Key takeaways
The Court of Appeal held in two recent decisions that a winding up petition should usually be stayed or dismissed where the petition debt is subject to an arbitration agreement: Re Simplicity & Vogue Retailing (HK) Co., Limited [2024] HKCA 299 (“Re Simplicity”) and Arjowiggins HKK 2 Limited v Shandong Chenming Paper Holdings Limited [2024] HKCA 352 (“Arjowiggins”). This follows the Court of Final Appeal decision in Re Guy Kwok Hung Lam [2023] HKCFA 9 (“Re Guy Lam”) which adopted a similar approach for a petition debt governed by an exclusive jurisdiction clause (“EJC”) (previously noted here). Arjowiggins further held that the same approach should apply to a cross-claim subject to an arbitration agreement, while Re Simplicity noted that it is unnecessary for the debtor to have commenced arbitration proceedings to rely on the arbitration agreement.
Background
In Re Simplicity, the company guaranteed the payment obligation for certain convertible bonds which the issuer defaulted. The company was called upon to honour the guarantee but it only made partial payments for the amount owed. Following an unsatisfied statutory demand, the petitioner petitioned for the winding-up of the company. The company argued that as both the bond instrument and the guarantee contained arbitration clauses, any dispute over them should be referred to arbitration. It also argued that the guarantee was discharged by variation of contract. The Court of First Instance made a winding up order against which the company appealed.
In Arjowiggins, the petitioner petitioned to wind up the company for neglecting to pay in full a debt arising from an arbitral award which the petitioner had obtained leave to enforce in Hong Kong. The company applied for the petition to be adjourned or dismissed on the grounds that it had a cross-claim against the company in an amount exceeding the debt and the cross-claim was subject to an arbitration agreement, in respect of which arbitration proceedings had been commenced. The Court of First Instance stayed the petition pending determination of the arbitration proceedings and the petitioner appealed.
Court of Appeal decisions
Re Guy Lam followed
The Court of Appeal in Re Simplicity held that in the absence of “strong reasons”, the court should stay or dismiss the petition if the petition debt is disputed and is covered by an arbitration clause. Examples of strong reasons include the defence being an abuse of process or the existence of risk of insolvency affecting third parties. The Court of Appeal emphasised that the approach of the court in exercising its discretion is “multi-factorial” and it retains flexibility to deal with the case as the circumstances require. This mirrors the approach taken in Re Guy Lam for a debt governed by an EJC.
In Re Guy Lam, the Court of Final Appeal held that the “established approach”, where the court makes a bankruptcy order if it decides that the petition debt is not bona fide disputed on substantial grounds, should not be adopted in the EJC context. Adopting the established approach would require the court to conduct a summary judgment type determination of liability for the debt relied upon, contrary to the parties’ agreed dispute resolution mechanism. The Court of Appeal in Re Simplicity held that such reasoning applied equally, if not more strongly, in the context of arbitration clauses.
Lasmos clarified
In respect of the requirement laid down in Lasmos Limited v Southwest Pacific Bauxite (HK) Limited [2018] HKCFI 426 that the debtor should actively pursue arbitration, the Court of Appeal in Re Simplicity held that what is required is a genuine intention to arbitrate or otherwise taking steps pursuant to the dispute resolution agreement. Commencing preliminary stages such as mediation pursuant to the dispute resolution agreement would suffice. Alternatively, the court could grant a short adjournment for the debtor to commence arbitration if no steps have been taken at the time of the hearing, subject to an undertaking that the debtor proceed with the arbitration without delay.
Application of Re Guy Lam in Re Simplicity
In Re Simplicity, the Court of Appeal held that the company failed to provide sufficient and proper evidence demonstrating that it disputed the debt. The company filed no evidence to oppose the petition. It only asserted that it would rely on the arbitration clause in the skeleton submissions and would commence an arbitration in an affidavit for extension of time. The fact that the company did not pay the sum in the statutory demand was not evidence that the petition debt was disputed either, as part payments were made before the petition was presented. In any event, despite the existence of the arbitration agreement, the Court of Appeal regarded the contract variation defence was devoid of merits and “borders on the frivolous or abuse of process” such that it should exercise the jurisdiction to wind up the company.
Application of Re Guy Lam in Arjowiggins
The appeal in Arjowiggins focused on whether Re Guy Lam applies in a case where the company opposing the petition raises a mere cross-claim which is different from a dispute or a set-off to the petition debt. The Court of Appeal held that a cross-claim greater than or equal to the petition debt should be treated as a dispute of the petition debt itself. Applying the reasoning in Re Guy Lam, if the cross-claim is subject to an arbitration agreement, it would be against the parties’ agreement if the court goes into the merits to consider whether the cross-claim is genuine and serious. While the Court of Appeal noted that delay in putting forward a cross-claim might amount to abuse of process in appropriate circumstances, this did not arise on the facts as the petitioner had withheld documents forming the basis of the cross-claim from the company. For these reasons, the Court of Appeal dismissed the petitioner’s appeal.
Commentary
It is unsurprising that the Court of Appeal followed Re Guy Lam. The Court of Appeal decisions demonstrated the courts’ stance in upholding the parties’ private choice of dispute resolution mechanism by agreement. If the petition debt, a claim of set-off, or a cross-claim is subject to an EJC or an arbitration clause, the court shall usually stay or dismiss the petition for the parties to resolve the dispute in the forum of their choice.
However, this does not mean that an EJC or an arbitration clause can always serve as a shield for the petitioned party to hide behind. The insolvency court retains jurisdiction in exercising its discretion not to hold the parties to the agreed dispute resolution mechanism when it finds that, for example, the risks of insolvency affect third parties and a dispute of the petition debt borders on the frivolous or abuse of process, as demonstrated in Re Simplicity.
When making an active choice on the dispute resolution mechanism, parties should be aware of both the positive and negative aspects of the free choice. The negative aspect is that they are restricted from bringing proceedings other than what has been expressly agreed when a dispute arises.