Arbitration Agreements and Insolvency
The Court of Appeal clarifies the proper approach when faced with a creditor’s winding-up petition where the underlying debt is subject to an arbitration agreement in its recent decisions of: Re Simplicity & Vogue Retailing (HK) Co Limited [2024] HKCA 299 and Re Shandong Chenming Paper Holdings Ltd [2024] HKCA 352.
Importantly, the Court confirmed that the Court’s discretion should be exercised by applying the principle in Re Guy Lam [2023] HKCFA 9 by analogy. We have previously commented on that important decision (see our case commentary). The Court also clarified the application of Lasmos in its exercise of discretion.
The Lasmos approach
In Re Southwest Pacific Bauxite (HK) Ltd [2018] 2 HKLRD 449 (a decision which is commonly referred as “Lasmos”),[1] Harris J stated that a creditor’s winding-up petition should “generally” be dismissed where it is shown that:
(1) if a company disputes the debt relied on by the petitioner;
(2) the contract under which the debt is alleged to arise contains an arbitration clause that covers any dispute relating to the debt; and
(3) the company takes the steps required under the arbitration clause to commence the contractually mandated dispute resolution process (which might include preliminary stages such as mediation) and files an affirmation in accordance with r.32 of the Companies (Winding-Up) Rules (Cap.32H, Sub.Leg.) demonstrating this.[2]
Nevertheless, the Court retains a discretion. There may be exceptional cases where it will be appropriate to stay the petition.
Further, Harris J added that the failure to file opposing affirmation in accordance with r. 32 (above) may have the same consequences even where there is an arbitration clause as would be the case where there is not. In the exercise of its discretion, the Companies Court may take the view that in the absence of any evidence filed in time by the debtor company, it should be wound up immediately or there should be a condition imposed for allowing the necessary evidence to be filed out of time such as payment into court.[3]
Conflicting decisions at first instance
The Court of Appeal handed down its decision in two different appeals at the same time together because they raised a common question of law concerning the application of Re Guy Lam [2023] HKCFA 9 in which the debtor company seeks to stay or dismiss the winding-up proceedings so as to refer the dispute to arbitration.
First, in Re Simplicity & Vogue Retailing (HK) Co Limited [2023] HKCFI 1443, the debtor company agreed to guarantee the obligations of an issuer of convertible bonds. The debtor argued that the guarantee was discharged by reason of a variation to which the debtor did not agree, and that there were arbitration clauses in the bond instrument and guarantee and thus the dispute should be referred to arbitration. The debtor did not, however, satisfy the third Lasmos requirement of taking steps under the arbitration clause, but instead only referred to the existence of the clause. On the latter, the debtor argued that the Court should follow Re Guy Lam but not Lasmos.
In the first instance, Linda Chan J ordered that the debtor be wound up. She held that Re Guy Lam only applies to exclusive jurisdiction clauses but not arbitration clauses. As far as arbitration clauses are concerned, the approach of the Companies Court is guided by the principles stated in the Court of Appeal’s judgments in But Ka Chon v Interactive Brokers LLC [2019] 4 HKLRD 85 and Sit Kwong Lam v Petrolimex Singapore Pte Ltd [2019] 5 HKLRD 646, and in deciding whether to exercise its discretion to dismiss or stay a petition where the parties have agreed to an arbitration clause, the Court will also consider whether the Lasmos requirements are satisfied.
Second, in Re Shandong Chenming Paper Holdings Ltd [2023] 4 HKLRD 359, after an earlier challenge to jurisdiction was determined by the Court of Final Appeal, the winding-up petition was relisted before Harris J, and Harris J was asked to determine an application by the debtor company to dismiss or adjourn the creditor’s winding-up petition. The principal opposition by the debtor company was that it had advanced a cross-claim by way of an arbitration (the 2nd arbitration) in excess of the debt in favour of the creditor established by an earlier arbitration award (the 1st arbitration) and that the cross-claim should be determined in the 2nd arbitration.
In the first instance, Harris J stayed the petition and found that where the Court was faced with either a disputed debt or a cross-claim which was subject to an arbitration agreement, the prima facie standard applies such that the winding-up proceedings will be stayed or dismissed as long as (1) there is a valid arbitration agreement between the parties; and (2) the dispute falls within the scope of the arbitration agreement, provided that the dispute is not being raised by the debtor in abuse of the Court’s process. The judge further observed that the Court of Appeal and the Court of Final Appeal decisions in Re Guy Lam confirmed that the Lasmos approach applies to arbitrations just as it has been expressly found to apply to exclusive jurisdiction clauses, and that the approach applies to both disputed debts and cross-claims.
The Court of Appeal judgments
Both appeals were dismissed.
As Kwan VP succinctly explained, the only difference between the two cases is that the dispute sought to be referred to arbitration in Re Simplicity is the petition debt (a disputed debt petition), whereas the debtor company in Re Shandong Chenming does not dispute the petition debt but seeks to refer to arbitration its cross-claim which is greater than the amount of the petition debt (a cross-claim petition).[4]
In Re Simplicity, Kwan VP accepted that the Re Guy Lam approach should apply by analogy, and that its reasoning on the appropriate exercise of discretion also applies equally to arbitration clauses [34]-[36]. Further, having regard to the statutory framework protective of arbitration, there is apparently an even stronger case for upholding the parties’ contractual bargain that disputes falling within the scope of an arbitration clause should be resolved by arbitration [37].
Following the approach in Re Guy Lam:
(1) The threshold character of a dispute about indebtedness leaves room for the exercise of discretion by the Court to decline to exercise the jurisdiction to determine that question, leaving the dispute to be resolved by arbitration as agreed and with regard to the public policy in holding the parties to their agreement.
(2) Such public policy consideration is not the only consideration and it may exist in an “attenuated form”, as when a wholly frivolous defence is mounted which would constitute an abuse of process.
(3) The emphasis here is that the Court is concerned with an exercise of discretion, whether it be the exercise of its jurisdiction to make a bankruptcy or winding-up order upon being satisfied with proof of the petitioning debt, or in making a determination whether there is a bona fide dispute of the debt on substantial grounds, or in ordering that the petition be dismissed or stayed.
(4) The approach of the Court in exercising its discretion is “multi-factorial”.
(5) The public policy of the legislative scheme for the Court’s insolvency jurisdiction may be prominent where the grounds for disputing the debt are obviously insubstantial.
(6) The significance of this public policy may be much diminished where there is no supporting creditor and no evidence of a creditor community at risk. The “strong reasons” or “wholly exceptional circumstances” test should not “obscure the range of considerations relevant to the court’s discretion”.
(7) The “countervailing factors” mentioned, being “the risk of insolvency affecting third parties and a dispute that borders on the frivolous or abuse of process”, are just instances where the Court may exercise its discretion not to hold the parties to the agreed dispute resolution mechanism.
By this approach, the Court retains flexibility to deal with the case as the circumstances require.[5]
The debtor nonetheless failed in its appeal because it never put in an affidavit in opposition. The bare references to (1) the existence of an arbitration clause and (2) a general intention to formally commence an arbitration are insufficient to indicate that the petition debt was disputed and that the dispute would be referred to arbitration.
In this way, the Court confirmed the importance of the third requirement in Lasmos. Kwan VP explained:
(1) It is not onerous to demonstrate that there is a genuine intention to arbitrate.
(2) To deter a debtor from merely raising an arbitration clause as a tactical move with no genuine intention to arbitrate, it is sensible for the Court to require itself to be satisfied of the genuine intention so as to hold the parties to their agreed dispute resolution mechanism.
(3) The Courts have emphasized that the steps required under the arbitration clause to commence the process may include preliminary stages such as mediation.
(4) Even if no steps were taken at all, the Court could still exercise its discretion in an appropriate case to grant a short adjournment for the debtor to commence arbitration and require an undertaking from him to proceed with the arbitration with all due dispatch.
(5) If no progress is made during the adjournment, the Court could consider lifting the stay and proceed to exercise its jurisdiction on the petition debt.[6]
Moreover, even leaving Lasmos aside, the Court clarified that the discretion would not have been exercised in dismissing the petition. This is because the sole ground of opposition was without merit and borders on being frivolous or abuse of process. Under the Re Guy Lam approach, this would be a sufficient countervailing factor which militates against the exercise of discretion to decline jurisdiction in the winding-up petition and hold the parties to their agreement to arbitrate [47].
In Re Shandong Chenming, the petitioner conceded that Re Guy Lam applies by analogy to a case where the petition debt is disputed and the dispute falls within an arbitration agreement. Godfrey Lam JA noted [23] that this concession is correct for the reasons in Re Simplicity (above).
The Court of Appeal’s judgment further carefully explains how the three different concepts of disputed debts, set-offs and cross-claims are dealt with respectively when raised in opposition to a winding-up in petition, in the absence of any forum agreement [26]-[32]. Having reviewed the relevant authorities, the Court concluded that the Re Guy Lam approach is applicable irrespective of whether the dispute that falls within the scope of an exclusive forum agreement has been raised by a dispute of the petition debt, a claim of set-off or a cross-claim that does not give rise to set-off [51].
Key take aways
The Court of Appeal’s twin decisions provide much needed clarity in the law. The discretion is multi-factorial and the Court would not dismiss the creditor’s petition simply because of the existence of an arbitration agreement.
As the Court of Appeal made clear in Re Shandong Chenming, extending Re Guy Lam to cross-claims would not create a debt dodger’s charter. To rely on that approach the debtor would have to show a valid exclusive forum agreement between the parties that governed the cross-claim. In any event, the Court of Final Appeal in Re Guy Lam had built in a safety valve that allows the rule to be displaced where the dispute “borders on the frivolous or abuse of process” [49]. Delay in putting forward a cross-claim may in appropriate circumstances support a finding that it was raised in abuse of the Court’s process as a pretext to stave off a winding-up [50].
[1] Lasmos Limited was the name of the creditor petitioner.
[2] Re Southwest Pacific Bauxite (HK) Ltd [2018] 2 HKLRD 449 [31].
[3] Re Southwest Pacific Bauxite (HK) Ltd [2018] 2 HKLRD 449 [31].
[4] Re Simplicity & Vogue Retailing (HK) Co Limited [2024] HKCA 299 [3].
[5] Re Simplicity & Vogue Retailing (HK) Co Limited [2024] HKCA 299 [38]-[39].
[6] Re Simplicity & Vogue Retailing (HK) Co Limited [2024] HKCA 299 [42].
Author
Richard Yip
“One of the strongest junior barristers around, his stand-out qualities include an excellent handle on the detail, an insightful legal mind, and sound commercial sense.”
Legal 500 Asia-Pacific 2021 – 2024, Commercial Disputes — Leading Juniors, Tier 1
Richard has a broad civil practice with a focus on shareholder disputes, commercial litigation, financial regulation, competition law and personal injuries. He joined Denis Chang’s Chambers in 2011. Prior to joining the bar, Richard was a corporate finance solicitor at Herbert Smith Freehills.
He represented four respondents in the second case before the Hong Kong Competition Tribunal, where the economic efficiency defence was raised for the very first time in Hong Kong. He was also involved in a number of substantial shareholder disputes, including Acropolis Ltd v W&Q Investment Ltd, 2018 HKCA 379 (appeal against interlocutory injunction concerning the EGM voting results of a listed company) and Waddington Ltd v Chan Chun Hoo Thomas, HCA 3291/2003 (trial of a double derivative action).Richard is also actively involved in the community and academia. He is a part-time lecturer at the University of Hong Kong.
Visit Richard’s profile for more details.
Samantha Lau
Samantha graduated from the University of Hong Kong with double first-class degrees in law and government, before attending Harvard Law School for postgraduate studies, where she graduated with a top prize for her essay on equality law. She later served as a judicial assistant of the Court of Final Appeal of Hong Kong, before being awarded the Hong Kong Bar Scholarship. She is also called to the Bar in New York.
Samantha accepts instructions in all areas of Chambers’ practice. She has a wide civil practice with an emphasis on civil and commercial litigation, as well as international arbitration. She has experience in arbitration before SIAC, LCIA and HKIAC.
Samantha is able to provide legal advice and conduct hearings in English, Mandarin and Cantonese.
Visit Samantha’s profile for more details.
Keith Cheung
Keith is developing a broad civil practice with particular experience and interest in commercial litigation, company law, insolvency, arbitration, trusts, probate and intellectual property. He has represented domestic, Mainland and overseas clients in Hong Kong and worked with legal teams in offshore litigation in the Cayman Islands and the British Virgin Islands.
Keith is a member of the Chartered Institute of Arbitrators and the Hong Kong Institute of Arbitrators.
Prior to joining the Bar, Keith qualified as a solicitor with a major international law firm. He has received awards from international and domestic mooting competitions including the Best Speaker Award from a practitioners’ moot organised by Essex Court Chambers and the Singapore Academy of Law.
Find out more from Keith’s profile.
This article was first published on 24 April 2024.
Disclaimer: This article does not constitute legal advice and seeks to set out the general principles of the law. Detailed advice should therefore be sought from a legal professional relating to the individual merits and facts of a particular case. The photographs which appear in this article are included for decorative purposes only and should not be taken as a depiction of any matter to which the case is related. The views and opinions expressed in this article/material are solely those of the members authoring it and do not necessarily reflect the official policy or position of Denis Chang’s Chambers, or of any other member or members of Denis Chang’s Chambers.