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- The Hong Kong position: stay or dismiss winding-up petition absent countervailing factors
- The England and BVI positions: genuine dispute on substantial grounds
- Implications of the diverging decisions
How does an arbitration clause, or an exclusive jurisdiction clause in favour of foreign courts, affect insolvency proceedings?
The effect of an arbitration clause, or an exclusive jurisdiction clause in favour of foreign courts, on insolvency proceedings has been a topic of longstanding debate in the Courts of Hong Kong, England and other common law jurisdictions.
The UK Privy Council was recently faced with this topic in Sian Participation Corp (In Liquidation) v Halimeda International Ltd [2024] UKPC 16. The Board held that the correct test, as a matter of British Virgin Islands (BVI) law and English law, is the “Established Approach”, i.e., whether the petitioned debt is disputed on genuine and substantial grounds. If the test is not satisfied, the Court shall exercise its insolvency jurisdiction to grant a winding-up or bankruptcy order, even if the disputed debt is subject to an arbitration clause or an exclusive jurisdiction clause in favour of foreign courts.
This marks a clear divergence from the seemingly settled Hong Kong jurisprudence in Re Guy Kwok Hung Lam [2023] HKCFA 9, Re Simplicity & Vogue Retailing (HK) Co., Limited [2024] HKCA 299 and Re Shandong Chenming Paper Holdings Limited [2024] HKCA 352. These cases held that the Established Approach should not apply where the petitioned debt is subject to an arbitration clause or an exclusive jurisdiction clause in favour of foreign courts, and Hong Kong Courts should generally exercise its insolvency jurisdiction to dismiss or stay a bankruptcy or winding-up petition pending the determination of the disputed debt in the agreed forum absent countervailing factors.
In this article, our litigation, arbitration and insolvency specialists in Hong Kong consider the diverging approaches between Re Guy/Re Simplicity/Re Shandong and Sian Participation, as well as the practical implications that the Privy Council’s decision may have in this evolving area of law.
The Hong Kong position: stay or dismiss winding-up petition absent countervailing factors
In our earlier client bulletin Bankruptcy petition vs exclusive jurisdiction clause - who has the last word? we considered the implications of the Court of Final Appeal (CFA) decision in Re Guy Kwok Hung Lam [2023] HKCFA 9 (Re Guy). The CFA confirmed that, for a disputed petition debt subject to an exclusive jurisdiction clause in favour of a foreign court (EJC), absent “countervailing factors” (such as the risk of insolvency affecting third parties and a dispute that borders on the frivolous or abuse of process), the parties ought to be held to their agreed forum.
Since then, the Hong Kong Court of Appeal (CA) handed down two decisions, Re Simplicity & Vogue Retailing (HK) Co., Limited [2024] HKCA 299 (Re Simplicity) and Re Shandong Chenming Paper Holdings Limited [2024] HKCA 352 (Re Shandong), which clarified that the Re Guy approach also applies if:
(i) a disputed debt is subject to an arbitration agreement; or
(ii) if a debtor has a claim for set-off or cross-claim subject to an arbitration clause, such that the Hong Kong Court will, absent countervailing factors (such as abuse of process), exercise its discretion to stay or dismiss a winding-up petition pending determination of the disputed debt in accordance with the arbitration clause.
The Court would adopt a “multi-factorial” approach in exercising its insolvency discretion, and would need to be satisfied of the debtor’s genuine intention to arbitrate, which may include commencing arbitration or engaging in preliminary steps such as mediation.
The practical effect of Re Guy, Re Simplicity and Re Shandong is that, when the petitioned debt is subject to an arbitration clause or an EJC, creditors will, absent “countervailing factors”, very likely be held to their agreed forum (i.e., foreign courts or arbitration) when attempting to invoke the Court’s insolvency jurisdiction against debtors, even if the dispute on the petitioned debt does not meet the threshold of a genuine dispute on substantial grounds. In other words, the Established Approach generally does not apply in the context of arbitration clauses or EJCs.
The England and BVI positions: genuine dispute on substantial grounds
In Sian Participation Corp (In Liquidation) v Halimeda International Ltd [2024] UKPC 16 (Sian Participation), a Privy Council case recently decided after Re Guy, Re Simplicity and Re Shandong, the creditor made a liquidation application against the company in the British Virgin Islands (BVI) on the basis of a petitioned debt subject to an arbitration clause. Both BVI Courts at first instance and on appeal upheld the creditor’s liquidation application on the basis that the company failed to show that the debt was disputed on genuine and substantial grounds. The company appealed to the Privy Council for a determination on what the correct test is when Courts exercise their insolvency jurisdiction when the debt is subject to an arbitration agreement.
The Privy Council held that the correct test, as a matter of BVI law and English law, is the Established Approach, i.e. whether the petitioned debt is disputed on genuine and substantial grounds. The Courts cannot simply exercise their discretion to stay or dismiss a winding up petition on the basis that the debt is covered by an arbitration clause or EJC. The reason is simple – insolvency proceedings do not seek to, nor do they resolve any dispute in relation to the petitioned debt, and are not covered by “generally worded” arbitration clauses or EJCs. Even if a winding-up order is granted, a liquidator is free to dispute the petitioned debt and reject a creditor’s proof of debt. On the other hand, the Privy Council noted that different considerations would arise if the agreement or clause was framed in terms which may apply to a creditor’s winding-up petition.
Sian Participation is a significant decision reversing the English law “pro-arbitration” approach in Salford Estates (No 2) Ltd v Altomart Ltd (No 2) [2014] EWCA Civ 1575; [2015] Ch 589 (Salford Estates), where it was held that a winding-up petition should be dismissed in favour of arbitration unless there are “wholly exceptional circumstances”. Note that Hong Kong Courts have endorsed the approach in Salford Estates – in Re Simplicity, the Court of Appeal adopted a “multi-factorial” approach and explained that the “wholly exceptional circumstances” test should not obscure the range of considerations relevant to the court’s discretion. In arriving at its decision, the Privy Council considered the Hong Kong Court of First Instance case Dayang (HK) Marine Shipping Co Ltd v Asia Master Logistics Ltd [2020] HKCFI 311 and the Hong Kong Court of Appeal case But Ka Chon v Interactive Brokers LLC [2019] HKCA 873, where the Courts in both cases expressed doubt on the Salford Estates approach for imposing an unprecedented fetter upon the Court’s discretion to wind up.
Going forward, when faced with a winding-up petition in the BVI or English Court, a company cannot simply rely on an arbitration clause or an EJC to circumvent the Court’s insolvency jurisdiction in making a winding-up order unless there is a genuine dispute on the petitioned debt on substantial grounds.
Implications of the diverging decisions
Sian Participation represents a stark divergence from Hong Kong insolvency jurisprudence, as it has essentially adopted the Established Approach in the context of arbitration clauses and EJCs. Although the judgment itself is not binding in Hong Kong, its potential implications on the previously settled approach in Re Guy Lam/Re Simplicity/Re Shandong cannot be neglected. Sian Participation will no doubt be relied upon when the Hong Kong Court next considers, likely in the near future, the interplay between insolvency and arbitration or EJCs.
Potential practical implications of the diverging decisions are summarised below:
- Effect of arbitration clause/EJC on insolvency proceedings is presently unsettled in common law jurisdictions other than England and the BVI.
Sian Participation addresses the position under BVI law and English law. However, it remains to be seen whether Courts in other common law jurisdictions such as the Cayman Islands or Singapore will adopt the Sian Participation approach. Given this uncertainty, and in circumstances where many cross-border financing structures involve obligors from these jurisdictions, insolvency practitioners should watch this space for future developments.
In Hong Kong, we expect that creditors will rely on Sian Participation in future winding-up proceedings to advocate for the Established Approach when the petitioned debt is subject to an EJC or arbitration clause, or at least argue that Sian Participation is persuasive authority when the Courts apply the “multi-factorial” approach in exercising its insolvency jurisdiction.
There may be a time when this issue is further debated before the CFA, but until then, Re Guy Lam/Re Simplicity/Re Shandong remain the leading appellant authorities as a matter of Hong Kong law.
- Parties to consider tailoring dispute resolution clauses to cover insolvency proceedings.
The Privy Council emphasised in its judgment that the test on whether the debt is disputed on genuine and substantial grounds applies to a “generally worded” arbitration agreement or EJC. It is therefore conceivable for parties to tailor an arbitration or EJC to make clear that arbitration or foreign court proceedings have the effect of suspending the Court’s insolvency jurisdiction for winding-up proceedings brought about by either party (or both).
The precise wording of the dispute resolution clause in question is an important factor in determining Court’s approach in exercising its insolvency jurisdiction in face of arbitration or EJC. Accordingly, it is important for creditors to carefully consider the preferred dispute resolution mechanism early at the document drafting and negotiation stage. In doing so, creditors are recommended to game out all potential enforcement scenarios and consider options that could best achieve their intended objective, be it achieving recovery or maximising leverage by commencing winding-up proceedings, arbitration proceedings or court proceedings.
For transactions involving multiple contracts, parties should consider aligning dispute resolution clauses across contracts to avoid further complications. For parties that have already agreed to EJCs or arbitration clauses on day one of a transaction, it will be prudent to consider putting dispute resolution clauses on the agenda when deals are up for re-negotiation.
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