The City of St. John’s (the “City”) was successful on an appeal from an order affirming an arbitration award, which held that an interest in land and water rights leased to the respondent Newfoundland Power Inc. (“Newfoundland Power”) ought to be valued as part of the going concern.

Administrative law – Decisions of administrative tribunals – Arbitration Board – Natural resources – Electricity – Municipalities – Utility services – Contracts – Landlord and tenant – Leases – Land and water rights – Valuation – Judicial review – Standard of review – Reasonableness simpliciter

St. John’s (City) v. Newfoundland Power Inc., [2013] N.J. No. 121, 2013 NLCA 21, Newfoundland and Labrador Supreme Court – Court of Appeal, March 19, 2013, B.G. Welsh, M. Rowe and M.F. Harrington JJ.A.

Newfoundland Power is a company permitted to sell surplus electricity. The City has the power to provide for lighting requirements of its residents and has been granted the right to possess and control waters and the watershed of the Mobile River to facilitate the provision of this power.

In 1946, the City leased its interest in lands and water rights to Newfoundland Power. Newfoundland Power then constructed and operated an electrical power generating plant in the Mobile River watershed area. The lease stated that after a 47-year term, the lease could be terminated upon three years’ notice and payment by the City to Newfoundland Power for the value of “all works and erections in use”. However, in 1949, the lease was amended to delete the words “aggregate cost of works and erections … less depreciation” and to replace those with the words “value of all works and erections … in use”. This was with respect to defining criteria to determine the payment amount to be made to Newfoundland Power at the end of the lease.

In February 2006, the City gave Newfoundland Power notice of termination of the lease with an effective date of termination three years later, in 2009. Under the relevant clause in the lease, a panel of arbitrators was constituted to determine what amount of payment would be due to Newfoundland Power. The questions on arbitration were: 1) what is to be valued under the provision of clause 1 of the amended lease; and 2) what is the meaning of the word “value” in clause 1 of the amended lease.

The majority of the arbitration panel held that the value associated with the Mobile River watershed as a going concern must include water rights and land rights held by Newfoundland Power at the end of the lease. They referred to section 29 of the St. John’s Street Railway Act, which indicated that the “municipal body having charge of the municipal affairs of the town of St. John’s may, after the lapse of 60 years from the date of this charter, purchase the undertaking, plant, property, assets and rights of the company as a going concern, … the value of said undertaking, plant, property, assets and rights of the company shall be appraised by three experienced arbitrators …”. The majority concluded that the valuation should take into account “rights” of the company and that this would include land and water rights and not just physical buildings.

With respect to defining the meaning of the word “value” as used in clause 1 of the amended lease, the majority held that there was no reason, in looking at dictionary definitions of the word value, to imply that depreciated costs should be included in a valuation. They relied heavily on the fact that the words “aggregate cost of works and erections … less depreciation” were replaced by the words “value of all works and erections”.

The minority arbitrator held that the intangible rights, such as water rights and land rights, would not be included and that these were leased to Newfoundland Power on certain terms and conditions, one of which was that the lease could be terminated after 50 years. The water rights were not given to the company in perpetuity.

The minority arbitrator found that clearer language could have been used if anything other than the “works and erections” was to be included. She felt that the wording of clause 1 clearly referred to physical assets within the normal meaning of the words, and not to intangible rights.

The minority arbitrator found that the replacement of the words “aggregate cost of works and erections … less depreciation” with the words “value of all works and erections” did not preclude the possibility that a depreciated cost approach could still be used in reaching a valuation. She felt that the parties were in a position to present evidence and argument on how the assets should be valued; depreciation might form part of this valuation.

Newfoundland Power applied for judicial review of the arbitration panel’s decision. The application judge applied a standard of reasonableness to the majority decision of the arbitrators and held that the decision had met that standard.

On appeal from that judicial review, the Court held that a reviewing court must be correct, both in determining the appropriate standard of review and in applying it.

The applications judge had been correct in determining the appropriate standard of review to be reasonableness. There were privative clauses present. The purpose of the tribunal was a consensual arbitration panel, suggesting a more deferential stance. The parties had chosen this form of adjudication, and the nature of the question was one of mixed fact and law which has been held to apply to “the construction and interpretation of a written instrument, leading to a determination of its legal effect”. The only factor weighing in favour of a correctness standard of review was the expertise of the tribunal. The experienced arbitrators were not the type of tribunal having the degree of attachment to the subject matter that would demand a high level of deference. However, since all of the other factors favoured a reasonableness standard, this was a correct determination of the standard of review.

In applying the reasonableness standard, the majority was held to have made a number of errors of reasoning which led to a result that was unreasonable and not supported by the wording of the lease and the context of its negotiation. The outcome was not among the defensible possible acceptable outcomes in this commercial context.

Specifically, the majority should not have referenced section 29 of the St. John’s Street Railway Act to bolster its conclusion that all assets and rights of Newfoundland Power were to be valued as opposed to only the physical assets. Second, they did not give sufficient weight to the use of the words “works and erections” in the lease.

Section 29 of the St. John’s Street Railway Act indicated that if the right to purchase was exercised, the City had to pay the value of the undertaking, plant, property, assets and rights of Newfoundland Power. However, that right to purchase was not the one being exercised in this scenario. Rather, the question was what should be valued upon termination of the lease after the minimum 47-year term with the three year notice period set out in the lease. Valuation would vary significantly, depending on whether the City acquired the electrical generating plant by purchase pursuant to section 29, or whether they acquired it by termination of the lease, as was the case here.

The right of termination after the 47-year period and three years’ notice expressly contemplated a compensation formula in favour of Newfoundland Power, limited to the value of the works and erections in use at the end of the lease. The majority’s decision that the closing portion of clause 1 supported a valuation scheme consistent with the City exercising its rights under section 29 was unreasonable and ignored the specific nature of the franchise rights that had been granted by the City to Newfoundland Power.

The wording of clause 1 in terms of the words “works and erections … in use” had also been unreasonable. The words “in use” were simply added, so that any structures that were no longer functioning would not be included in the assessment of value. These words did not intend to transform the valuation from one limited to physical assets to one including all associated rights and intangible property. The decision of the majority arbitrators on the question of what should be valued was set aside and the Court’s reasoning was substituted for it.

With respect to the meaning of the word “value”, the decision of the arbitrators was again found to be unreasonable and something that should not have been upheld by the application judge. While the fact that the words “aggregate cost of works and erections … less depreciation” were removed from clause 1 might suggest that the valuation method could no longer be applied, it would not give proper effect to the fact that the words chosen by the parties to replace them could still be interpreted to mean aggregate cost, after depreciation. The effect of this amendment appeared to give greater flexibility to the arbitrators in determining which valuation method would be appropriate upon termination of the lease. The decision with respect to question two was therefore set aside and remitted to the panel of arbitrators, so that it could be considered in a manner consistent with the Court’s decision on question one. That is, the panel would be allowed to consider whether an appropriate basis for valuation was aggregate cost of all works and erections in use, less depreciation.

The appeal was allowed.

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