Introduction

When a company has become unable to pay a debt owing under an agreement, the creditor can present a winding up petition against the company. What if the company argues that the creditor had breached its duty under the agreement and the agreement contains an arbitration clause? Can the company, in the winding-up proceedings, rely on the arbitration clause and argue that the dispute should be resolved by way of arbitration? In Dayang (HK) Marine Shipping Co Ltd v Asia Master Logistics Ltd [2020] HKCFI 311, the Court of First Instance clarified the position of Hong Kong law and ruled that when a debtor opposes a winding up petition, it has the burden of proving the debt is disputed in good faith and on substantial grounds, and the existence of an arbitration clause does not absolve the debtor of such burden in the winding up proceedings.

Background of the case

Dayang (HK) Marine Shipping Co Ltd (“Dayang”) and Asia Master Logistics Ltd (“Asia Master”) entered into a charterparty in which Dayang chartered its vessel to Asia Master (the “Agreement”). Asia Master agreed, among other things, to pay the hire of the vessel every 10 days in advance and the Agreement contained an arbitration clause to the effect that arbitration will take place in Hong Kong with English law to be applied.

Asia Master chartered the vessel for approximately 77 days and the amount of hire was US$321,377.30 (the “Debt”). However, the debt remained outstanding. Dayang then petitioned to wind up Asia Master. Asia Master did not deny that the Debt was due and owing but it argued that Dayang had breach its duties under the Agreement that Dayang should bear some responsibility of the losses it suffered and it sought to rely on the arbitration clause to resolve the dispute. The Court found that Asia Master was not in a position to say that its counterclaim would exceed and extinguish the Debt and, in any event, Asia Master failed to produce sufficient evidence to support the alleged breach of duties on the part of Dayang.

The traditional approach and the Lasmos approach

Under the traditional approach, a debtor may apply to dismiss or stay a winding up petition on the ground that there is a bona fide dispute on substantial grounds, irrespective of the existence of any arbitration clause. It is not permissible for the debtor to merely deny the existence of the debt (the “Traditional Approach”).

In this case, Asia Master sought to rely on the case Re Southwest Pacific Bauxite (HK) Ltd [2018] 2 HKLDR 449 in which it was held that a winding up petition should general be dismissed if (1) a company disputes the debt relied on by the petitioner; (2) the contract under which the debt is alleged to raise contains an arbitration clause that covers any dispute relating to the debt; and (3) the company takes the steps required under the arbitration clause to commence the contractually mandated dispute resolution process (the “Lasmos Approach”).

The Court found that Asia Master had not taken steps to commence arbitration, so even under the Lasmos Approach, a winding up order should be made. Against this background, the Court provide analysis of the approach under Hong Kong law.

The decision

The Court held that it has a flexible discretion in making a winding up order, however, the Lasmos Approach is antithetical to the nature of a discretion and represents an unprecedented fetter on the Court’s discretion. The inflexibility in the Lasmos Approach might also be prejudicial to the interests of creditor-petitioners.

Further, the Court found that the Lasmos Approach is far from settled under Singapore law and English law and noted the hesitancy by the Singapore courts to stay or dismiss winding up proceedings on the mere say-so of the debtor-company.

Having analysed the application of the Traditional Approach and the Lasmos Approach in different cases, the Court relied primarily on the Traditional Approach in making a winding up order against Asia Master and summarised that the present state of the law should be as follows:

1.        Where a debtor-company intends to dispute the existence of a debt, it must show that there is a bona fide dispute on substantial grounds. It should not be suffice for the debtor-company to merely deny the debt. This test would apply in all cases whether or not the debt had arisen from a contract incorporating an arbitration clause.

2.        The existence of an arbitration agreement should be regarded as irrelevant to the exercise of discretion by the Court.

3.        The fact that arbitration proceedings have commenced or would be commenced may be relevant evidence that there is a bona fide dispute. However, this alone would not be sufficient to prove the existence of a bona fide dispute on substantial grounds.

4.        Where the creditor-petitioner petitions in circumstances where it knows there to be a bona fide dispute over the debt on substantial grounds, it runs the risk of being liable to pay the debtor-petitioner’s costs on an indemnity basis. It would also be at risk of liability under the tort of malicious prosecution.

Conclusion

This case sheds light on the developments in relation to how the Court will deal with a winding up petition with respect to the existence of an arbitration clause in the agreement or arbitration proceedings. However, it remains to be seen whether the appellate court will adopt the Lasmos Approach and how it views the reasoning and decision in this case.

Debtors are reminded that the existence of an arbitration agreement or an arbitration proceedings may not be helpful in absolving debtors from a winding up proceedings. Showing that there is a bona fide dispute over the debt on substantial grounds is essential in persuading the Court to dismiss the winding up petition.

In any event, a creditor who wishes to issue a winding up petition against its debtor is suggested to seek professional advice from its lawyers before commencing any actions, especially when there will be a bona fide dispute over the debt, to avoid adverse costs consequences.