The Court of Appeal has  finally laid to rest the issue of whether an arbitration agreement or a winding-up petition should take precedence in an insolvency context. The Court of Appeal handed down two parallel rulings in which the issue was finally determined, after a series of conflicting first instance decisions.

In Simplicity & Vogue Retailing (HK) Co., Limited [2024] HKCA 299 簡尚零售 (香港) 有限公司, the Court of Appeal (Hon Kwan VP, Barma JA and G Lam JA) was asked to decide whether the approach regarding exclusive jurisdiction clauses (EJC) in bankruptcy proceedings laid down by the Court of Final Appeal in Re Lam Kwok Hung Guy (2023) 26 HKCFAR 119, should also apply where there is an agreement between the parties to refer their dispute relating to the petition debt to arbitration.

First instance decisions queried

At first instance in Simplicity, the Honourable Madam Justice Linda Chan dismissed an argument that the petition should be stayed because of the presence of an arbitration clause in a bond instrument and guarantee, since the company had taken no steps to commence arbitration. She said that in her view, the ratio in Re Lam Kwok Hung Guy should apply only to EJCs not arbitration clauses.

For his part, the Honourable Mr Justice Harris – when deciding Shandong Chenming Paper Holdings Ltd [2023] HKCFI 2065 at first instance - saw no difference between an EJC and an arbitration clause. This was an approach he had set out in his 2018 decision Lasmos Limited v Southwest Pacific Bauxite [2018] HKCFI 426. Harris J had no doubt that the Lasmos approach “applies to arbitrations just as it has been expressly found to apply to EJCs (this is not in dispute) and that, secondly, the judgment applies to disputed debts and cross-claims”. He nevertheless granted leave to appeal.

Court of Appeal

In Simplicity, the Court of Appeal noted there had been a “divergence of views in the Court of First Instance whether the Lasmos approach should be followed.” (see Hogan Lovells alerter Agree to disagree – does winding-up or arbitration take precedence in insolvency?)

The controversy, the Court of Appeal noted “is whether the debtor should be required to demonstrate a bona fide dispute of the petition debt on substantial grounds notwithstanding the existence of an arbitration clause in order for a petition to be stayed or dismissed”. It was now “appropriate that this controversy should be laid to rest”.

The Court of Appeal rehearsed the “cogent reasons” why the EJC approach should apply equally in the context of arbitration clauses.

There was no reason why the question whether the debt is disputed in good faith on substantial grounds, should not be determined through the agreed dispute resolution mechanism. The question was whether the petitioner had the requisite standing to lodge the petition in the first place. The Court of Appeal noted the “strong policy of the law to require parties to abide by their contracts”. There was “no reason why a creditor’s voluntary surrender of rights to petition for winding up should be held unenforceable for being contrary to public policy.” However, what was required is a genuine intention to arbitrate, such as commencing arbitration or engaging in the preliminary steps such as mediation. 

The Court of Appeal said it would be an anomaly that a party bound by a dispute resolution clause could not expect to proceed with an ordinary action for his claim, “but can resort to the more draconian measure of presenting a petition for winding up or bankruptcy and expect the court to deal with it by determining whether the debtor has raised any bona fide dispute on substantial grounds.”

In this case, there was no evidence in opposition and nothing to show that the petitioning debt was disputed.  Although the company had confirmed it intends to and will formally commence an arbitration and stated in its skeleton submissions it would rely on the arbitration clause, that could not be regarded as sufficient and proper evidence to indicate that the petition debt was disputed and that the dispute would be referred to arbitration.  The defence raised was also wholly without merit and bordered “on the frivolous or abuse of process”. That would be a sufficient countervailing factor which militated against the exercise of discretion to decline jurisdiction in the winding-up petition and hold the parties to their agreement to arbitrate.

Broad interpretation

In Shandong Chenming Paper Holdings Limited [2024] HKCA 352, the Court of Appeal indicated, in dismissing the petitioner’s appeal,  that it was prepared to give the principle a wide application, saying “we consider that the Guy Lam approach is applicable 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.”  There is no real difference in

principle between cross-claims and disputes of debt as grounds of resistance to winding-up.

Welcome clarity

The Court of Appeal decisions provide welcome clarity on an issue that has vexed creditors and litigators alike in recent years. They align Hong Kong with the position in Singapore following the test set out in AnAn Group (Singapore) Pte Ltd [2020] 1 SLR 1158, which was itself further refined in a decision late last year (see Hogan Lovells alerter AnAn refined - Singapore Court of Appeal allows winding-up in spite of arbitration agreement).

Whilst upholding the sanctity of the parties’ bargain, the decisions do however leave creditors with very real questions to answer when wishing to issue winding up proceedings when faced with late applications to arbitrate.

A creditor seeking a winding-up petition should come to court with a complete understanding of the factual matrix. Although it is likely that the court will defer to the debtor if an arbitration clause is present, the creditor will want the court to use its discretion to the fullest and take into account any delay in the commencement of arbitration indicating a genuine intention to arbitrate, bad faith or impropriety on behalf of the debtor. 

Where the parties agreed to have all the disputes under the agreement giving rise to the cross-claim determined in another forum, the public policy in holding parties to their agreements comes into play, just as it does in a disputed debt case.

Debtors have now also been warned that delays in putting forward a cross-claim may not find much sympathy from the court if the cross-claim is considered merely a means of staving off a winding-up and an abuse of the court’s process.

From the point of view of the debtor, applications to arbitrate must be genuine and filed in good time. Concrete steps should be taken to show as evidence to the court of a genuine intention to arbitrate.