Stay of Play: Winding-Up v. Arbitration (Again)

The recent Hong Kong Court of First Instance decision of Re Shandong Chenming Paper Holdings Limited marks another intersection between the public domain of insolvency and the private realm of arbitration. 

In this and previous decisions, the Hong Kong courts have grappled with the issue of which should take priority – a winding-up petition, or the contractual term in the relevant contract that states disputes are to be resolved through arbitration or litigation. 

Two primary considerations fuel this debate:

• The need to protect the interests of creditors in the event of insolvency, and the principle that parties cannot contract out of insolvency legislation. 
• The rights of contracting parties to agree with the terms of their own contract without interference, and therefore to be able to settle any disputes through contractual terms referring such matters to arbitration or litigation. Incidentally, under s 20 of the Arbitration Ordinance, there is the ability to stay in court proceedings if the arbitration agreement is valid and capable of being performed, emphasising the importance of parties’ autonomy to choose how to resolve their disputes. 

So, which is it? Or perhaps the challenge is to strike a balance, which promotes a consistent approach across both ordinary actions and insolvency proceedings, where exclusive jurisdiction or arbitration clauses are engaged. 

An Overview of Recent Case Law

It used to be the case that when the court was faced with a winding up petition, and the relevant contractual terms between the parties included a clause dealing with how disputes between those parties should be settled, the court would first consider whether there was a genuine good faith dispute on substantial grounds. In other words, an arbitration clause, for example, would not have come into play when determining that question. The courts viewed winding up proceedings as a class remedy, a remedy being sought on behalf of all creditors, not to be derailed by the terms of a contract.

Then in Lasmos Ltd v Southwest Pacific Bauxite (HK) Ltd in 2018, when the Court had to decide whether to dismiss a winding-up petition where the relevant contractual terms included an arbitration clause, this time the Court departed from the usual approach after considering case law from other jurisdictions. The court decided that because there was an arbitration clause a winding-up petition should generally be dismissed. Matters to be considered are:

• Whether the company (which is the subject of the petition) contests the debt on which the petitioner relies.
• Whether the debt in question arises from a contract that includes an arbitration clause that covers the dispute relating to the debt. 
• Whether the company has initiated the contractually-mandated dispute resolution process. 

The Court added that, despite this decision, it still retained a discretion to decide whether to make a winding up order in such cases.

In Re But Ka Chon v Interactive Brokers LLC the next year (see TDW’s article here), the Court of Appeal did not have to determine the appropriateness, or otherwise, of the Lasmos approach but commented obiter that the Lasmos approach would be a substantial curtailment of the court’s insolvency jurisdiction, noting that s 20 of the Arbitration Ordinance did not cover winding up petitions.

A similar issue came before the Court of Final Appeal in early May this year, in Re Guy Kwok-Hung Lam. This case concerned the courts’ discretion to decline jurisdiction to make a bankruptcy order where the underlying dispute was subject to an exclusive jurisdiction clause favouring a jurisdiction other than Hong Kong (an exclusive jurisdiction clause).

The majority of the court held that a petition should not proceed where the debt is disputed and the dispute is subject to an exclusive jurisdiction clause in favour of a foreign court. It opined that, in general, parties should be held to their contractual agreements. However, exceptions apply for example where there is a risk of insolvency affecting third parties or if the defence is frivolous or an abuse of process.

Hot on the heels of Guy Lam, the Court at first instance in Simplicity & Vogue Retailing (HK) Co Ltd commented that:

• it retained a discretion to wind up companies even where there is an arbitration clause, stating that the Guy Lam approach applied only to exclusive jurisdiction clauses and not arbitration clauses, and 
• that the court should not adopt a purely mechanistic approach that fetters the courts’ discretion.

The Court stated that an arbitration clause should not invariably lead to a refusal to consider the merits of any defence and require the parties to litigate or arbitrate their dispute. Rather, the courts should decide (without considering any detailed arguments or disputed evidence) whether the defence is wholly without merit or one which “borders on the frivolous or abuse of process” (citing Guy Lam). 

Shan Dong: Spotlight on the Latest CFI Decision

The Shandong Chenming litigation concerns a winding-up petition which was presented six years ago based on a debt arising from an arbitration award. The petition was put on hold due to a dispute over whether the second core requirement for making a winding-up order against a foreign company (namely that there must be a reasonable possibility that the winding-up order would benefit those applying for it) could be satisfied. The issue was whether the threat of a winding-up petition could be viewed as a benefit satisfying this requirement. The dispute was resolved in favour of the creditor in June 2022 and the winding-up petition was then “revived”.

In the latest saga of the Shandong case, the debtor company had launched a second arbitration against the petitioner alleging that it had a cross-claim against the petitioner which exceeded the petitioning debt. In a recent judgment (published on 11 August 2023), the debtor company successfully resisted the winding-up petition on the basis that its cross-claim would be subject to arbitration taking place in May 2024.  

The Court held that the principles established in the Guy Lam case applied equally to cases involving arbitration clauses and in relation to cross-claims being raised by debtors. In circumstances where the petitioner was unable to argue that the subject matter of the second arbitration was frivolous or amounted to an abuse of process, the petition stayed pending future arbitration.

The State of Play

The legal landscape in this area is still evolving. Several decisions, including those from the Court of Final Appeal, lean towards giving prominence to exclusive jurisdiction or arbitration clauses. However, as can be seen, the court’s discretion still remains and nothing is certain.  

Ian De Witt, Tim Au, Elizabeth Chan

If you would like to discuss any of the matters raised in this article, please contact:

Ian De Witt

Partner | Email

Tim Au

Partner | Email

Disclaimer: This publication is general in nature and is not intended to constitute legal advice. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.