Introduction

If there is an arbitration clause in the contract between two parties, can one party who claims that an undisputed sum is owed by the party commence winding-up proceedings against the party in default? Some recent Hong Kong cases show that the answer is not entirely certain. This article examines how the Court will exercise its discretion to stay or dismiss a winding up petition in favour of arbitration when the debt upon which the petition is based arises from a contract containing an arbitration clause.

The position before Lasmos

The legal position in Hong Kong prior to Re Southwest Pacific Bauxite (HK) Ltd [2018] 2 HKLRD 449 (“Lasmos”) was that the debtor is required to demonstrate that there is a “bona fide dispute on substantial grounds” (Hollmet Ag & Another v Merdian Success Metal Supplies Ltd [1997] HKLRD 828). The petition will not be automatically stayed in favour of arbitration simply because the debt arises under an agreement which contains an arbitration clause.

Lasmos

In Lasmos, the Honourable Mr Justice Harris departed from the previous Hong Kong authorities and held that the petition should generally be dismissed:

1.          if a company disputes the debt relied on by the petitioner (this is regarded as a dispute sufficient for the purpose of arbitration, without regard to the quality of the dispute or substantive merits);

 

2.          the contract under which the debt is alleged to arise 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 (which might include preliminary stages such as mediation) and files an affirmation in accordance with rule 32 of the Companies (Winding-Up) Rules (Cap. 32H) demonstrating this.

 

The Judge however recognised that there may be exceptional cases in which it will be appropriate to stay the petition, such as where the circumstances justify the appointment of provisional liquidators; e.g., where it is sought to engage the referral back provisions because of substantiated concerns that there had been fraudulent preferences; and where it is sought to engage the avoidance provisions.

But Ka Chon

In a later case But Ka Chon v Interactive Brokers LLC [2019] HKCA 873, the Court of Appeal, in obiter, expressed some reservations on the Lasmos approach. In But Ka Chon, the Court of Appeal agreed with the trial judge that Lasmos was inapplicable as there was no genuine dispute to be arbitrated. Even if Lasmos was applicable, the third requirement (which is to actually commence arbitration) was not satisfied by the debtor in But Ka Chon. The Court of Appeal nonetheless made the following important observations on in obiter:

1.          Insolvency petitions do not come within the wording of article 8(1) of the UNCITRAL Model Law (which has effect by virtue of section 20 of the Arbitration Ordinance (Cap. 609)). It follows that there is no automatic, mandatory or non-discretionary stay under that provision;

 

2.          Pre-Lasmos, there is a discretionary power to be exercised under the insolvency legislation whether to dismiss or stay a petition where the alleged debt arises out of a transaction containing an arbitration agreement. In exercising its discretion, the Court will consider all relevant circumstances, including the financial position of the company, the existence of other creditors, and the position taken by them;

 

3.          Lasmos decided that the discretion under the insolvency legislation should be exercised only one way: the petition should “generally be dismissed” save in exceptional circumstances, upon satisfaction of the three requirements;

 

4.          It is contrary to public policy to preclude or fetter the exercise of the statutory right conferred on a creditor to petition for bankruptcy or winding up on the ground of insolvency. Even though the Lasmos approach may not be regarded as totally precluding a creditor from invoking the insolvency jurisdiction of the Court, it is a substantial curtailment of his statutory right.

 

5.          However, the Court of Appeal did acknowledge that considerable weight should be given to the factor of arbitration in the exercise of the Court’s discretion and such discretion should not be exercised in a way that would inevitably encourage parties to an arbitration agreement to seek to bypass the arbitration agreement/legislation by presenting a winding up petition.

Re Golden Oasis Health Ltd

Facts

This latest decision concerns a summons (the “Summons”) filed by New Health Elite International Ltd (“NHE”) for an order that all further proceedings in the winding up petition (the “Petition”) against Golden Oasis Health Ltd (the “Company”) be stayed pending arbitration pursuant to an arbitration clause (the “Arbitration Clause”) contained in a shareholders’ agreement (the “Shareholders’ Agreement”) made between the Gold Swing Enterprises Ltd (the petitioner, “GSE”), NHE and others.

The Petition was based on a debt (the “Debt”) owed by the Company to Smart Even Ventures Ltd (“SEV”), which was assigned to GSE by a deed of assignment (the “Deed”). The Deed was part of a transaction whereby SEV sold its 20% shares in the Company to GSE by a sale and purchase agreement (the “SPA”), and the Debt represented the shareholder’s loan due from the Company to SEV.

Issue

The issue was whether NHE was entitled to rely on the agreement to arbitrate to stay the Petition.

Decision

Mr Justice Anthony Chan dismissed the Summons for the simple reason that there was no relevant arbitration clause to support it. The Court was unable to see how NHE can satisfy the second and third requirements of the Lasmos approach.

In respect of the second requirement, the contract(s) under which the Debt arose was the Deed and possibly also the SPA. Neither the Deed nor the SPA contained any arbitration clause. On the contrary, both the Deed and the SPA contained a jurisdiction clause which conferred jurisdiction on the Hong Kong courts. Further, although the SPA was completed with the execution of the Deed which took place on the same day as the Shareholders’ Agreement, the SPA was unrelated to the Shareholders’ Agreement except that GSE became a shareholder of the Company by the SPA and with that status the Shareholders’ Agreement became related to GSE. The Debt was a claim by GSE against the Company which was not a party to the Shareholders’ Agreement. It was further held that the dispute relating to the Debt or the Deed did not fall within the scope of the Arbitration Clause on its construction.

In respect of the third requirement, no arbitral proceedings had been commenced by either the Company or NHE pursuant to the Arbitration Clause despite the issue of a statutory demand from GSE, the Petition and the Summons. Mr Justice Anthony Chan agreed the view expressed in But Ka Chon supporting the third requirement of Lasmos that “it would make no sense to dismiss or stay an insolvency petition on the mere existence of an arbitration agreement when the debtor has no genuine intention to arbitrate”. It was held that on the facts it was “very difficult to see any genuine intention to arbitrate on either the part of the Company or NHE”.

Hence, it was concluded that irrespective of whether the approach in Lasmos should be followed, the Summons must be dismissed.

Conclusion

Similar to But Ka Chon, the Court in Re Golden Oasis Health Ltd did not find it necessary to directly rule on the correctness of the Lasmos approach. Mr Justice Anthony Chan noted that “it is unnecessary to deal with the reservations expressed in But Ka Chon”. It remains to be seen whether the Court, in future cases, will reformulate the Lasmos approach. Yet it is fair to say that if a company/debtor wishes to dispute a claim and dismiss or stay a winding-up petition on the ground that there is an arbitration clause in the relevant contract, concrete steps must be taken to initiate the arbitration proceedings, preferably before a winding-up petition is issued.

 

For enquiries, please contact our Litigation & Dispute Resolution Department:

E: insolvency@onc.hk                                   T: (852) 2810 1212 W: www.onc.hk                                             F: (852) 2804 6311 19th Floor, Three Exchange Square, 8 Connaught Place, Central, Hong Kong

Important: The law and procedure on this subject are very specialised and complicated. This article is just a very general outline for reference and cannot be relied upon as legal advice in any individual case. If any advice or assistance is needed, please contact our solicitors.

Published by ONC Lawyers © 2019