Back to basics - Hong Kong Court of Appeal queries approach to winding-up petitions where arbitration is involved

Hogan Lovells

The Hong Kong Court of Appeal has suggested that a previous Court decision may have overstepped the mark by suggesting that an arbitration clause in a client agreement should generally take precedence over a creditor's right to present a winding-up petition.

In But Ka Chon v Interactive Brokers LLC [2019] HKCA 873 (an otherwise fairly routine financial product misrepresentation case), Vice President of the Court of Appeal Madam Justice Kwan made obiter comments implying that the test previously set out by Harris J last year in Lasmos Limited v Southwest Pacific Bauxite (HK) Limited [2018] HKCFI 426, which followed recent English authority, appeared to be at odds with classical Hong Kong and Commonwealth authority whereby a winding-up petition may only be dismissed by establishing a bona fide defence on substantial grounds to the claim for the underlying debt.

Margin of error

But Ka Chon concerned an appeal against a judge's decision to dismiss the plaintiff's application to set aside the statutory demand issued by the defendant in the sum of almost HK$80 million. The plaintiff was an experienced trader whose Swiss Franc/Euro margin account with the defendant suffered significant losses upon the unpegging of the exchange rate.

The defendant started liquidating the position after the plaintiff failed to inject funds to resolve the deficit. The defendant issued a statutory demand for the sum owing on 23 November 2016 which was served on the plaintiff on 12 December 2016.

The plaintiff sought to set aside the demand, arguing in a counterclaim that the defendant had mishandled the account and also that the dispute should be referred to arbitration pursuant to a clause in the client agreement.

Old or new?

Before the Lasmos case, the position in Hong Kong had been that a winding-up petition based on the ground of insolvency would not be stayed to arbitration if the debt arises under an agreement which contains an arbitration clause. To defeat the petition, the debtor must first demonstrate that it has a "bona fide defence on substantial grounds to the claim for the underlying debt" (Re Sky Datamann (Hong Kong) Limited (unrep., HCCW 487/2001).

But recent authority in Singapore and England had taken a different approach, with the English Court of Appeal holding in Salford Estates (No 2) Ltd v Altomart Ltd (No 2) [2015] that a winding-up petition should be dismissed in favour of arbitration, saying "it would be anomalous, in the circumstances, for the Companies' Court to conduct a summary judgment type analysis of liability for an unadmitted debt, on which a winding up petition is grounded, when the creditor has agreed to refer any dispute relating to the debt to arbitration", as that would be "entirely contrary to the parties' agreement as to the proper forum for the resolution of such an issue and to the legislative policy of the 1996 [Arbitration] Act".

Harris J in Lasmos was attracted to this reasoning, suggesting that a Court should generally dismiss winding-up petitions if: (a) a company disputes the debt relied upon by the winding-up petitioner; (b) the contract under which the debt is alleged to have arisen contains an arbitration clause that covers any dispute relating to the debt; and (c) the company takes the steps required under the arbitration clause to commence the contractually mandated dispute resolution process and files an affirmation in accordance with Rule 32 of the Companies (Winding Up) Rules (Cap 32H) demonstrating this (see Hogan Lovells client briefing Winding-up petition v arbitration clause: Hong Kong Court dismisses winding-up petition in favour of arbitration clause).

The Court in Lasmos did provide for circumstances in which a creditor whose debt is disputed would be justified in issuing a winding-up petition prior to the conclusion of arbitration, for instance a risk of misappropriation of assets or some other matter, which would normally justify the appointment of provisional liquidators.

The Court of Appeal dismissed the appeal in But Ka Chon (and a related counterclaim) querying whether the plaintiff ever had any genuine intention to arbitrate and noting that no Notice of Arbitration had ever been served on the defendant. But Kwan V-P went on to discuss the Lasmos approach and whether it was appropriate for insolvencies in Hong Kong.

Obiter remarks

Kwan V-P made the following pithy observations:

  • It was clear on the authorities that a petition (whether for winding up or bankruptcy) does not come within the wording of article 8(1) of the UNCITRAL Model Law, in that it is not "brought in a matter which is the subject of an arbitration agreement". There was therefore no automatic, mandatory or non-discretionary stay under that provision;
  • The courts have a discretionary power under the insolvency legislation whether to dismiss or stay a petition where the alleged debt arises out of a transaction containing an arbitration agreement;
  • The creditor has a statutory right to petition for bankruptcy or winding-up on the ground of insolvency. It was contrary to public policy to preclude or fetter the exercise of this statutory right. The Lasmos approach represents a substantial curtailment of this statutory right;
  • The Salford approach was itself open to question, since it was highly unlikely that Parliament had intended section 9 of the Arbitration Act 1996, in the words of Etherton C in Salford, to confer on the debtor the right to a non-discretionary order striking at the heart of the Court's winding up jurisdiction;
  • The Court of Appeal had not been referred to any legislative materials in the enactment of the Arbitration Ordinance in 2011 as indicating a legislative intent to change the position in Hong Kong;
  • The Lasmos approach had not been followed by the Eastern Caribbean Court of Appeal in Jinpeng Group Ltd v Peak Hotels and Resorts Ltd, "as the BVI court's statutory jurisdiction to wind up a company based on its inability to pay its debts as they fall due unless the debt is disputed on genuine and substantial grounds is 'too firmly a part of BVI law' to now require a creditor exercising the statutory right to prove exceptional circumstances to establish his status to wind up a company. The statutory jurisdiction is satisfied once the creditor is applying on the basis of a debt that is not disputed on genuine and substantial grounds. The position is the same as regards the insolvency legislation in Hong Kong";
  • Considerable weight should be given to the factor of arbitration in the exercise of the discretion and it would be wrong to encourage parties to an arbitration agreement to try to bypass the agreement by presenting a winding-up petition;
  • If a debtor wishes to obtain a stay of winding-up proceedings, the debtor must establish in the usual way there is a bona fide dispute on substantial grounds. If it fails to do so, it can expect only a short adjournment to enable it to commence the arbitration. It cannot simply put up its hands and say the Court has no jurisdiction because of the agreement.

As you were

The case reaffirms the traditional Hong Kong position, that a winding-up petition in relation to a liquidated debt may only be dismissed where there is a bona fide dispute on substantial grounds, despite the presence of an arbitration clause in the agreement.

Creditors may welcome the restatement of the classical position, whilst still being mindful of the complexity and costs of arbitration should the alleged debtor succeed in convincing the court of the existence of a genuine dispute.

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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