Canadian courts will generally over-rule a decision of a domestic arbitral tribunal only if the decision is “unreasonable.”  What does this word mean? Is the standard of “unreasonableness” different in a commercial arbitration than, say, in a labour or employment arbitration?  If the arbitral award is found to fall within the bounds of reasonableness by the judge who hears the motion to over-rule it, how can an appellate court then say that the decision is “unreasonable”?

These questions are raised by the recent decision of the Newfoundland and Labrador Court of Appeal in St. John’s (City) v. Newfoundland Power Inc.  The Court of Appeal allowed an appeal and set aside the decision of the arbitral tribunal under a long term power lease, even though the judge who first heard the motion to set aside the arbitral decision upheld the decision as reasonable.  When one judge had found that the arbitral decision was reasonable, how did the Court of Appeal arrive at the decision that it was unreasonable?

Background

The arbitration arose under a long term lease between the City of St. John’s and Newfoundland Power. The lease was for the use of the Mobile River.  Clause 1 of the lease permitted the City to terminate the lease upon:

“payment to the Company of the value of all works and erections constructed or provided by the Company within and without the Mobile River watershed subsequent to the date of this Lease for the primary purpose of developing the waters of Mobile provided such works and erections are in use by the Company for that primary purpose at the time notice of termination of the Lease is given by the Council and also at the time of termination of the said Lease…” (emphasis added)

The meaning of the underlined words was the source of the contention. Newfoundland Power said that they meant that, on termination of the lease, the City was required to pay for the on-going value of its operating business in the Mobile River watershed as the time of the termination, including the value that it derived from the use of the river which it leased from the City.  The City said that, on termination of the lease, it was only required to pay for the physical works and erections which Newfoundland Power had constructed and nothing more.

The lease had been previously amended to delete the words “aggregate cost of works and erections … less depreciation” and replace them with the words “value of all works and erections … in use.”

The Arbitral Decision

The majority of the arbitral tribunal decided in favour of Newfoundland Power and held that the City was obliged to pay the full amount of the value of Newfoundland Power’s business in the Mobile River watershed.

The majority held that this interpretation followed from the concluding words of clause 1 of the Lease. Those words contained a proviso which referred to another right of the City under section 29 of the governing statute (the St. John’s Street Railway Act), namely, the right to purchase the assets and business of Newfoundland Power.  Under that right, the City was obliged to pay for the “value of the said undertaking, plant, property, assets and rights of the Company.”

The majority held that the reason for the reference to section 29 of the Act within clause 1 was to provide guidance to the appraisers in making valuation when the City terminated the lease.  The majority stated that “the wording of Clause 1 of the Lease as amended ties the termination process to the concepts expressed in Section 29 of the St. John’s Street Railway Act”.  Accordingly, the majority of the arbitral tribunal concluded that, upon termination of Newfoundland Power’s rights, (rather than the purchase of Newfoundland Power’s business),  the valuation of Newfoundland Power’s undertaking must take into account the “assets” and “rights” of the Company as they were explicitly referred to in section 29.

With respect to the meaning of the word “value” in the lease, the majority of the arbitral tribunal referred to dictionary meanings and concluded that the ordinary meaning of “value” did not mean “depreciated cost”.  The majority referred to the fact that clause 1 of the lease had been amended to remove the words “aggregate cost of works and erections… less depreciation” and had replaced those words with the words “value of all works and erections”.  From this amendment, the majority concluded that the appraisal process would be incorrectly conducted if it applied “cost less depreciation”.  Due to the amendment, the word “value” could not mean “cost less depreciation.”

Privative Clauses

In the present case, two privative clauses applied to the decision of the arbitral tribunal.  One was contained in clause 1 of the lease itself. That clause stated that “the award of any two such arbitrators shall be final and binding between the parties”.  The other was in section 36 of the Arbitration Act, RSNL 1990, c. A-14 which states that “the award made by arbitrators or an umpire is final and binding on the parties and persons claiming under them.”

Standard of Review 

 Newfoundland and Labrador has not adopted the Uniform Law Conference’s Uniform Arbitration Act.  That Uniform Act provides for a right of appeal if leave is granted by the provincial superior court from a decision of an arbitral tribunal.  The Uniform Act has been adopted in most of the Canadian provinces, but not in Newfoundland and Labrador.  Therefore, the only remedy to overturn the decision of an arbitral tribunal in Newfoundland and Labrador is an application for judicial review.

Both the judge hearing the original application and the Court of Appeal held that the proper standard of judicial review was set forth in the decision of the Supreme Court of Canada in Dunsmuir v. New Brunswick, [2008] 1 S.C.R. 190.  Under Dunsmuir, there are only two standards of judicial review: correctness and reasonableness. There are two steps in determining which standard of review applies. The first step in the Dunsmuir analysis is to determine whether the courts have already established an appropriate standard of review for the particular tribunal whose decision was being reviewed. Both courts agreed that no appropriate standard of judicial review had been established for this arbitral tribunal.

The next step in the Dunsmuir analysis is the “contextual analysis” in which the following factors are considered:

(1) the presence or absence of a privative clause;

(2) the purposes of the tribunal;

(3) the nature of the question at issue; and

(4) the expertise of the tribunal.

The Court of Appeal agreed with the application judge that when these factors were applied to the arbitral tribunal in the present case, the proper standard of review was reasonableness. That is, the arbitral decision should only be set aside if it was unreasonable.

The Court of Appeal then considered how the reasonableness standard should be applied. It referred to the decision of the Supreme Court of Canada in Newfoundland and Labrador Nurses’ Union v. Newfoundland and Labrador (Treasury Board), [2011] 3 S.C.R. 708.  It held that this decision had clarified that the adequacy of reasons is not a “stand-alone basis for quashing a decision.”  Courts are not required, as it said, to “undertake two discrete analyses – one for the reasons and a separate one for the result.”  The Court of Appeal noted Justice Abella’s statement in the Newfoundland and Labrador Nurses’ Union decision that:

 “even if the reasons in fact given do not seem wholly adequate to support the decision, the court must first seek to supplement them before it seeks to subvert them. For if it is right that among the reasons for deference are the appointment of the tribunal and not the court as the front line adjudicator, the tribunal’s proximity to the dispute, its expertise, etc, then it is also the case that its decision should be presumed to be correct even if its reasons are in some respects defective.”

 The Newfoundland and Labrador Court of Appeal then stated its duty in applying the Dunsmuir test as follows:

 “This Court must therefore determine whether the reasons meet the standard of justification, transparency and intelligibility’.  Even if the reasoning is in some respects flawed, this Court must determine whether the outcome is acceptable as being defensible in respect of the facts and the law by examining any alternative arguments which could have been made.” (emphasis added)

 Decision of the Court of Appeal

 The Court of Appeal said the following in starting its analysis:

 “In this case, however, I am satisfied that the majority made a number of errors in its reasoning process which led to a result that is not reasonable and supportable given the wording of the lease and the context in which it was negotiated.  The outcome is not defensible as a possible, acceptable outcome, given the commercial context in which the lease was to be interpreted and applied.”

 The Court of Appeal held that the majority of the arbitral tribunal had made two fundamental errors in the interpretation of clause 1 of the lease. The first error arose from the majority applying the valuation provision relating to the purchase of the business of Newfoundland Power.  That provision had no application when the valuation related to the termination of the lease.

The Court of Appeal said:

 “What was to be valued varied significantly depending on whether the City acquired the electrical generating plant by purchase pursuant to section 29 or by termination of the lease.  If the City terminated the lease after forty-seven years it had to pay the value of the “works and erections … in use”.  If the City exercised its right to purchase the Company as a going concern under section 29 of the St. John’s Street Railway Act, which it could do during the forty-seven year term of the Lease, it had to pay the value of the “undertaking, plant, property, assets and rights”….

 Intuitively, the different bases of valuation make sense.  If the City terminated the lease, Newfoundland Power would no longer have the right to use the water or the land on which the works and erections sat.  In other words, its franchise would be terminated….

 Here, Newfoundland Power and the City entered into a lease from the City with an express right of termination after forty-seven years upon three years notice with a compensation formula in favor of Newfoundland Power limited to the value of works and erections in use at the end of the lease to be valued by three arbitrators.  There would be no other compensation based on a going concern or otherwise because of the express language set out in the amended clause 1 of the lease dated, October 21, 1949…..

 The majority’s holding that the closing portion of clause 1 supported the contention that the valuation which occurs on the termination of the lease must be consistent with the valuation that occurs upon the City exercising its rights under section 29 was unsupportable and unreasonable and ignores the specific nature of the franchise rights granted by the City to Newfoundland Power.”

The Court of Appeal also held that the majority of the arbitral tribunal had erred in its interpretation of the word “value.”  It effectively said that the majority had ignored the fact that what was to be valued was “the works and erections in use”, not the business. It said:

 “The words “works and erections” generally refer to physical assets, a fact noted by the minority arbitrator.  While the addition of the words “in use” could connote an intention that the City would be taking over an operating facility, read in the context of the discussion above, it is clear that the words “in use” did not intend to transform the valuation from one including only physical assets into one including all associated rights and intangible property.  Their inclusion was meant only to identify which physical assets are to be valued, i.e. only those which are in use.

 This interpretation is commercially sensible.  Presumably, the words “in use” were added so that structures which were no longer necessary or functioning for the purpose of electrical power generation, would not be included in the assessment of value.  Newfoundland Power is to be paid for the value of only those physical assets which it was using to generate electrical power at the time of notice and termination. These are the only structures of value that it is losing upon termination of the lease.

 The Court of Appeal held that the majority of the arbitral tribunal had erred by relying so heavily on the changed definition of “value” in the lease.  In the court’s view, the amendment inserted into the lease “one method of valuation with the broader concept of ‘value’, which included as a possible interpretation the original method of valuation….The effect of the amendment, from a stand point of reasonableness, would appear to be intended to give greater flexibility to the arbitrators in determining which method of valuation is appropriate upon termination of the lease of those works and erections that are in use and are to be valued.”

The Court of Appeal then considered what result flowed from its conclusions, particularly in light of the finding by the application judge to the contrary.  It said the following:

 “The errors identified in the reasoning process of the majority of the arbitrators led to a decision which is unreasonable and unsupportable based upon the wording of the lease and the context in which the agreement was made.  Therefore, the applications judge erred by finding that the decision of the majority was reasonable and within the range of possible outcomes.”

 The Court of Appeal accordingly allowed the appeal and referred the matter back to the arbitral tribunal to be determined in accordance with the analysis in the Court of Appeal’s decision.

Discussion

This decision appears to reflect a tendency by the courts to review commercial agreements on a stricter basis than other agreements.  In the case of commercial agreements, the courts have at their disposal long-standing and well known principles of contractual interpretation.  When the arbitral decision offends one or more of those principles, then a court can conclude that the decision is “unreasonable”.

Two of the best known principles of contractual interpretation are the rule prohibiting reference to irrelevant considerations and the parole evidence rule.  Once the Court of Appeal concluded that the valuation principles applicable to the purchase of Newfoundland Power’s business were irrelevant to the valuation arising from the termination of the lease, then it was almost inevitable that it would conclude that the arbitral decision was unreasonable.  When, in addition, the court concluded that the prior versions of clause 1 were not helpful in arriving at the proper  interpretation of that clause, then its inclination to interfere was likely greater.  The only expertise brought by the arbitral tribunal to the process of interpreting the lease was legal expertise, and the court, which is comfortable with interpreting commercial agreements and rightly considers itself expert in doing so, undoubtedly felt that it should have little reluctance in setting the tribunal’s award aside.

This decision will be of interest to those involved in disputes involving the interpretation of construction and procurement agreements.  Those disputes often involve loaded words such as “value” and the dispute may revolve around whether certain factors are relevant or irrelevant in the interpretation process, or whether the negotiations or prior drafts of the agreement should be looked at. If one party to a construction dispute believes that the arbitration tribunal got the interpretation wrong, then the decision in St. John’s v. Newfoundland Power will be a useful decision in support of an application for judicial review.

Another view of this decision may be that courts are far too ready to set aside arbitral decisions.  Those with this view will see this decision as exactly the kind of case in which the court improperly intervened on a valuation matter that was at the heart of what the arbitral tribunal was asked to decide.

As a footnote to this decision, one could consider how it would have been decided if the arbitration in question was an international commercial arbitration, not a domestic arbitration, and the Model Law attached to the International Commercial Arbitration Act of Newfoundland and Labrador had applied. That Act is similar to the many provincial statutes which adopt the UNCITRAL Model Law across Canada.  Article 34 of the Model Law states the grounds upon which there may be recourse against an arbitral decision. Those grounds include:

  • incapacity by a party
  • invalidity of the agreement
  • lack of notice
  • the arbitral tribunal deciding a dispute or matter falling outside the terms of the arbitration agreement
  • the wrong composition of the tribunal or
  • the determination by the tribunal of a matter which is incapable of being arbitrated, or contrary to public policy.

None of those grounds appear to include an error of law made by an international commercial arbitration tribunal within its prima facie jurisdiction. If that is so, then this decision highlights the wider authority that international commercial arbitration tribunals have than domestic tribunals.  It also highlights the broader supervisory authority that provincial superior courts have over domestic arbitrations than over international commercial arbitration tribunals.  The Model Law appears to contemplate that international commercial arbitration tribunals may make errors of law within their jurisdiction and that Law gives the courts no express authority to set aside such errors.  This being the case, it may be doubtful that the Dunsmuir analysis has any application to international commercial arbitration.

With respect to domestic arbitration tribunals, however, Canadian law contemplates that provincial superior courts have authority to set aside errors of law made by domestic arbitration tribunals based upon the standards of “correctness” and “reasonableness” stated in Dunsmuir. If the decision in St. John’s v. Newfoundland Power tends to show that the courts apply a higher degree of scrutiny to legal error by commercial than to other types of arbitration, then it may be ironical that that there is no judicial review for error of law made in international commercial arbitrations.

See Heintzman and Goldsmith on Canadian Building Contracts, 4th ed, chapter 10

St. John’s (City) v. Newfoundland Power Inc., 2013 NLCA 21

Arbitration  –  Standard of Review  –  Error of Law  –  Reasonableness  –  Contracts  -Interpretation

Thomas G. Heintzman O.C., Q.C., FCIArb                                                                                         August 1, 2013

www.heintzmanadr.com

www.constructionlawcanada.com