

So how does one deal with such a situation.  Mr. Haas’ concern was that he could be “ganged up on” if there are 3 arbitrators for the others and only 1 for himself.  A few things should be considered (and businesses and their lawyers should think about this when drafting their arbitration clauses):

1. Subsection 10(4) of the Arbitration Act, 1991 provides that if there is 3 or more arbitrators then they must elect a chair from among themselves.  Why?  Because if there is no unanimous or majority decision on an issue, then the chair has the tie-breaking decision.  So some further thought should be given to determining how a chair is to be selected in case the arbitrators cannot agree among themselves.  While subsection 10(4) indicates who is to make the decision on a chair, it does not go further to indicate what is to happen if they cannot agree.  Presumably, though, an application could be made to the Superior Court for the determination (or appointment) of a chair for the arbitral tribunal.  But it is often preferable to establish a procedure for making this determination rather than leaving it to a judge of the Superior Court who will impose (or at least that is how the “losing party” will feel) a chair.  Specifically giving powers to the chair of the tribunal may alleviate a “ganging up” situation.  For example, you can provide that the binding decision will be that of the chair and at least one other arbitrator – which could minimize or negate a concern similar to that of Mr. Haas in this case.

2. Subsection 11(1) of the Arbitration Act, 1991 provides that every arbitrator must be impartial and independent of the parties.  This helps to alleviate Mr. Haas’ concern that he would be ganged up on because the arbitrators should be impartial.  That’s all nice and wonderful in theory but, sometimes in practice, it’s a bit of a pie in the sky view.  If an arbitrator is consistently appointed by a particular party or law firm, there can be an implicit assumption that that arbitrator should try to find in favour of the party that appointed him/her in order to ensure future work from that party or law firm.  A way to minimize this is to ensure that there be certain standards imposed for arbitrators.  For example, saying that any arbitrator appointed by any party must be a member of the Chartered Institute of Arbitrators.  Why?  Because they have a code of ethics that requires strict impartiality.  To give an example, I worked hard (and spent a good deal of money) to get my Fellow status with the Chartered Institute (known as being an FCIArb).  Yes, it would be nice to get hired as an arbitrator and be paid for that arbitration.  But it wouldn’t be worth the risk of losing my FCIArb status if a complaint was made and found to be valid that I was not completely impartial.  In addition, if there truly is an issue of bias, then that is one of the bases on which an arbitrator can be challenged or on which any arbitral award can be challenged or not enforced.

3. There can be an agreement up front about picking one or three arbitrators and setting out a specific list.  For example, I had a settlement years ago where the lawsuit was being settled right away and the lawsuit would not go to trial.  However, there were valuation issues that would continue for at least another year or two and, while about 80% of the lawsuit could be finalized right then and there, the other 20% would require additional time and there could be further disputes about how to deal with that remaining 20%.  The parties decided that they would settle the lawsuit and deal immediately with the 80%.  In the event that any disputes arose for the 20%, those disputes would be handled by arbitration.  But the settlement went further and actually provided that it would be only one arbitrator and provided a list of 5 or 6 arbitrators, in order of preference, to be appointed – but the same could have occurred for a panel of 3 arbitrators with a slightly longer list of potential candidates.  If none of those arbitrators were available or willing to hear the dispute, then the first fallback was for the parties to agree on someone else or, failing that, to get someone appointed by an institution from its roster (I believe it was the ICC).  Agreeing to arbitrators before-hand (even if setting a list), can avoid the concern of impartiality since everyone should have agreed before any dispute even arises and therefore cannot feel that the arbitrator(s) is/are chosen with a bias in favour of whomever has appointed them.

Something to think about.