The interface between arbitration clauses and winding up petitions – The Court of Appeal comments

In Re Southwest Pacific Bauxite (HK) Ltd [2018] 2 HKLRD 449, the Honourable Mr Justice Harris held that a petition to wind up a company on the ground of insolvency should “generally be dismissed” where:

(a) 

a company disputes the debt relied on by the petitioner;

(b) 

the contract under which the debt is alleged to arise contains an arbitration clause that governs any dispute relating to the debt; and

(c) 

the company takes the steps required under the arbitration clause to commence the contractually mandated dispute resolution process, and files an affirmation demonstrating this.

The effect of this approach is that where there is an arbitration clause, a debtor is entitled to have a petition dismissed without having to show that the petitioning debt is bona fide disputed on substantial grounds: it is sufficient to show that the debt is “disputed”, and for that it is sufficient to show the debt is not admitted.

The Southwest Pacific Bauxite decision represented a departure from previous Hong Kong cases that had considered this issue, and limits the ability of petitioners to seek winding up orders where the contract which created the creditor-debtor relationship contains an arbitration clause, even in cases where, on an objective view, there can be no dispute that a debt is owed.

This issue came before the Court of Appeal in the recent judgment in But Ka Chon re Interactive Brokers LLC [2019] HKCA 873.  Whilst this case related to a bankruptcy matter, the same principles are applicable.

Interactive Brokers LLC (IB) had presented a statutory demand in relation to a debt of some HK$79 million owed to it by Mr But.  Mr But made an application to set aside the statutory demand, but this application was dismissed at First Instance.  IB then presented a bankruptcy petition against Mr But, but that petition was stayed by consent, pending the resolution of Mr But’s appeal against the dismissal of his application to set the statutory demand aside.

In his appeal, Mr But alleged that the debt was disputed on substantial grounds and he had a cross claim as a result of misrepresentations made by IB.  He also relied on an arbitration clause appearing in his customer agreement with IB.  The Court of Appeal upheld the first instance’s decision that Mr But’s misrepresentation claim had no merit, and thus the debt was not bona fide disputed and the threshold requirement for setting aside the statutory demand was not met.

In considering the arbitration agreement, the judge at first instance had decided that irrespective of whether he followed Southwest Pacific Bauxite or previous authorities, he would still exercise his discretion to dismiss Mr But’s application to set aside the statutory demand as the third requirement had not been satisfied, in that Mr But had not taken any steps to commence arbitration and he had no genuine intention to do so.  The Court of Appeal agreed with this analysis, and said there was no basis to interfere with the exercise of the judge’s discretion that the application to set aside the statutory demand be dismissed.

The Honourable Madam Justice Kwan VP, giving the judgment of the Court, stated that in the circumstances it was not strictly necessary to decide whether Southwest Pacific Bauxite should be adopted in an application to set aside a statutory demand, but in view of the importance of the issue to insolvency proceedings, she made certain obiter observations as follows:

(a)

The wording of article 8 of UNCITRAL Model Law on International Commercial Arbitration, which provides that a court before which an action is brought in a matter which is the subject of an arbitration agreement shall refer the parties to arbitration, does not cover an insolvency proceeding.  Having found no automatic mandatory or non-discretionary stay under arbitration legislation, Kwan VP considered that there was a discretionary power to be exercised under the insolvency legislation whether to dismiss or stay a petition where the alleged debt arose out of a transaction concerning an arbitration agreement.  She noted that this was the position in Hong Kong prior to 2018. 

(b) 

The Southwest Pacific Bauxite case decided that the discretion under the insolvency legislation should be exercised only one way, in that the petition should generally be dismissed save in “exceptional” or “wholly exceptional” circumstances upon satisfaction of the 3 requirements referred to above.

(c) 

A statutory right is conferred on a creditor to petition for bankruptcy or winding up on the ground of insolvency.  It is contrary to public policy to preclude or fetter the exercise of the right, and even though the Southwest Pacific Bauxite approach may not be regarded as totally precluding a creditor from invoking the insolvency jurisdiction, it was a substantial curtailment of a statutory right.

(d)

The Eastern Caribbean Court of Appeal had recently declined to adopt the approach adopted in Southwest Pacific Bauxite, holding that the BVI Court’s jurisdiction to wind up a company based on its inability to pay debts as they fall due unless the debt is disputed on genuine and substantial grounds was too firmly a part of BVI law to now require a creditor exercising the statutory right to prove exceptional circumstances to establish the status to wind up a company.  The jurisdiction was satisfied once the creditor was applying on the basis of a debt not disputed on genuine and substantial grounds, which had been the same position in Hong Kong.

Having made these observations, Kwan VP had reservations about the discretion under the insolvency legislation being exercised only one way to substantially curtail the right of a creditor to present a petition.

Kwan VP said that she acknowledged that considerable weight should be given to the factor of arbitration in the exercise of the discretion, lest parties to an arbitration agreement be encouraged, as a standard tactic, to bypass that agreement and the legislation by presenting a winding up petition.  She also acknowledged that there may well have been insufficient weight given to the arbitration factor pre-Southwest Pacific Bauxite.  However, having said that, she did not think the Court was powerless to deal with any such tactic that may be practised by a creditor seeking to apply improper pressure on a debtor.  Nor did she think that the discretion should invariably be exercised in favour of granting a winding up or bankruptcy order where the Court was satisfied there was no bona fide dispute on substantial grounds, thus putting an end to any arbitration proceedings.

The judge said, however, that as the appeal was to be dismissed, the discretion could be exercised by the judge hearing the bankruptcy petition on the lifting of the stay when further directions were to be given by the Court of First Instance.  This was not the occasion to decide the appropriateness of the approach taken in Southwest Pacific Bauxite.

Whilst it is understandable why Kwan VP’s remarks on the tension between winding up procedure and the arbitration clause are obiter, given the way that the appeal was decided, the decision casts doubt on the decision in Southwest Pacific Bauxite, but does not overrule it. It remains to be seen, therefore, whether the Southwest Pacific Bauxite approach will continue to prevail when the Court is next faced with a winding up petition brought on a debt arising out of an agreement containing an arbitration clause.  In the meantime, parties bringing winding up proceedings where an arbitration clause exists face a level of uncertainty.