Court File and Parties
COURT FILE NO.: CV- 20-00649326-00CL DATE: 2020-12-17 SUPERIOR COURT OF JUSTICE - ONTARIO
RE: HALEX CAPITAL INC., Applicant AND: NATURAL ENERGY SYSTEMS INC., Respondent
BEFORE: Dietrich J.
COUNSEL: Mike Shakra and Joshua Foster, for the Applicant Kurt R. Pearson, for the Moving Party, Douglas Hallett
HEARD: December 3, 2020
Endorsement
Overview
[1] The Respondent, Natural Energy Systems Inc. (“NES”), was incorporated as a vehicle to commercialize unique waste-to-energy technology. NES owns proprietary and patented processes for converting organic materials, including organic waste, into a methane product gas with a high-energy content value. The patents for this technology are the principal assets of NES and require regular renewal in various countries. NES has no employees, no operations, and no revenue.
[2] Douglas Hallett is the founder and a shareholder of NES. Mr. Hallet, together with another, now deceased shareholder of NES, invested considerable time and money into inventing this technology.
[3] The Applicant, Halex Capital Inc. (“Halex”), is a shareholder and creditor of NES. Dragan Matovic is the chairman and CEO of Halex. Since 2015, he has also been the chairman and CEO of NES. He is a director of both companies.
[4] Halex has made a number of loans to NES. On January 31, 2020, it entered into a general security agreement (“GSA”) with NES with respect to loans made in 2019 and 2020. These loans are reflected in a consolidated promissory note dated January 31, 2020 issued by NES in the principal amount of $175,000. The GSA gives Halex a security interest in all of NES’s present and after-acquired property.
[5] Mr. Hallett also has a GSA with NES, which he obtained in 2014. He claims this GSA gives him security over NES’s technology and the patents. He disputes the validity of Halex’s GSA. Halex, meanwhile, disputes the validity of Mr. Hallett’s GSA, or, alternatively, disputes the quantum of the property secured.
[6] There are other disputes between Mr. Hallett and NES regarding alleged breaches of a unanimous shareholder agreement signed in 2008 (the “USA”). These disputes, including Mr. Hallett’s removal from the board of directors, the suspension of his shareholder rights, and the authority of NES to grant Halex a GSA, are the subject of an ongoing arbitration. The arbitration commenced on January 28, 2020 pursuant to an arbitration agreement between NES and Mr. Hallett. It is Mr. Hallett’s position that the issue of the validity of Halex’s GSA is squarely before the arbitrator and ought to be resolved in that context. Halex submits that it is not a party to the arbitration.
[7] Dragan Matovic agreed to participate in the arbitration as a director of NES. Mr. Matovic was also the principal of Halex. Despite this agreement, and despite Mr. Matovic’s participation in several conference calls with the arbitrator, after years of litigation, Halex brought an application to appoint a receiver over all the property of NES on November 13, 2020.
[8] Mr. Hallett sought an adjournment of the receivership application, which was granted on terms that include the appointment of Baigel Corp. as Interim Receiver until December 3, 2020, when the merits of the application would be heard.
[9] Today, on the return of Halex’s application to appoint a receiver, Mr. Hallett brings a motion for an order staying the receivership application. He asserts that the issues at the root of the application are disputes between Mr. Hallett and Halex as shareholders and ought to be resolved through arbitration in accordance with the USA.
[10] For the reasons that follow, I decline to stay the application to appoint a receiver. A stay in these circumstances, in which it appears that no party to the arbitration is prepared to front the costs of the arbitration on behalf of NES, is not appropriate. Absent a receivership, there is no plan for the preservation of NES’s intellectual property through patent renewals. If the property is not preserved, the interests of all of the stakeholders in NES will be compromised.
Mr. Hallett’s Motion
[11] Mr. Hallett brings a motion for an order staying the Applicant’s motion to appoint a receiver and an order referring all of the issues raised to arbitration in accordance with the USA. Alternatively, he seeks dismissal of Halex’s application for receivership.
[12] Mr. Hallett asserts that Halex is a shareholder and is governed by the Dispute Resolution clause in the USA. That clause provides that the shareholders agree to arbitrate “all disputes and questions whatsoever which shall arise between any of the parties in connection with this Agreement … or as to any other matter in any way relating to this Agreement.”
[13] I am satisfied that Halex is a shareholder under the USA even though it was not an original shareholder and has not signed the USA. Halex meets the definition of “Shareholder” in the USA, which is “any person who from time to time owns Shares.” Mr. Matovic admits that Halex is a holding company, and, under the USA, a “Holding Company” is a permitted transferee. The USA provides that every issue of shares shall be subject to the condition that the subscriber, if not a party, agrees to be bound by the USA and become a party in accordance with the USA. Also, the USA requires that all share certificates of NES be endorsed with a legend stating that, among other things, any transferee of the securities evidenced by the certificate is deemed and required to be a party to the USA. On examination, Mr. Matovic refused to answer whether the share certificate issued to Halex included the endorsement. Based on this refusal, I am prepared to draw the inference that it did. I find that Halex is bound by the USA.
[14] Mr. Hallett asserts that the issues relating to the GSA fall within the Dispute Resolution clause in the USA as a matter “relating to the USA.” He points to the resolution of NES’s Board of Directors in respect of the GSA granted to Halex on January 30, 2020, when it issued the consolidated promissory note. That resolution specifically refers to the USA and the article thereunder that provides that “each loan share [sic] be secured.” There is no dispute that “share” in this sentence is meant to be “shall.”
[15] I agree that this specific reference to the USA in the resolution regarding Halex’s GSA could bring that GSA dispute within the scope of the Dispute Resolution clause of the USA. In the result, the issues relating to it would be arbitrated along with the other issues included in the arbitration agreement. Further, in the arbitration, Mr. Hallett is relying on pleadings he prepared for the action NES brought against him, which ultimately went to the ongoing arbitration. In those pleadings, Mr. Hallet raises the validity of the GSA given to Halex.
[16] Mr. Hallett asserts that the receivership application is nothing more than a continuation of the shareholder dispute that has been ongoing since 2015 and has already been referred to arbitration. Mr. Matovic’s own evidence is that there are “legal and factual issues” relating to the validity of Mr. Hallett’s security under his GSA, as compared to Halex’s GSA. However, Mr. Matovic asserts that Halex is not a party to the arbitration agreement. He asserts that Halex has initiated the receivership proceedings pursuant to its GSA and the promissory notes, which do not contain an arbitration provision or refer to the USA.
Analysis of Mr. Hallett’s Motion
[17] Based on the evidentiary record, I am satisfied that it is at least arguable that the dispute with respect to the validity and priority of Mr. Hallett’s GSA and Halex’s GSA is covered by the arbitration agreement. It would therefore be appropriate to stay the receivership application to permit the arbitrator to determine whether the dispute regarding the Halex GSA falls within his jurisdiction and whether Halex is a party to the arbitration: King Valley Estates Inc. v. Wong et al., 2019 ONSC 4809, at para. 13; Dalimpex Ltd. v. Janicki (2003), 2003 CanLII 34234 (ON CA), 64 O.R. (3d) 737 (C.A.), at para. 21; and Haas v. Gunasekaram, 2016 ONCA 744, 62 B.L.R. (5th) 1, at para. 7.
[18] The difficulty in this case is that there is no evidence to suggest that NES has the resources to pay for the ongoing arbitration, or for counsel to represent it in the arbitration. NES is unrepresented in the proceedings before the court today. Mr. Hallett has not offered to front the costs of the arbitration on behalf of NES. His evidence is that “someone” should pay on behalf of NES. Halex has refused to cover any further costs of NES unless it is guaranteed a priority charge in the context of a receivership. A stay under these circumstances could well lead to NES losing its most valuable asset through failure to renew the patents for want of funds. This result is not in the interests of any of the stakeholders. A stay of the proceedings exposes NES to the possibility that it would be petitioned into bankruptcy by one or more of its creditors.
Halex’s Application
[19] Halex asserts that the appointment of a receiver is necessary and appropriate because NES has not responded to its demand for payment. On July 2, 2020, Halex demanded $265,000 on account of loans made to NES, plus unpaid interest, fees, and costs in connection with the consolidated promissory note. It claims that NES has had ample time to meet the demand. Halex also asserts that NES has no active business, operations, or revenue, and that Halex has been the primary source of funding for NES. According to Halex, as of October 30, 2020 NES had just $1,634.71 in its only bank account.
[20] Mr. Hallett says that the equitable remedy of a receivership should not be granted to Halex because NES issued the consolidated promissory note knowing that NES could not pay the initial sum, or any future sum purportedly included. He also contends that Mr. Matovic and Halex are in a conflict of interest in seeking to have a receiver appointed over the property of NES. This is because Halex is a shareholder of NES and Mr. Matovic is a shareholder, officer, and director of NES, as well as the chairman, director, and CEO of Halex. Mr. Hallett asserts that Mr. Matovic loaned money to NES at least in part to fund the litigation against Mr. Hallet, and with the specific intention of precipitating the insolvency and receivership of NES.
[21] Mr. Hallett further maintains that Halex has not proven that it advanced all of the amounts purportedly secured, that its security is not properly perfected, and that Halex purposely created a default necessary to appoint a receiver. Mr. Matovic denies this allegation and asserts that the loans by Halex reflected in the consolidated promissory note prevented NES from having to make an assignment in bankruptcy or from being petitioned into bankruptcy. The loans also permitted NES to maintain its intellectual property.
[22] Mr. Hallett submits that Mr. Matovic was not acting in good faith because he was in a conflict of interest regarding the granting of the Halex GSA. Accordingly, Halex should be denied the equitable remedy it seeks. Mr. Matovic’s evidence is that he acknowledged his conflict of interest and recused himself from voting on the resolution to approve the GSA with Halex. This evidence is corroborated by a letter from another director of NES, G. Paul Greenwood.
The Interim Receiver’s First Report
[23] Baigel Corp., a licensed insolvency trustee, became the Interim Receiver pursuant to the Interim Order of Koehnen J. made on November 13, 2020. That Order authorizes the Interim Receiver to take any necessary steps to preserve the property of NES.
[24] According to the First Report of the Interim Receiver, the assets of NES (not including the value of the intellectual property or an appeal involving the Canada Revenue Agency) had a value of about $80,000. Of this amount, $75,700 is represented by an HST refund, which has not been applied for. Apart from Mr. Hallett and Halex, who assert that they are secured creditors, the Interim Receiver lists nine creditors in its First Report, whose debts are unsecured. The total amount shown as owing to these unsecured creditors is $1,034,190.
Analysis of Halex’s Application
[25] Based on the evidentiary record, I am satisfied that the receivership proceedings were commenced to preserve the value of NES for the benefit of all of its stakeholders, including Mr. Hallett, and to determine stakeholder priorities. It appears that NES does not and likely will not have the resources to properly market and sell its assets to satisfy its obligations. It is, therefore, unlikely that NES will be able to repay or refinance amounts owing to Halex or any of its other creditors without a court-supervised receivership.
[26] At the time the Interim Receiver was appointed, the costs to maintain NES’s suite of approximately 39 patents was estimated by NES’s intellectual property counsel, Bereskin & Parr LLP, to be $46,263.80. Koehnen J. authorized the Interim Receiver to borrow up to $75,000 to pay expenses, including outstanding legal fees and fees to preserve the patents. The Interim Receiver borrowed sufficient funds to preserve NES’s intellectual property.
[27] On the evidentiary record before me, I am inclined to exercise my discretion to appoint Baigel Corp. as the receiver in this matter. It is just and convenient to do so in light of the fact that Halex has made a demand for payment on its promissory notes, has not withdrawn that demand, and payment has not been made. It appears that Halex has been the only source of funding for NES latterly, and there is no alternative source of financing available. Under these circumstances, it is not obvious how NES will repay or refinance the amounts owing to Halex or any of its other creditors, or arrange for the appropriate marketing and sale of its assets absent a receiver. I acknowledge that the dispute between Mr. Hallett and Halex regarding their respective GSAs will be an issue in the receivership. I am satisfied that a court-appointed receiver, being a neutral third party, can provide the court with an unbiased and impartial opinion on the validity, enforceability, and priority of their respective security.
[28] As long as the value of the intellectual property is preserved, NES’s principal asset can be monetized and sold. Mr. Hallett will have an opportunity to purchase the asset in a sales process conducted by the receiver.
Disposition
[29] An Order shall issue appointing Baigel Corp., licensed insolvency trustee, as Receiver, with security, over all of the present and after-acquired assets, undertakings, and properties of Natural Energy Systems Inc. pursuant to s. 243(1) of the Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3, as amended, and s. 101 of the Courts of Justice Act, R.S.O. 1990, c. C.43, as amended. The Order is effective as of the date of this endorsement and it is not required that it be entered.
Costs
[30] I have reviewed the Costs Outline or Bill of Costs submitted by each of the parties. Halex seeks full indemnity costs of $136,658, all-inclusive, for its costs on its initial application and on this application for receivership. Had Mr. Hallett succeeded on his motion and this application, he would have sought costs of $36,887.63, all inclusive, on a full indemnity basis. In my view, this matter involves a commercial dispute in which I find the equities are divided. Mr. Hallett, the founder of NES, and the only surviving inventor of its principal asset, has lost the opportunity to have his claims heard at arbitration. The loss comes through what could accurately be described as the school of hard knocks in the business world. NES, under the leadership of Mr. Matovic, whose holding company, Halex, is a significant creditor of NES, abandoned the arbitration at a critical time. Halex then moved to appoint a receiver. Neither Mr. Hallett nor NES could or would fund the arbitration. Halex was successful in its receivership application. Altogether, including consideration of the costs thrown away at arbitration, I conclude that no costs should be awarded for the application hearings.
Dietrich J.
Date: December 17, 2020