SUPERIOR COURT OF JUSTICE – ONTARIO
COMMERCIAL LIST
RE: YELLOW PAGES GROUP CORP.,
Plaintiff
AND:
STEPHEN CURRY, NEAL ROMANCHYCH and 411 LOCAL SEARCH CORP.
Defendants
BEFORE: Newbould J.
COUNSEL: Andrew Bernstein and Myriam Seers, for the defendants/moving party
Peter Howard and James S.F. Wilson, for the plaintiff/responding party
HEARD: October 28, 2013
ENDORSEMENT
1The defendants Stephen Curry and Neal Romanchych move to stay this action on the grounds that it is the subject of an arbitration pursuant to an arbitration agreement contained in an agreement under which the plaintiff has acquired 30% of the defendant 411 Local Search Corp. It was the plaintiff that started the arbitration, although at the same time it commenced this action claiming that the issues should be decided in this action.
2For the reasons that follow, the action is stayed pending the final determination of the arbitration.
Relevant facts
Relevant facts
3The plaintiff is a media and marketing solutions company in Canada. Its parent company is Yellow Media Limited, whose main business is the sale of advertising and directory services, including in Yellow Pages printed directories and on its website, YellowPages.ca.
4The defendant 411 Local Search Corp. (“411”) is an internet search company. Through its website, 411.ca, 411 provides an online directory service that offers advertising, marketing and digital media solutions and directory services to businesses and individuals. It is a digital competitor to the plaintiff.
5In 2010, pursuant to a Share and Asset Purchase Agreement dated February 22, 2010 (“Agreement”), the plaintiff acquired the 411 brand and 30% of the issued and outstanding shares of the 411, and agreed to option terms exercisable three or four years later and subject to certain conditions with respect to the remaining shares held by the other shareholders. The other shareholders include the defendants Stephen Curry and Neal Romanchych, directors and officers of 411, with Mr. Curry acting as the “Selling Securityholders’ Representative”.
6The Agreement provided for two closings. The first closing was when the 30% of the shares of 411 were acquired by the plaintiff in 2010. The second closing is to take place either 3 or 4 years after the first closing. After the three years, either the selling shareholders can put to the plaintiff the obligation to purchase the remaining 70% at a purchase price equal to 9 times the 411 EBITDA, based on the third year audited financial statements of 411, subject to certain adjustments, or the purchaser can require (“call”) the selling shareholders to sell the remaining 70% at a purchase price equal to 10 times the 411 EBITDA, again based on the third year audited financial statements of 411. If neither side elects to exercise these put or call rights, the Agreement provides for the same rights after the fourth year, with the EBITDA being based on the fourth year audited financial statements of 411, subject to the same adjustments.
7Under the Agreement, the selling shareholders were required to provide an EBITDA report to the plaintiff within 60 days of March 31, 2013. This meant that the audited financial statements needed to be finalized and approved before May 30, 2013. PricewaterhouseCoopers LLP signed an unqualified audit opinion for the 411 fiscal year ended March 31, 2013 and the financial statements were approved by the board of directors of 411 on May 28, 2013 over the objection of the plaintiff’s representatives on the board of 411.
8By letter of May 29, 2013, the defendant Stephen K. Curry, as the selling shareholders’ representative, sent the third year EBITDA report to the plaintiff. The plaintiff took exception to it and on June 12, 2013 provided a notice of dispute, stating:
Under section 3.5.6 of the Agreement the Purchaser hereby disputes the amount shown in the Third Year EBITDA report (all terms used herein are as defined in the Agreement). The Purchaser disputes the amounts set out in the attached Schedule “A” for the reasons including but not limited to those summarized therein. Further particulars are available.
Section 3.5.6 of the Agreement provides that the parties will work expeditiously and in good faith in an attempt to resolve any disputed amounts within a period of 15 days after the date of notification of a dispute, failing resolution of which such disputes shall be submitted for determination to KPMG LLP …
The purchaser is available to discuss the disputed amounts. However, the Purchaser will also be initiating an action this week that disputes the validity of the Third year Financial Statements….
In the event the parties are unable to resolve both disputes by discussion, it is the position of the Purchaser that the court proceedings must proceed to final resolution before there can be a determination based on the Third Year Audited Financial Statements. If necessary, the Purchasers will seek a court order to that effect.
Finally, in addition to the amounts set out in Schedule “Agreement”, the dispute will also include matters and items addressed in the contemplated litigation if, contrary to the Purchaser’s position, they are determined to be arbitrable under the contract.
9The attached schedule “A” listed disputes regarding 13 amounts in the third year EBITDA report.
10Six days later, the plaintiff commenced this action on June 18, 2013, claiming that the individual defendants have acted oppressively, a declaration that the third year audited financial statement are not proper or do not reflect the actual position of 411 by reason of the oppressive conduct and an order that the third year financial statements be restated to remedy the consequences of the oppressive conduct.
Analysis
Analysis
11The Arbitration Act, 1991 provides for a stay of an action in respect of a matter to be submitted to arbitration under an agreement or for a partial stay if the agreement deals with only some of the matters in respect of which the proceeding was commenced. More particularly, it provides:
- (1) If a party to an arbitration agreement commences a proceeding in respect of a matter to be submitted to arbitration under the agreement, the court in which the proceeding is commenced shall, on the motion of another party to the arbitration agreement, stay the proceeding.
(5) The court may stay the proceeding with respect to the matters dealt with in the arbitration agreement and allow it to continue with respect to other matters if it finds that,
(a) the agreement deals with only some of the matters in respect of which the proceeding was commenced; and
(b) it is reasonable to separate the matters dealt with in the agreement from the other matters.
12The general rule is that it is not for the court on an application for a stay of proceedings to reach any final determination as to the scope of the arbitration agreement. That is a matter within the jurisdiction of the arbitral tribunal. However, where it is clear that the dispute is outside the terms of the arbitration agreement, the court may and should reach such a final determination on an application for a stay of proceedings. See Dalimpex Ltd. v. Janicki (2003), 64 O.R. (3d) 737 (C.A.) para. 21.
13The arbitration clause in the agreement provides:
3.5.6 If the Purchaser disputes any amount shown in an EBITDA report, the parties will work expeditiously and in good faith in an attempt to resolve such disputes within a further period of 15 days after the date of notification by the Purchaser to the Selling Securityholders’ Representative of such disputes, failing resolution of which such disputes shall be submitted for determination to KPMG LLP …. The determination of EBITDA report (and relevant components thereof) for the relevant 12-month period by such … firm of chartered accountants shall be final and binding upon the parties and not subject to appeal. The costs and expenses of such third firm of chartered accountants shall be borne equally by the Purchaser and the Corporation. (emphasis added)
14The basic claim of the plaintiff is that in the third year following the first closing, the individual defendants took steps to artificially inflate earnings that had the effect of increasing the EBITDA of 411, which would increase the price to be paid to them and the other shareholders of 411 in a second closing. In its statement of claim, the plaintiff pleads that 411 was managed in the third year so as to improperly inflate income, as follows:
In the past several months, the Plaintiff has identified a number of issues giving rise to a material concern that the Corporation has been managed in the year ended 4 March 31, 2013, so as to improperly inflate income, at the expense of the best interests of the overall enterprise. The full details of the methods used are known to Mr. Curry and Mr. Romanchych, but they appear to include some of the classic indicia of inflated earnings; for example, booking transactions with related parties that yield above market returns, with or without substantial consideration; capitalizing costs without justification; failing to book material liabilities; and the booking of transactions as income without a reasonable belief that the transactions are or will remain as income after the end of the financial period.
In particular, YPG’s concern is that the business of the Corporation appears to have been managed so as to improperly inflate income by methods, the full details of which are known to the Management D&POs, but include without limitation that:
(a) the Defendants appear to have entered into a sublease agreement with a related party, possibly outside the ordinary course of business, for a one year term, at an inflated rate, and have continued booking rental income past the expiry of the sublease, while at the same time lease payments have been received to date;
(b) the Defendants appear to have obtained services from the same related party at below-market rates;
(c) the Defendants appear to have capitalized salaries without justification;
(d) the Defendants appear to have made no provision for future discounts on services despite an admitted practice of offering such;
(e) the Defendants appear to have been booking transactions as income without a reasonable belief that the transactions are or will remain as income after the end of the financial period.
15The plaintiff contends on this motion that the complaints regarding the improper attempts to inflate income are not something that is to be arbitrated but rather is a “dispute event” under the Agreement that permits an action under section 7.19 of the Agreement. I have some difficulty with that as a “dispute event” is defined as a failure of the second closing to occur following the exercise of a call right or put right. There has not yet been any exercise of a call or put right as the EBITDA report is being contested.
16The plaintiff contends that a pre-condition of an EBITDA report is that there be audited financial statements and that such a pre-condition does not exist as the audited financial statements are being challenged in the action in which a restatement of them is being requested. It contends that it is not open to an arbitrator to determine issues of oppressive conduct.
17The plaintiff contends that auditors act on the basis that management has been acting in good faith in preparing the financial statements and, that if the auditors cannot accept the good faith of management, they cannot sign a clean auditor’s certificate. That may or may not be the case. There is no evidence in the record on this issue. But in any event, the role of the arbitrator in this case is not to conduct an audit for the purpose of providing an auditor’s certificate regarding the financial statements, but rather to settle a dispute about certain matters of an accounting nature in the financial statements.
18A number of provisions of the agreement are referred to by both sides of this dispute. The Agreement does not lack for definitions (there are 162 at the outset of the agreement and many more throughout), and not surprisingly, the parties are not in agreement in their interpretation of some of the relevant provisions.
19However, some things seem relatively clear. EBITDA for the purposes of the selling price for the second closing “shall be calculated with reference to the Third Year Audited Financial Statements” (section 3.1(a)). The EBITDA portion of the Third Year EBITDA Report “shall be based on the Third Year Audited Financial Statements” (section 3.5.1). Thus the EBITDA report sent to the plaintiff contains figures from the third year financial statements audited by PWC, as follows:
Income Statement
EBITDA report
Motion Record, Tab C4
Motion Record, Tab C12
Sales
$15,355,007
Sales
$15,355,007
Cost of Sales
$352,663
Cost of Sales
$352,663
15,002,344
Gross Margin
15,002,344
Expenses – Selling
Selling Expenses
Advertising and promotion
$358,081
Advertising & promotion
$289,556
Total = $358,081
Media expenditures
$68,525
Bad debts
$1,101,657
Bad debts
$1,101,657
Commissions
$1,880,754
Commissions
$1,880,754
Consulting fees
$187,645
Consulting fees
$187,645
Total = $336,307
Miscellaneous
$281,185
Miscellaneous
$336,307
Travel
$55,122
Salaries and employee benefits
$4,509,779
Salaries and employee benefits (marketing and advertising)
$140,000
Total = $4,509,779
Salaries and employee benefits (sales)
$2,593,558
Client services
$1,776,221
Total Expenses – Selling
$8,374,223
Total Selling Expenses
$8,374,223
Expenses – General and Administrative
Consulting fees
$274,951
Consulting fees
$274,951
General and office
$576,450
General and office
$576,450
Interest and bank charges
$0
NA
Interest on long-term debt
$574,009
NA
Professional fees
$85,916
Professional fees
$85,916
Rent
$318,698
Rent
$318,698
Research and development
$103,155
Research and development
$103,155
Salaries and employee benefits
$1,096,558
Salaries and employee benefits
$1,096,558
Stock-based compensation
$1,288
Stock-based compensation
$1,288
Travel
$93,827
Travel
$93,827
Amortization of equipment
$141,394
NA
Amortization of intangible assets
$849,202
NA
20The Agreement provides that the EBITDA report shall include the EBITDA and some adjustments to it. The plaintiff says that only the adjustments and not the financial statements on which the EBITDA is based could be the subject of an arbitration, and bases this on the language of section 3.5.1 which states:
3.5.1 As soon as practicable after the Third Year Date and in any event no later than 60 days thereafter, the Selling Securityholders’ Representative shall prepare and deliver to the Purchaser a report that sets forth the amount of EBITDA for the twelve months ended as at the Third Year Date together with the Overdue AP, the G&A Adjustment, if any, and if available the Bad Receivable Adjustment (and if the Bad Receivable Adjustment is not available, it shall be delivered within 95 days of the Third Year Date) (the EB1TDA together with the Overdue AP, the applicable G&A Adjustment and the Bad Receivable Adjustment hereinafter referred to as the “Third Year EBITDA Report”). The EBITDA portion of the Third Year EBITDA Report shall be based on the Third Year Audited Financial Statements and shall be prepared in a manner consistent with (i) the methodology used to prepare the Sample EBITDA Statement and (ii) the definition of EBITDA.
21Whether this provision limits arbitration to the adjustments to be made to the EBITDA report and not to the financial statements on which the EBITDA report is based is a matter of debate that I need not get into.
22What the argument on this motion boils down to is whether it is arguable that the complaints of the plaintiff in this action fall within the arbitration clause in the Agreement or whether they clearly do not. In my view it cannot be said that they clearly do not. It is arguable that they do. The arbitration clause provides for arbitration if the purchaser (the plaintiff) disputes “any amount shown in an EBITDA report”. The amounts in dispute in the action are all amounts shown in the EBITDA report in question, and are contained in the list of disputed amounts in the notice of dispute sent by the plaintiff to 411, in which it was stated that the dispute would be sent to arbitration by KPMG if not resolved. The arbitration clause on its face does not limit the types of dispute regarding an amount shown in the EBITDA report that may be arbitrated.
Conclusion
Conclusion
23In the circumstances, an order should go staying this action under section 5(1) of the Arbitration Act, 1991 until the final determination of the arbitrator as to his jurisdiction, and if he concludes that he has jurisdiction, until a final determination of the dispute before the arbitrator.
24The defendants have identified Mr. Derek Rostant of KPMG as the appropriate person to be the arbitrator and have requested an order appointing him under section 10(1) of the Arbitration Act, 1991. The plaintiff has not indicated whether it agrees to Mr. Rostant. Unless the plaintiff sends notice opposing Mr. Rostant within 10 days, an order will go appointing him as arbitrator. If such a notice is given by the plaintiff, a further motion for the appointment of the arbitrator may be made if necessary.
25The moving defendants are entitled to their costs. If these cannot be agreed, brief written submissions along with a proper cost outline may be made within 10 days and the plaintiff shall have 10 days to respond with brief written reply submissions.
Newbould J.
Date: October 30, 2013