News & Insights

Hong Kong Court of Appeal confirms applicability of Re Guy Lam principles to arbitration clauses and cross-claims subject to arbitration agreement

View PDF

Authored by: Richard Hudson and Adeline Ng

In our previous article, we outlined the approach taken by the Court of First Instance (CFI) in Re Simplicity & Vogue Retailing (HK) Co., Limited and Re Shandong Chenming Paper Holdings Limited towards insolvency proceedings involving arbitration clauses, following the landmark decision of the Court of Final Appeal (CFA) in Re Lam Kwok Hung Guy, ex p Tor Asia Credit Master Fund LP (2023) 26 HKCFAR 119, where the CFA upheld the decision of the Court of Appeal (CA) that in the ordinary case of insolvency proceedings involving a foreign exclusive jurisdiction clause (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 effect of the EJC should be upheld.

Both CFI decisions were appealed to the CA and in April 2024, the CA handed down its two judgments in Re Simplicity & Vogue Retailing (HK) Co., Limited [2024] HKCA 299 and Re Shandong Chenming Paper Holdings Limited 2024 HKCA 352, which provided clarity and confirmed that the CFA’s approach in Re Guy Lam would also be applicable (i) in winding-up proceedings where the parties have agreed to refer their dispute relating to the petition debt to arbitration; and (ii) where the dispute that falls within the scope of an exclusive forum agreement has been raised as a cross-claim which does not give rise to set-off.

This article discusses the salient reasoning of the CA in the two decisions and their implications.

Re Simplicity & Vogue Retailing (HK) Co., Limited

In Re Simplicity & Vogue Retailing (HK) Co., Limited, the CA held that the reasoning of the CFA in Re Guy Lam, relating to the appropriate exercise of discretion to decline the exercise of the Court’s insolvency jurisdiction in the context of an EJC, applies equally to arbitration clauses. 

The CA’s reasoning is as follows:

1. Following the approach laid down by the CFA in Re Guy Lam, the threshold character of a dispute about indebtedness leaves room for the exercise of the Court’s discretion to decline to exercise the jurisdiction to determine that question, leaving the dispute to be resolved by arbitration as agreed and with regard to the public policy in holding the parties to their agreement.  It is noted that this public policy consideration is not the only consideration and it may exist in an “attenuated form”, as when a wholly frivolous defence is mounted that would constitute an abuse of process.

2. The Court’s approach in exercising its discretion is “multi-factorial”:

  1. The public policy of the legislative scheme for the Court’s insolvency jurisdiction may be prominent where the grounds for disputing the debt are obviously insubstantial;
  2. The significance of this public policy may be much diminished where there is no supporting creditor and no evidence of a creditor community at risk;
  3. The “strong reasons” or “wholly exceptional circumstances” test should not “obscure the range of considerations relevant to the Court’s discretion”;
  4. The “countervailing factors” mentioned in Re Guy Lam are just instances where the Court may exercise its discretion not to hold the parties to the agreed dispute resolution mechanism; and
  5. The Court retains flexibility to deal with the case as circumstances require.

3. To deter a debtor from merely raising an arbitration clause as a tactical move with no genuine intention to arbitrate, the Court would require itself to be satisfied of the genuine intention so as to hold the parties to their agreed dispute resolution mechanism.  As such, the third requirement in Re Southwest Pacific Bauxite (HK) Limited [2018] 2 HKLRD 449 (i.e. that the debtor should actively pursue arbitration) continues to be relevant.

Re Shandong Chenming Paper Holdings Limited

In Re Shandong Chenming Paper Holdings Limited, the company sought to dismiss or adjourn the petition on the basis that there was a cross-claim which was subject to an arbitration agreement and was pending determination by arbitration.

The CA was of the view that the CFA’s approach in Re Guy Lam applies irrespective of whether the dispute that falls within the scope of an exclusive forum agreement has been raised by a dispute of the petition debt, a claim of set-off, or a mere cross-claim.

To put things into context, one should take note of how the three different concepts of disputed debts, set-off and mere cross-claims are dealt with when raised in opposition to a winding-up petition, in the absence of any forum agreement, as helpfully summarized by the CA:

1. A disputed debt – Where the debt on which the petition is founded is disputed, the established rule of practice in insolvency proceedings is to ask whether there is a bona fide dispute of the petition debt on substantial grounds;

2. Set-off – Where the company opposes the petition by relying on a claim that exceeds and constitutes a transaction set-off against the petition debt, it is treated as a dispute on the petition debt itself.  The authorities show that a transaction set-off operates in complete or partial defeasance of the claim; and

3. A mere cross-claim – A mere cross-claim does not affect the petitioner’s standing to petition as a creditor, because the petition debt exists independently, notwithstanding the existence of a cross-claim that overtops it.  However, it has been the settled approach of Hong Kong courts to treat such cross claims in the same way as disputes of the petition debt.  The company has the onus of establishing that the cross-claim is genuine, serious and of substance.

In light of the distinction above, the CA was of the view that the principles laid down by the CFA in Re Guy Lam do not cover the case of a mere cross-claim and the CA had to determine as a matter of principle whether the Re Guy Lam principles apply to mere cross-claims subject to forum agreement.

In holding that the CFA’s approach in Re Guy Lam applies to mere cross-claims, the CA’s reasoning was as follows:

1. The CA considered that it was too narrow to confine the rationale in Re Guy Lam to the question of locus to petition and to say that it was wholly irrelevant once it was accepted the petitioner had locus because he had a debt which was not subject to set-off.  The authorities show that the Court also had a discretion to stay or dismiss a petition where the petitioner had undisputed locus in the strict sense but was faced with a cross-claim.  There was no reason in logic or policy to suggest that the parties’ forum agreement had no relevance to the exercise of this discretion.

2. In exercising its bankruptcy or winding-up jurisdiction, the Court “does not wear blinkers and look only at the petition debt”.  The Court would have regard to the entire relationship between the parties.  Although, in the absence of set-off, only the petition debt would be relevant to the petitioner’s locus, it was only part of the overall picture that would inform the exercise of the Court’s powers.  The Court would not ignore the debtor’s cross-claims against the petitioner, and indeed would regard them as practically equivalent to disputes of the debt.  Further, any “reverse cross-claim” by the petitioner against the debtor would be relevant as well.  In cases with claims in both directions, the question would be whether the petitioner was a net creditor having an interest in having the debtor wound up or bankrupted.  Such a question was clearly a matter to which a forum agreement between the parties (if one exists) would likely be relevant. 

3. Where a cross-claim was subject to an arbitration clause, it would be against the parties’ agreement for the Court to enter into its merits and determine that there was no genuine and serious cross-claim, or one that is of substance.  Such a determination would be akin to giving summary judgment in favour of the defendant and against the claimant in respect of the cross-claim.  Where the parties agreed to have all the disputes under the agreement giving rise to the cross-claim determined in another forum, the public policy in holding parties to their agreements would come into play, just as it would in a disputed debt case. 

4. By undertaking the type of summary judgment determination of the cross-claim as would be appropriate in an ordinary cross-claim case, the Court would have likewise “assumed the jurisdiction to decide a question which the parties had agreed would be determined in another forum.”

5. The CA did not consider that applying the Re Guy Lam approach to mere cross-claims would create a “debt dodger’s charter”.  To rely on that approach the debtor would have to show a valid exclusive forum agreement between the parties that governed the cross-claim.  In any event, the CFA in Re Guy Lam had built in a safety valve that allows the rule to be displaced where the dispute “borders on the frivolous or abuse of process”.

6. Delay in putting forward a cross-claim may in appropriate circumstances support a finding that it was raised in abuse of the Court’s process as a pretext to stave off a winding up.  In the present case, the CA noted that the company had provided an explanation for the delay in bringing the cross claims and the petitioner had not contended that the cross-claims were raised by the company in abuse of process.

Conclusion

The two CA decisions in Re Simplicity & Vogue Retailing (HK) Co., Limited and Re Shandong Chenming Paper Holdings Limited have confirmed the applicability of the CFA’s approach in Re Guy Lam in cases involving arbitration clauses, as well as cross claims which are subject to arbitration agreements.  These decisions provide helpful guidance on the circumstances in which a debtor may rely on an arbitration clause or cross claim(s) which is/are subject to an arbitration agreement to seek to stay or dismiss a petition.

There has, however, been an interesting development offshore.  The recent Privy Council decision in Sian Participation Corp v. Halimeda International Ltd [2024] UKPC 16 held that the correct test to apply when deciding whether to dismiss or set aside a winding up proceedings in favour of arbitration is whether the debt is disputed on genuine and substantial grounds.  This is different from the line of authority developing in Hong Kong following Re Guy Lam, and might be regarded as a more creditor friendly approach.  Of course, this Privy Council decision is not binding on the Hong Kong Courts and is at most of persuasive value, and hence until matters of this nature appear before the CFA again, we can expect that the Hong Kong Courts will continue to follow and apply the principles laid down in the CA decisions in  Re Simplicity & Vogue Retailing (HK) Co., Limited and Re Shandong Chenming Paper Holdings Limited when considering the application of the Re Guy Lam principles to arbitration clauses and mere cross-claims.

Key Contacts

Richard Hudson

Partner | Litigation and Dispute Resolution

Email or call +852 2825 9680

Related Services and Sectors:

Litigation and Dispute Resolution

Portfolio Builder

Select the legal services that you would like to download or add to the portfolio

Download    Add to portfolio   
Portfolio
Title Type CV Email

Remove All

Download


Click here to share this shortlist.
(It will expire after 30 days.)