B.C. – no arbitral error where arbitrator seeks assistance on legal principles raised in, but beyond, parties’ authorities – #183

In MSI Methylation Sciences, Inc. v. Quark Ventures Inc., 2019 BCSC 440, Madam Justice Elaine J. Adair dismissed claims that the arbitrator had committed arbitral error due to breach of natural justice by allegedly (i) deciding the dispute on authorities not submitted by either party and (ii) adopting his own theory of damages not advanced by either party.  Adair J. held that the legal principles were not obscure legal points raised for the first time, created by the arbitrator or divorced from the cases and argument submitted by the parties.  Adair J. also held that the arbitrator did not commit arbitral error by not referring to each of a party’s submissions or seeking assistance beyond authorities submitted.

MSI Methylation Sciences, Inc. (“MSI”), a clinical-stage pharmaceutical company, and Quark Venture Inc. (“Quark”), an investor in life sciences and clean and advanced technology, signed a September 2016 agreement (“Investment Agreement”) in which:

(a) MSI agreed to issue treasury shares giving Quark a majority interest in MSI;

(b) Quark agreed to provide US$30 million in funds to MSI in four “tranches” : approx. US$1 million (“First Tranche”), US$4 million (“Second Tranche”), US$11 million (“Third Tranche”) and US$14 million (“Fourth Tranche”); and,

(c) MSI agreed to use the funds in accordance with a specified budget to complete a clinical study for a proprietary formulation “MSI-195”.

Quark provided the First Tranche on September 30, 2016 but, in late November 2016, Quark advised that there would be no further investment and none were made.

MSI commenced arbitration on March 16, 2017, alleging Quark’s breach of the Investment Agreement by its failure to prove Second Tranche and claiming damages of US$29 million.  It sought an order for specific performance and, subsequently, in lieu of specific performance or alternatively, common law damages for breach of contract.

MSI and Quark agreed on the appointment of the arbitrator, one “selected as a person who was familiar with contract law, venture capital, private equity and private placement in the field of Life Sciences”.  During the arbitration, the arbitrator held several procedural meetings with counsel for MSI and Quark.

The merits hearing took place April 2-7 and 9-11, 2018.  Evidence in chief was adduced by affidavit and witness statements and cross-examinations were provided.  Closing submissions took place over two (2) days.  MSI did not provide a written argument but did provide a written outline of MSI’s submissions.  Quark provided a written closing submission.

A key issue later arose on the nature of the arguments made to the arbitrator, including a disagreement over the scope and source of some of the arguments contained in the arbitrator’s resulting June 21, 2018 award (“Award”).  At paras 16-19, Adair J. summarizes the arguments made MSI and Quark regarding specific performance and damages.  Before closing its submissions, MSI withdrew its claim for damages in lieu of specific performance and, instead, proceeded with damages for breach of contract and for lost opportunity.

At paras. 20-31, Adair J. outlines key sections of the arbitrator’s Award and excerpts a series of paragraphs which set out the arbitrator’s reasoning in support of the remedy he issued.  In the Award, the arbitrator ordered Quark to pay MSI US$20 million.

Following submissions on currency and the application of B.C.’s Foreign Money Claims Act, RSBC 1996, c 155, the arbitrator issued a second award, on September 12, 2018, dealing with those issues plus interest and costs.  He ordered Quark to pay MSI US$80,066.67.

Quark applied to set aside the Award under section 30(1)(a) of B.C.’s Arbitration Act, RSBC 1996, c 55 on the basis that the arbitrator committed arbitral error and, in the alternative, for leave to appeal on questions of law under section 31.  MSI applied under section 29 of the Arbitration Act for enforcement of the Award.

The Arbitration Act at section 1 defines “arbitral error” as meaning:

an error that is made by an arbitrator in the course of an arbitration and that consists of one or more of the following:

(a) corrupt or fraudulent conduct;

(b) bias;

(c) exceeding the arbitrator’s powers;

(d) failure to observe the rules of natural justice”.

Quark relied on the last category (d), namely an alleged failure to observe the rules of natural justice. It claimed that the arbitrator failed to observe the rules of natural justice and thereby committed arbitral error by basing his conclusions “on an approach to damages that was not advanced by the parties and on which the parties were not given an opportunity to make submissions”.

Quark claimed that the arbitrator had adopted “his own theory of damages”, assessed damages on a basis which Quark argued neither MSI nor Quark had taken as a position, and drew conclusions “without seeking any submissions from the parties on these issues”.

Quark argued further that the arbitrator’s approach had parallels to Hawkeye Power Corporation v. Sigma Engineering Ltd., 2012 BCCA 414, a court trial decision in which a new trial was ordered on the basis that the judge had decided the dispute on an interpretation of the contract that was neither argued nor put to the parties.

[38] Quark says that, of the cases relied on by the Arbitrator with respect to damages assessment, only one was cited by either party, and at no time did the Arbitrator seek submissions from the parties on the cases he relied on.  Quark says that the Arbitrator was under a duty (consistent with the requirements of natural justice) to determine the Arbitration on the basis of the cases which had been advanced by each party, and of which each party had notice.  Quark says further that the parties are entitled to assume that the Arbitrator will base the Award solely on the evidence and argument presented by them prior to the making of the Award.

Quark also argued that the arbitrator “ignored the evidence before him” regarding the Third Tranche not closing and was “obligated to deal with these essential issues raised by Quark in relation to MSI’s claim for damages, and a failure to do so amounts to a failure to observe the rules of natural justice and, therefore, arbitral error”.

The errors, Quark submitted, “go the heart of the Award, forming a critical component of the Arbitrator’s assessment of damages” which it argued was “made in a vacuum and evidence”.

MSI responded, arguing that Quark’s claim of arbitral error was “if anything, simply another means by which Quark seeks to express its unhappiness with the substantive outcomes reflected in the Award”, objecting to Quark’s use of section 30.

[44] MSI says that, on the record, it is clear that the Arbitrator, throughout his involvement, was sensitive to procedural fairness issues.  During closing submissions, the Arbitrator frequently asked questions and engaged in discussion with counsel.  MSI says that the Arbitrator and counsel for the parties had several exchanges during closing submissions regarding the method by which damages would be calculated (or assessed).

MSI argued that Quark was attempting “to revive opportunities to argue about damages that it declined to use fully during the hearing” and that, in fact, the assessment of damages on the basis of loss of opportunity was argued before the arbitrator.  It relied on the terms of natural justice as set out 0927613 B.C. Ltd. v. 0941187 B.C. Ltd., 2015 BCCA 457 in paras 59-60.

(1) Arbitral error based on breach of natural justice – Adair J. dealt first with Quark’s argument that the Award should be set aside due to arbitral error stemming from breach of natural justice.

Adair J. disagreed with Quark’s characterization of the arbitrator’s handling of natural justice and found no arbitral error.

Adair J. held that the record provided to her demonstrated that (a) MSI’s submissions on damages included compensation for loss of opportunity to receive the Third Tranche and Fourth Tranche and (b) Quark’s authorities addressed loss of opportunity and it spoke to that issued during its closing submissions.

That Quark chose not to develop the point more fully in closing submissions, and (for example) make submissions addressing more explicitly an appropriate contingency deduction in the context of loss of opportunity, does not create a breach of natural justice and arbitral error.

Adair J. also considered the specific point made by Quark that the arbitrator committed arbitral error by relying on Pacific Destination Properties Inc. v. Granville West Capital Corporation, 1999 BCCA 115, a case that neither Quark nor MSI had cited to the arbitrator and in regard to neither had had an opportunity to make submissions.

Referring to ICBC v. Patko, 2008 BCCA 65 para. 37, Adair J. held that “it is not an error or a breach of natural justice for an arbitrator (or a judge) to rely on case authorities not cited by counsel”.  In that case, at that paragraph, the B.C. Court of Appeal cited Pacific Wash-A-Matic Ltd. v. R.O. Booth Holdings Ltd., 1979 CanLII 632 (BC CA).  In that earlier B.C. Court of Appeal case, the Court reversed a trial decision which had introduced a new issue, not submitted by either counsel, and for which neither party had adduced evidence.  The Court had the following to state, relying on a prior Saskatchewan Court of Appeal decision in Assie v. Saskatchewan Telecommunications, 1978 CanLII 1811 (SK CA):

[20] A third ground of appeal was advanced on behalf of the appellant. As I have indicated, at trial the respondent relied upon a plea of assignment, and in argument raised the question as to whether or not the appellant was estopped from denying that it was bound by the agreement between the respondent and Mila Park Estates Ltd.

[21] The learned trial Judge did not accede to those submissions. No submissions were made to her on the question of novation, nor on the question of lease. She reserved judgment and, ultimately, without indicating to counsel the basis on which she proposed to dispose of the claim, handed down reasons for judgment.

[22]  Counsel for the appellant submits that, as a result of that course, the appellant was prejudiced. He referred to a decision of the Saskatchewan Court of Appeal in Assie v. Saskatchewan Telecommunications, reported in (1978), 1978 CanLII 1811 (SK CA), 90 D.L.R. (3d) 410, [1978] 6 W.W.R. 69, 7 C.P.C. 299. At pp. 413-14 D.L.R., p. 73 W.W.R., Mr. Justice Brownridge, in delivering the judgment of the Court, stated:

In my respectful opinion, it would have been preferable in this case for the learned trial Judge to have called in counsel for both parties to inform them of what he was contemplating doing and giving them an opportunity to make submissions, On the facts of this case, it is difficult to escape the feeling that the defendant suffered some prejudice when judgment was founded upon a basis which was not pleaded, on which no opportunity to adduce evidence was afforded and on which no argument of counsel was heard.

[23] I subscribe to what Mr. Justice Brownridge said on that occasion. Here, counsel for the appellant contends that, had he known that the trial Judge was going to found her judgment on novation or lease, particularly on novation, he might well have considered calling other evidence and certainly would have welcomed the opportunity to make submissions on those subjects.

Adair J. distinguished between deciding a case on an issue not argued and allowing for a decision-maker experienced in the matter to “seek assistance beyond the authorities counsel provides”. 

In my view, the same principle applies to the Arbitrator, who was selected (in part) because of his expertise in contract law.

Adair J. also held that principles relied on by the arbitrator were not “obscure legal points that were raised only for the first time in the Award or that the parties (specifically Quark) had no opportunity to address.  Rather, they were well established.”  She also determined that the principles “fell within the law as stated in the authorities that the parties had squarely put before the Arbitrator”, referring to certain authorities submitted by MSI and Quark.

In regard to Quark’s other ground, namely the arbitrator’s alleged failure to address all of Quark’s submissions, Adair J. considered and dismissed this ground at para. 57.

[57] I would also not give effect to Quark’s argument that the Arbitrator committed arbitral error by not expressly addressing all of Quark’s submissions on damages in the Award.  Like a trial judge, while an arbitrator must give comprehensible reasons for the arbitrator’s decision, the arbitrator is not required to refer to all the arguments, provisions or jurisprudence or to make specific findings on each constituent element, for the decision to be reasonable:  see [Sattva Capital Corp. v. Creston Moly Corp., [2014] 2 SCR 633, 2014 SCC 53], at para. 75.  In my view, the Arbitrator met the standard that applies.

That reference to Sattva Capital Corp. v. Creston Moly Corp. is to the following statement.   Note that the Supreme Court states that the assessment is done in light of the applicable standard of review which could be correctness or reasonableness.  The leeway granted on the leave to appeal might vary if the standard is correctness:

[75] Assessing whether the issue raised by an application for leave to appeal has arguable merit must be done in light of the standard of review on which the merits of the appeal will be judged. This requires a preliminary assessment of the applicable standard of review. As I will later explain, reasonableness will almost always apply to commercial arbitrations conducted pursuant to the AA, except in the rare circumstances where the question is one that would attract a correctness standard, such as a constitutional question or a question of law of central importance to the legal system as a whole and outside the adjudicator’s expertise. Therefore, the leave inquiry will ordinarily ask whether there is any arguable merit to the position that the arbitrator’s decision on the question at issue is unreasonable, keeping in mind that the decision-maker is not required to refer to all the arguments, provisions or jurisprudence or to make specific findings on each constituent element, for the decision to be reasonable (Newfoundland and Labrador Nurses’ Union v. Newfoundland and Labrador (Treasury Board), 2011 SCC 62 (CanLII), [2011] 3 S.C.R. 708, at para. 16). Of course, the leave court’s assessment of the standard of review is only preliminary and does not bind the court which considers the merits of the appeal. As such, this should not be taken as an invitation to engage in extensive arguments or analysis about the standard of review at the leave stage.

The reference to Newfoundland and Labrador Nurses’ Union v. Newfoundland and Labrador (Treasury Board) provides the following statement on the contents of reasons:

[16] Reasons may not include all the arguments, statutory provisions, jurisprudence or other details the reviewing judge would have preferred, but that does not impugn the validity of either the reasons or the result under a reasonableness analysis.  A decision-maker is not required to make an explicit finding on each constituent element, however subordinate, leading to its final conclusion (Service Employees’ International Union, Local No. 333 v. Nipawin District Staff Nurses Assn., 1973 CanLII 191 (SCC), [1975] 1 S.C.R. 382, at p. 391).  In other words, if the reasons allow the reviewing court to understand why the tribunal made its decision and permit it to determine whether the conclusion is within the range of acceptable outcomes, the Dunsmuir criteria are met.

(2) Leave to appeal on questions of law – Quark argued that, under section 31 of the Arbitration Act, the court could grant leave on three (3) separate questions which it characterized as questions of law.

At para. 62, Adair J. was careful not to pre-empt a proper examination by a court on the merits of an appeal and stated that the leave to appeal stage required a lighter hand.

At the leave stage, it is not appropriate to consider the full merits of a case and make a final determination regarding whether an error of law was made.  However, some preliminary consideration of the question of law is necessary to determine whether the appeal has the potential to succeed and thus to change the result in the case.  The appropriate threshold for assessing the legal question at issue under s. 31(2) is whether it has arguable merit or a reasonable prospect of success.  Assessing whether the issue raised by an application for leave to appeal has arguable merit must be done in light of the standard of review on which the merits of the appeal will be judged.  This requires a preliminary assessment of the applicable standard of review.  Except in rare cases (none of which apply here), reasonableness will almost always apply to commercial arbitrations conducted pursuant to the Arbitration Act.

Referring to Teal Cedar Products Ltd. v. British Columbia, [2017] 1 SCR 688, 2017 SCC 32, paras 43-47, Adair J. reiterated the distinction between the three (3) principal types of questions, namely legal (questions “about what the correct legal test is”), factual (questions “about what actually took place between the parties”) or mixed fact and law (questions about “whether the facts satisfy the legal tests”).

At para. 65, Adair J. identified the three (3) questions raised by Quark and dealt with them in turn:  

question 1 – paras 69-72

[72] In my view, Quark’s first proposed question does not state a question of law.  It is, at best, a question of mixed fact and law concerning how the Arbitrator, who was clearly aware of the correct legal test, as well as the nature and object of the Investment Agreement, carried out the assessment of contract damages based on the facts.

question 2 – paras 73-78

[77] In my view, this question is, again, not a question of law, but is (at best) a question of mixed fact and law concerning how the Arbitrator assessed damages.  In addition, it misinterprets how the Arbitrator assessed damages, and is not a question that arises out of the Award.

question 3 – paras 79-81

[81] I agree with MSI.  Quark’s third proposed question does not identify a question of law.  Rather, it seeks to challenge a finding of fact made by the Arbitrator.  The Arbitrator identified the correct legal test.  He did not “decline” to take the shares into account.  Rather, he found as a fact that the shares had no value.

(3) Enforcement of the Award – Adair J. then turned to MSI’s application under section 29 for enforcement of the Award.  She noted that “an award is not entitled to automatic enforcement” and the court may refuse or adjourn the application if the award is not “perfected”.  See Bekar v. TD Evergreen, 2006 BCCA 266, para. 38, The Owners, Strata Plan BCS 3165 v. KBK No. 11 Ventures Ltd., 2014 BCSC 2276, para. 96 and Hassall v. Children’s & Women’s Health Centre, 2001 BCSC 1399, para. 1.

Finding that no grounds had been established on which to refuse enforcement of either the Award or the subsequent award dealing with currency, interest and costs, Adair J. enforced the both as an order of the court.

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