Revisit the Hong Kong position: When dispute resolution clauses meet insolvency proceedings

Introduction

Before the landmark decision of the Hong Kong Court of Final Appeal in Guy Kwok-Hung Lam v Tor Asia Credit Master Fund LP [2023] HKCFA 9 (“Re Guy Lam”), there had been a long-standing debate over the impact, if any, of an exclusive jurisdiction clause in favour of a foreign court (“EJC”) on the presentation of bankruptcy / winding-up petitions.

In short, it is now well-settled that in an ordinary case where the petition debt is disputed and the dispute is subject to an EJC, the petition is liable for dismissal unless there are countervailing factors, such as the risk of the debtor’s insolvency impacting third parties and the debtor’s reliance on disputes that border on the frivolous or abuse of process.

The approach in Re Guy Lam has been extended to insolvency proceedings where the petition debt is disputed and the dispute is subject to an arbitration clause.        

Re Guy Lam: The “multi-factorial” approach 

Case Background

The respondent disputed an alleged debt arising out of a Credit and Guaranty Agreement which contained an EJC in favour of the New York Courts.  The respondent contended that the dispute should be determined by a New York Court pursuant to the EJC, and a bankruptcy order should not be made by the Hong Kong Court on the basis of the EJC.

In the Court of First Instance, the first instance judge made a bankruptcy order on the basis that the respondent failed to show that there was a bona fide dispute on substantial grounds in respect of the petition debt.  

The Court of Appeal reversed the first instance decision, set aside the bankruptcy order and dismissed the bankruptcy petition.

The decision of the Court of Appeal was affirmed by the Court of Final Appeal. 

Decision of the Court of Final Appeal

To start with, the insolvency jurisdiction conferred on the Court of First Instance is not amenable to exclusion by contract.  An agreement between the parties to an EJC only informs the Court’s discretion to decline to exercise its jurisdiction. 

In the ordinary case of an 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 petitioner and the respondent ought to be held to their contract.  In particular, the respondent is not required to demonstrate that there is a bona fide dispute on substantial ground over the petition debt.  

It is important to note that the approach of the Court in exercising its discretion is “multi-factorial”.  While a “strong cause” test is indicated, it should not obscure the range of considerations relevant to the Court’s discretion.  The public policy of the legislative scheme for the Court’s insolvency jurisdiction may assume greater prominence where the grounds for disputing the debt are obviously insubstantial.  Where there is no evidence of a creditor community at risk, the significance of such public policy is much diminished. 

Re Guy Lam followed in insolvency proceedings involving an arbitration agreement  

The approach in Re Guy Lam is followed by the Court of Appeal in Re Simplicity & Vogue Retailing (HK) Co Ltd [2024] HKCA 299 (“Re Simplicity”) and Re Shandong Chenming Paper Holdings Ltd [2024] HKCA 352 (“Re Chenming”), both of which concern the effect of an arbitration agreement in the insolvency context.  As a matter of stare decisis, the Court of Appeal’s approach in Re Simplicity and Re Chenming is binding on and followed by the Court of First Instance in its recent decision in Re Mega Gold and Re Man Chun Sing Matthew (heard together in [2024] HKCFI 2286) (“Re Mega Gold”).

The following are some of the key points to note from these recent judgments: 

1. Re Simplicity - The Court of Appeal has highlighted that, in view of the statutory framework protective of arbitration in Hong Kong, there is “an even stronger case for upholding the parties’ contractual bargain that disputes falling within the scope of the arbitration should be resolved by arbitration”.  Sufficient and proper evidence to indicate that the petition debt is disputed is still required.  Building onto the approach in Re Guy Lam, the Court of Appeal has further held that, in the case of arbitration agreements, the respondent should also demonstrate that there is a genuine intention to arbitrate. The steps required under the arbitration clause to commence the process may include preliminary stages such as mediation.  Even if no step at all has been taken, in an appropriate case, the Court may exercise its discretion to grant a short adjournment for the respondent to commence arbitration. 
2. Re Chenming - Unlike the respondent in Re Simplicity who sought to refer a dispute over the petition debt to arbitration, the respondent in Re Chenming sought to refer to arbitration its cross-claim which was greater than the amount of the petition debt.  It was held that the same approach would apply to disputes over the petition debt and the cross-claim (whether it would give rise to set-off or not) which were subject to an arbitration agreement. 
3. Re Mega Gold – The issue of whether the defence put forward by a respondent bordered on the frivolous or abuse of process is fact-specific.  The Court of First Instance recognised that it was a high threshold which would usually require one to show that the defence was bound to fail and hence would not warrant a chance to be further investigated at trial. 

Commentary

It is worth noting that the approach adopted by Hong Kong Court departs from the English Privy Council’s judgment in Sian Participation Corp (in Liquidation) v Halimeda International Ltd [2024] UKPC 16 for winding-up and bankruptcy petitions concerning arbitration agreements. 

Parties should be alert to the potential differences in the approach adopted by the insolvency courts across jurisdictions and, in such context, carefully consider the implications of agreeing to an EJC and/or arbitration agreement.