Disputes relating to shareholder agreements are relatively common and can cause massive disruption to business operations. For example, shareholders might argue that their shares have been reduced in value, leading to a dispute.

If the shareholder agreement has a mandatory arbitration clause, a preliminary issue could be determining the appropriate forum for bringing the dispute. The clause may well restrict the ability of a party to bring the dispute to the courts.

This blog takes a look at the impact of mandatory arbitration clauses. We also discuss a decision of the Supreme Court of British Columbia from earlier this year in which a company sought to prevent some shareholders’ claims from being brought before the court, relying on a mandatory arbitration clause in the shareholder agreement.

What is a mandatory arbitration clause?

A mandatory arbitration clause is a clause in a contract that attempts to require the parties to the agreement to resolve their disputes through arbitration rather than through the court system. Arbitration is an alternative form of dispute settlement, where the dispute is decided by one or more arbitrators rather than judges. It is a private alternative to litigation but still involves an adversarial approach.

British Columbia’s Arbitration Act allows people to agree to resolve disputes by arbitration. Section 7 says that if a party starts court proceedings when they previously agreed the dispute would be submitted to arbitration, another party may apply to the court to stay (that is, put a hold on) proceedings.

How does the court decide whether to stay proceedings to allow for arbitration?

The Arbitration Act requires the court to stay proceedings unless it determines that the agreement to arbitrate is void, inoperative or incapable of being performed. This reflects the preference of the courts to uphold arbitration clauses.

Generally, if the party seeking to stay the court proceedings makes an arguable case that the issues in dispute are subject to an arbitration clause, and the party that brought the court proceedings cannot show that the clause is void, inoperative or incapable of being performed, the court will stay proceedings.

The requirement to simply show an arguable case means that jurisdictional issues relating to the scope of the arbitration clause are usually first resolved by the arbitrator rather than the court.

Plaintiffs brought court proceedings claiming their shares were deprived of value

In 3-Sigma Consulting Inc. v. Ostara Nutrient Recovery Technologies Inc., a group of minority shareholders (the plaintiffs) brought proceedings in court against the company and its majority shareholders, directors and senior management (the defendants).

The plaintiffs claimed the defendants arranged a sale of the company that benefitted the defendants at the plaintiffs’ expense. They alleged the company entered into a convertible note financing term sheet with the majority shareholders. This, the plaintiffs stated, resulted in the latter becoming preferred shareholders with a preferential position on a sale, which was triggered by a second round of investments.

The plaintiffs claim this arrangement was not disclosed to them, and other misrepresentations were made instead, resulting in a sale that rendered their shares worthless.

Defendants relied on a mandatory arbitration clause in the shareholder agreement

The defendants sought to stay the court proceedings, pointing to a mandatory arbitration clause in the company’s shareholder agreement. It required any dispute or claim “involving the interpretation or enforcement of any provision of this Agreement or breach hereof or otherwise arising under or in connection” with the agreement be submitted to arbitration.

The plaintiffs argued the clause did not apply because not all of the plaintiffs and defendants had signed the shareholder agreement. Further, their tort claims did not arise under or in connection with the contract because the agreement did not contain director and officer duties (for example, to provide information to shareholders).

Possibility that mandatory arbitration clause applied to all shareholders

Justice Matthews of the Supreme Court of B.C. decided that the first issue was whether the plaintiffs who had not signed the shareholder agreement were subject to the mandatory arbitration clause.

The defendants argued that the clause could be interpreted to capture all shareholders for various reasons. One such reason, the defendants stated, was that the definition of “shareholders” in the agreement covered those who had signed the agreement as well as holders of securities who agreed to become bound by the shareholder agreement.

The Court found it plausible that the mandatory arbitration clause could cover the non-signatories, although these issues would need to be examined by an arbitrator. Some examples set out in prior case law included situations where:

  • An entity was considered a party to an arbitration agreement because they were a nominee of a contracting party; or
  • There is an agency relationship between a party and a non-signatory; or
  • There is an established reason to pierce the corporate veil.

Arguable that plaintiffs’ claims fell within the scope of the mandatory arbitration clause

Turning to whether the claims by the plaintiffs fell within the scope of the clause, the Court observed that the words “in connection with” broadened its scope. Furthermore, the agreement obliged the company to provide information to certain shareholders and allowed certain shareholders to demand some information. It was, therefore arguable that the agreement was relevant to determining the scope of the duty to provide information.

Given the nexus between the dispute and the shareholder agreement, in the sense of the latter being relevant, the Court decided that the defendants had established an arguable case. As a result, the court decided to stay the court proceedings to allow the arbitral tribunal to determine whether it had jurisdiction to determine the plaintiffs’ claim.

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Shareholder disputes, if not addressed in a timely manner, can cause business interruptions and reputational damage to an organization. With extensive experience advising parties on either side of a shareholder agreement, Roland Luo creates personalized, effective legal solutions to reduce costly discord within a business.

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