Arbitration vs. Winding-Up Petition: Who wins? What is the law now?

22 April 2020

Mr Justice Harris in Re Southwest Pacific Bauxite (HK) Ltd [2018] 2 HKLRD 449 (more generally known as “Lasmos”) held that, where a creditor presents a winding-up petition based on a disputed debt which is covered by an arbitration clause, the Court would generally dismiss the petition, absent exceptional circumstances. Examples of exceptional circumstances include circumstances which would justify the appointment of provisional liquidators and invoking the insolvency look-back provisions to avoid antecedent transactions.

A recent flurry of post-Lasmos cases have led some commentators and the Singapore court to suggest that the position in Hong Kong is now unsettled.

But we should not overlook the fact that Lasmos remains firmly the law at first instance in Hong Kong. If the Hong Kong Court of Appeal revisits Lasmos, the recent Singapore Court of Appeal decision in AnAn Group (Singapore) v VTB Bank (Public Joint Stock Company) [2020] SGCA 33 provides a lesson of what not to do because, with great respect, the Singapore decision appears in all practicality to be a self-contradiction.

Hong Kong law post-Lasmos

The ratio decidendi in Lasmos is that where there is an arbitration clause covering the disputed petition debt, the petition would be dismissed or stayed absent exceptional circumstances, provided the company has taken steps to commence arbitration.

The position is to be contrasted to a situation where the petition debt is disputed and there is no arbitration clause. In such a case, the court’s general approach is to dismiss the petition only if the debt is subject to a bona fide dispute on substantial grounds.

There is not a single post-Lasmos case whose ratio questions Lasmos.

For present purposes, there are three relevant post-Lasmos cases.

In Re Sit Kwong Lam [2019] 2 HKLRD 924, Peter Ng J expressed the view that the Lasmos approach would mean curtailing the creditor’s statutory right to present a winding-up petition, and therefore the arbitration clause would be unenforceable as a matter of public policy (Re Greater Beijing Region Expressways Ltd [1999] 4 HKC 807 (“GBRE”)). But this view was strictly obiter because the actual decision there was that the parties’ agreement contained no arbitration clause at all. The Court of Appeal then upheld the decision and expressed no view on the correctness of Lasmos ([2019] 5 HKLRD 646).

In But Ka Chon v Interactive Brokers LLC [2019] 4 HKLRD 85, the Court of Appeal expressed some reservations about the correctness of Lasmos, in particular whether the discretion under the insolvency legislation should be exercised only one way to substantially curtail the creditor’s right to present a winding-up petition. But this view was strictly obiter because the debtor there had taken no steps to commence arbitration.

In Re Asia Master Logistics Ltd [2020] HKCFI 311, DHCJ William Wong SC commented that the existence of an arbitration clause should be regarded as irrelevant to the Court’s exercise of discretion when dealing with a disputed petition. Again this comment was strictly obiter because the debtor there had taken no steps to commence arbitration.

Therefore, at least at first instance, Lasmos remains the law of the land.

Potential appellate review of Lasmos – issues to be resolved

Should the Court of Appeal seek to review the correctness of Lasmos, the key open issues are:

First, what is the precise scope of the GBRE decision? At present the most serious challenge to Lasmos is the notion extended from GBRE that a creditor’s statutory right to present a winding-up petition cannot be curtailed by an arbitration clause.

Second, is Lasmos consistent with the Court of Appeal decision in Joseph Ghossoub v Team Y&R Holdings Hong Kong (HCMP 3136/2016, unreported, 21 July 2017) (Team Y&R)? Team Y&R refused to enforce the exclusive jurisdiction clause in a shareholders’ agreement requiring allegations in an unfair prejudice petition to be resolved in the English court because the Court of Appeal reasoned that enforcing the jurisdiction clause would fetter the petitioner’s statutory right as a minority shareholder to present an unfair prejudice petition.

Third, assuming Lasmos is correct in principle, what is the proper level of review of the debt dispute? DHCJ William Wong SC in Asia Master hinted that his Lordship’s main concern was not with the correctness of Lasmos as such, but with the proper level of review needed.

What not to follow: the Singapore approach

The AnAn decision is meant to be the definitive word on this topic in Singapore.

The Singapore approach is in brief as follows:

(a) Where a creditor presents a winding-up petition and the debtor disputes the petition debt, the Singapore court will apply the prima facie standard of review such that the court will dismiss or stay the petition if (i) there is a valid arbitration agreement between the parties; and (ii) the dispute falls within the arbitration agreement, provided the debtor’s dispute is not an abuse of the court’s process. Under this prima facie standard of review, the court will not consider the merits of the dispute.

(b) Abuse of the court’s process is a control mechanism which addresses the debtor’s abusive conduct and the threshold for abusive conduct is very high. An example of such abusive conduct is where the debtor seeks to stave off substantiated concerns which justify the invocation of the insolvency regime, such as when assets have gone missing and there is an urgent need to appoint independent persons to investigate and recover the assets, or when there had been fraudulent preferences. In determining the existence of any such abuse of process, the court does not engage in examining the merits of the parties’ dispute (at [99]).

(c) Where the prime facie standard of review is met, the court would ordinarily dismiss the petition. But the court would be prepared to only stay the petition if the “creditor is able to demonstrate legitimate concerns about the solvency of the company as a going concern, and that no triable issues are raised by the debtor” (at [111] (original emphasis)).

With great respect, the Singapore approach is hard to follow and appears to be self-contradictory in practice.

First, the court emphasised throughout that, when applying the prima facie standard of review, the court would not concern itself at all with the merits of the parties’ dispute. But when deciding the precise form of order once the prima facie standard of review is met (namely, whether to dismiss or stay the petition), the court is bound to consider if the creditor has demonstrated (a) legitimate concerns about the debtor’s solvency and (b) the absence of triable issues raised by the debtor. In practice, the petitioning creditor will of course do his best to prove the company’s insolvency and the frivolity of the company’s dispute in order to avoid a dismissal of the petition. Therefore, in practice, the court’s determination is bound to descend into the merits of the parties’ dispute, despite the court’s aspiration to stand above the merits.

Secondly, the court emphasised that a creditor needs to cross a high threshold in order to prove that the debtor’s opposition to the petition amounts to an abuse of process. One of the examples given is drawn from Lasmos concerning the appointment of provisional liquidators. This seems extraordinary. Provisional liquidators are often appointed to preserve assets and displace the existing management over the company’s strenuous opposition. In appointing provisional liquidators and overruling the company’s opposition in such situation, case-law does not label the company’s opposition as abuse of process (eg Revenue and Customs Commissioners v Rochdale Drinks Distributors Ltd [2012] STC 186). It seems that the Singapore approach has in effect created a new category of abuse of process and lowered the threshold of abuse of process, while intending it to be a very high threshold.

The truth is that the prima facie standard of review may be too extreme in an insolvency context, and thus the Singapore court sought to temper it with some gatekeeper. But in the gatekeeping exercise the court seems to have inadvertently constructed a consequence that it specifically hoped to avoid: “parties would effectively be granted a backdoor to argue on the merits of the dispute, even though the prima facie standard precisely prevents such arguments from being raised or entertained” (at [99]).

Conclusion

As a matter of stare decisis, Lasmos remains firmly the law at first instance in Hong Kong. Should the Court of Appeal revisit Lasmos, it must also revisit GBRE and Team Y&R.

Revisiting Lasmos requires a balancing exercise. As the Singapore court aptly put it, “balanced against the company’s interests are the interests of its creditors, both individually and collectively”.

With great respect, the Singapore answer to this balancing exercise appears in all practicality to be a self-contradiction. Let’s see if the Hong Kong Court of Appeal will get things right.

Look-Chan Ho acted for the petitioner in Re Sit Kwong Lam and authored this Article.

 

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