When can a creditor seek to wind up if there is an arbitration clause? – Re Asia Master Logistics Limited

16 March 2020

Following the decision in Re Southwest Pacific Bauxite (HK) Limited [2018] 2 HKLRD 499 (“Lasmos”), there has been a lot of debate on the Court’s approach when dealing with a winding-up petition based on a debt arising out of a contract containing an arbitration clause. The decision of DHCJ William Wong SC in Re Asia Master Logistics Limited (“Asia Master”) seeks to provide clarification in this area of the law.

The debate

Traditionally, if a company failed to satisfy a statutory demand for payment of a debt, the petitioner could file a petition to wind-up the company. The company may then apply to dismiss or stay the petition on the ground that there is a bona fide dispute on substantial grounds. It was not permissible for the company to merely deny, without more, the existence of the debt.  Under this approach, the company still has to demonstrate a bona fide dispute based on substantial grounds to stay or dismiss the petition whether or not there is an arbitration clause in the contract giving rise to the relevant debt (“Traditional Approach”).

In Lasmos, the Court held that a company responding to a winding up petition based on a debt arising out of a contract containing an arbitration clause would no longer need to show a bona fide dispute on substantial grounds when applying to stay or dismiss the petition. The Court will generally dismiss the petition if (i) the company disputes the debt, (ii) the contract under which the debt purportedly arises contains an arbitration clause which covers any dispute relating to the debt, and (iii) the company has taken steps required under the arbitration clause to commence the dispute resolution process and files an affirmation demonstrating this (“Lasmos Approach”).

In Asia Master, following a comprehensive review of the authorities and the justification for and against the Lasmos Approach, the Court effectively affirmed the Traditional Approach and came to the view that in all cases where a company that intends to dispute a debt, the company must show that there is a bona fide dispute on substantial grounds. In other words, the company cannot simply deny the debt and simply rely on the arbitration clause in the contract giving rise to the relevant debt.

The facts and decision in Asia Master

A winding up petition was presented against the subject company. The company does not dispute the subject debt and attempted to raise a counterclaim, which the company was not able to substantiate. As a last-ditch effort to resist the petition, the company relied on an arbitration clause in a fixture note which gave rise to the subject debt in order to resist the petition. 

The Court rejected the argument based on the arbitration clause primarily on the basis that the company had not commenced arbitration proceedings. Accordingly, even if the Lasmos Approach were applicable, the Court would still make a winding-up order. Nonetheless, the Court went on to discuss the justifications for and against the Lasmos Approach and made a number of observations in an attempt to resolve this important debate.  

The Court’s reasoning in Asia Master

The Court identified and rejected two potential justifications for the Lasmos Approach, namely (1) it gives effect to the parties’ freedom to contract (“Contractual Justification”), and (2) it is consistent with the development in other common law jurisdictions (“Comparative Justification”). 

The Court rejected the Contractual Justification on the basis that a winding-up petition does not come within the scope of the creditor-petitioner’s obligations to arbitrate to begin with. This is because the determination of a winding-up petition does not resolve disputes over liability. If a creditor attempts to improperly invoke the Court’s jurisdiction to “determine or resolve” a dispute, the Court has the power to prevent and punish abuse of process.

The Court rejected the Comparative Justification. Having reviewed a number of English and Singaporean authorities, the Court concluded that the Lasmos Approach is far from settled under the law of those two jurisdiction. The Court also noted that the hesitancy by the Singapore courts to stay or dismiss winding-up proceedings on the mere say-so of the debtor-company would suggest otherwise.

Crucially, the Court observed that the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32) (“Ordinance”) gives the Courts a flexible discretion in deciding whether or not to wind up a company. It would be wrong to dismiss or stay a winding-up petition just because the conditions in Lasmos are satisfied because this would be an unprecedented fetter on the Court’s hitherto discretion to make a winding-up order. Accordingly, the Court did not follow the Lasmos Approach and restated the law as follows:-

“First, where a debtor-company intends to dispute the existence of a debt, he must show that there is a bona fide dispute on substantial grounds. It should not suffice for the debtor-company to merely deny the debt. This test would apply in all cases whether or not the debt had arisen from a contract incorporating an arbitration clause.

Secondly, the existence of an arbitration agreement should be regarded as irrelevant to the exercise of discretion.

Thirdly, the fact that arbitration proceedings have commenced or would be commenced may be relevant evidence that there is a bona fide dispute. However, this alone would not be sufficient to prove the existence of a bona fide dispute on substantial grounds.

Fourthly, where the creditor-petitioner petitions in circumstances where it knows there to be a bona fide dispute over the debt on substantial grounds, it runs the risk of being liable to pay the debtor-petitioner’s costs on an indemnity basis. It would also be at risk of liability under the tort of malicious prosecution.”

Commentary

The Court’s observations on Lasmos are obiter in nature and an appellate Court’s decision is needed before the debate can be conclusively resolved. However, the Court’s approach in Asia Master has certainly made it much more difficult for insolvent companies to rely on the Lasmos line of authorities to easily resist a winding-up petition when there are in fact no bona fide disputes on substantial grounds.

 

José-Antonio Maurellet SC and Terrence Tai authored this Case Report

   

 

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