Introduction

It is well established in law that a dispute over a petition debt is a basis of dismissing a bankruptcy petition, as confirmed in the Court of Final Appeal in Re Lam Kwok Hung Guy, ex p Tor Asia Credit Master Fund LP (2023) 26 HKCFAR 119 (“Guy Lam Case”). The question that follows is whether this rationale only has limited application on disputed debts, or whether it can be extended to set-offs and cross-claims in winding-up petitions. This issue is examined by the Court of Appeal in Arjowiggins Hkk 2 Ltd v Shandong Chenming Paper Holdings Ltd (2024) HKCA 352.

Brief facts

In October 2005, the Petitioner and the Company entered into a joint venture agreement (the “Agreement”). The Agreement is governed by the laws of the People’s Republic of China and contains an arbitration clause which provides that any dispute arising out of or in connection with this Agreement shall be referred to and finally resolved by arbitration in Hong Kong in accordance with the Arbitration Rules of the Hong Kong International Arbitration Centre.

Disputes subsequently arose between the parties, and in October 2012, pursuant to the arbitration clause in the Agreement, the Petitioner commenced arbitration against the Company for breach of contract. The arbitral tribunal rendered its award in November 2015, ordering the Company to pay damages to the Petitioner. On 18 October 2016, the Petitioner served a statutory demand on the Company for, among others, the damages ordered. The Company did not pay any part of the amounts demanded. Instead, on 7 November 2016, it applied to Harris J for, and obtained, an injunction to prevent the Petitioner from presenting a petition to wind it up. A second set of arbitration was issued by the Company against the Petitioner in October 2018 seeking recovery of the books and records of the joint venture company in the Petitioner’s possession but the Final Award in favour of the Company was set aside. The Company commenced a third set of arbitral proceedings against the Petitioner on 20 June 2022 pursuing, among others, a cross-claim against the Petitioner for breach of the Agreement in an amount exceeding the remainder of the petition debt.

Reference was made to the Guy Lam Case where the Court of Final Appeal held that where the petition debt is disputed and the dispute is subject to an exclusive jurisdiction agreement between the parties in favour of another forum, the petition should not be allowed to proceed. The issue before the Court of Appeal in this case is whether the approach in the Guy Lam Case would equally apply in the context of a cross claim.

Harris J’s decision

Harris J essentially adopted the approach of the Guy Lam Case and held that where the debtor shows it has a genuine and serious cross-claim, the winding-up petition will be stayed or dismissed. In other words, there is no difference of approach to disputed debts and cross-claims generally. The Petitioner appealed against Harris J’s decision.

The Court of Appeal

The Court of Appeal set out the following guiding principles on disputed debts, set-offs, and cross-claims in winding-up petitions:

1.       In case of disputed debts, one must ask whether there is a bona fide dispute of the petition debt on substantial grounds. If there is, the petition is usually dismissed, leaving it to the petitioner to establish itself as a creditor by a judgment obtained in a civil action.

2.       If the company opposes the winding-up petition by relying on a claim that set-off against the petition debt, it is also treated as a dispute of the petition debt as a transaction set-off operates in complete or partial defeasance of the claim.

3.       In case of a cross-claim, while in principle such a cross-claim does not affect the petitioner’s standing to petition as a creditor because the petition debt exists independently, it has been the settled approach of the courts in Hong Kong to treat such cross-claims in the same way as disputes of the petition debt.

Accordingly, the Petitioner’s appeal was dismissed.

Takeaway

Creditors must prudently consider whether to commence a winding-up petition against the debtors when there is a possibility of a cross-claim being raised. As is now confirmed by the Court of Appeal, a cross-claim which is of a larger amount of petition debt may result in the winding-up petition being stayed.