November 15, 2022

By Brian Babcock

THE ISSUE

Courts do not generally have jurisdiction to decide upon matters of business judgment. This is referred to as non-justiciability.

Because an arbitration clause creates “private law” between the parties, a clear and specific clause awarding jurisdiction to an arbitrator over matters of business judgment may be enforceable. That, however, was not the result in a recent Superior Court of Ontario case which suggests not only that more precise drafting is required, but also that the modern trend of courts deferring to arbitrators still will sometimes hit a speed bump.

This “business judgment rule” was explained by the Ontario Court of Appeal as far back as 1991 in a case called Brant Investments Ltd. v. KeepRite Inc which stated that “it would generally be impossible” for a trial judge to substitute his or her own business judgment for that of managers, directors, or a committee charged with making a business decision because: “it is unlikely that he will have the background knowledge and expertise of the individuals involved; he could have little or no knowledge of the background and skills of the persons who would be carrying out any proposed plan; and it is unlikely that he would have any knowledge of the specialized market in which the corporation operated. In short, he does not know enough to make the business decision required.”

THE CASE

In 1107051 Ontario Ltd. v. GG Kingspa Enterprises Limited Partnership, two sophisticated business organisations entered into a detailed co-tenancy agreement to jointly develop a commercial, condominium, and hotel complex in downtown Toronto. The agreement contained an arbitration clause which referred any dispute under the agreement to arbitration.

In time it came to pass that the parties could not agree as to whether it was practical to continue with the plan to construct a hotel as part of the development. They were deadlocked. One of the parties therefore invoked the arbitration clause. The arbitrator ruled that he had jurisdiction.

In the agreement in question, the parties had not given the arbitrator the power to break a deadlock within the management committee relating to a business decision and, in fact, had expressly agreed that the management committee had exclusive authority over matters of business judgment. Because business judgment is largely subjective, there are no criteria by which an arbitrator could determine the issue – it is a question of differing opinions as to business strategy, rather than a matter of law. The agreement had specifically set up the structure of the management committee in a manner that had potential for deadlock.

The losing party then appealed to the Superior Court. The judge hearing the appeal agreed that although parties to a commercial agreement may agree to arbitrate not non-justiciable disputes, they must do so by clear and specific language in their agreement.

This decision is based upon a 1959 Court of Appeal decision which was upheld by the Supreme Court of Canada as well as a 2014 Ontario Court of Appeal decision that resolve that a non-justiciable matter cannot be resolved in court because the matter lacks a sufficient legal component to engage the decision-making capacity of the courts – that is, there is no legal standard for a judge (or an arbitrator) to apply to the facts. For a dispute to be justiciable, there must be a legal component such as a claim for breach of the agreement or other recognized cause of action. Non-legal business matters do not fit within that requirement.

Allowing a business decision to go to arbitration, or to the courts, would cast the arbitrator or a judge in the role of project manager – a role for which they are not well suited in most cases. The judge also points out that the broader interpretation of the arbitration clause would mean that decisions as small as the finishes in a kitchen could be sent to arbitration and that this was not a reasonable interpretation of the arbitration clause.

The deadlock is exactly what the parties bargained for. If they cannot resolve the deadlock in themselves, then they do have other mechanisms under the agreement, namely either selling the entire project, or one party buying the other’s interest.

What might be controversial is that the judge hearing the application decides that there is no commercial absurdity in this because “it is entirely reasonable for the parties to attempt to resolve the deadlock and a compromise may be required to resolve the deadlock. This is exactly what the parties bargained for…”. Nothing in the agreement provides for arbitration of a dispute involving the overall configuration of the project. The judge was of the view that had the parties intended such business disputes to be decided by an arbitrator, they would have identified an arbitrator with a background in the development industry specifically.

Given recent opinions of the Court of Appeal about commercial absurdity, this might be a question that could turn out differently on appeal. The Court of Appeal might simply agree that no absurdity results because it is a question of fact and is not appealable.

TAKEAWAYS

  • Co-venture agreements are contracts and the courts continue to recognize the principle of freedom to contract.
  • Judges are reluctant to play in the sandbox of business judgment.
  • This decision illustrates the key importance of careful drafting of arbitration clauses in agreements.
  • If you want an arbitrator to settle deadlock between co-venturers, specifically provide that power or jurisdiction to an arbitrator.
  • If so, you want to make sure that you designate an arbitrator with trusted business judgment.
  • The fact that it may be difficult for the parties to agree on an arbitrator whose judgment everybody trusts to resolve business matters illustrates further the difficulty with such an arrangement.
  • If you’re agreement does not grant an arbitrator the power to exercise business judgment in the case of deadlock, your agreement must include other mechanisms to break a deadlock.
  • Conventionally in shareholder agreements, this is done through a buy/sell provision.
  • That is not necessarily the only mechanism and there are a variety of ways that a buy/sell provision can be constructed to reflect the intention of the parties.

WHAT WEILERS LAW CAN DO FOR YOU

The corporate commercial lawyers at Weilers Law are skilled drafters of agreements. However, the agreement is only as good as the input and direction that you give to us. For that reason, we have a proud tradition of developing close relationships with our clients that ensures a progressive approach to drafting.

If you do end up in a business dispute, the litigation and alternative dispute resolution lawyers at Weilers Law are conscious of issues of jurisdiction and will provide you with guidance, assistance, and representation in attempting to resolve your disputes in a cost effective and sound manner.

If you are entering into a business agreement, or want to get out of one, Weilers Law may be the right lawyers for you.