An exclusive jurisdiction clause (EJC) is a clause in a contract limiting the determination of disputes under that contract to one agreed jurisdiction or forum. It has been unclear whether an EJC could be relied upon to dispute a debt in the context of bankruptcy proceedings. It is trite that a bona fide dispute on the debt on substantial grounds is sufficient for a bankruptcy or winding-up petition to fail. Recently, the Court of Appeal clarified the position on whether an EJC was a bona fide dispute on the debt on substantial grounds in the landmark decision of Guy Kwok-Hung Lam v. Tor Asia Credit Master Fund LP CACV 393/2021 [2022] HKCA 1297.

Facts

A loan agreement (Agreement), entered into between a secured creditor (petitioner) and the debtor (appellant), contained an EJC that each party would submit to the exclusive jurisdiction of the courts in New York “for the purposes of all legal proceedings arising out of or relating to this Loan Agreement”. On the basis of an alleged event of default, the creditor issued a statutory demand for the outstanding sum. The creditor then presented a bankruptcy petition against the debtor in Hong Kong after the statutory demand went unanswered.

The debtor disputed the petition debt on five grounds. In particular, there was no extant event of default under the Agreement as a result of the creditor’s waiver of any such default or on the basis of an estoppel against the creditor, and the petition debt was subject to an EJC. At first instance, Linda Chan J agreed with the petitioner that “there is a settled understanding of the law that an EJC does not prevent a winding-up or bankruptcy petition from being presented in an appropriate jurisdiction”. The general principle that as long as there is a bona fide dispute on substantial grounds in respect of the debt, a creditor has locus to start an insolvency proceeding, was cited. The existence of an EJC was construed as merely a factor to be taken into account.

Appeal

On appeal, the Court of Appeal was asked to determine whether the petition should have been dismissed or stayed. The appellant argued that Linda Chan J should have dismissed the petition by applying Harris J’s approach in Re Southwest Pacific Bauxite (HK) Ltd [2018] HKFI 426 (Lasmos approach). The Lasmos approach provides that a winding-up petition should generally be dismissed if three conditions are satisfied: (1) the company disputes the alleged debt; (2) the contract giving rise to the alleged debt contains an arbitration clause that covers any dispute relating to the debt; and (3) the company takes the steps required under the arbitration clause to commence the contractually mandated dispute resolution process. However, the petitioner argued that the Lasmos approach was only applicable under arbitration clauses in contrast to an EJC. Consequently, the creditor submitted that it was a “settled understanding of the law” that the question for the court remained to be whether the debt was bona fide disputed on substantial grounds.

The appellant was successful in his appeal. G Lam JA reviewed cases from multiple common law jurisdictions and identified the following considerations in his judgment: (1) the approach to stays of ordinary actions based on an EJC; (2) the effect of arbitration clauses on winding-up petitions; (3) whether the EJC was engaged; (4) whether the approach in ordinary actions should be applied in insolvency proceedings; (5) whether there is a dispute to be resolved in the agreed forum; (6) whether the Lasmos approach would fetter the creditor’s statutory right to petition for bankruptcy or winding-up on the ground of insolvency; and (7) the effect of EJCs on insolvency proceedings. 

Stay

In relation to issue (1), the Court of Appeal confirmed that a stay of proceedings would only be refused where the debtor had no arguable defence. This is in contradistinction to the merits of the creditor’s case – even if the creditor were highly likely to succeed, the merits of the creditor’s case should be neither relevant nor significant in determining the appropriate forum. The mere fact that a case would be stronger in a certain jurisdiction would be an absurd reason, encouraging forum shopping. The terms of the agreement should be upheld and the parties’ choice of forum in their jurisdictional agreements should be respected.

Was the EJC triggered?

With regard to issue (3), the creditor argued that a petition was not a legal proceeding and so the EJC was not triggered. The Court of Appeal disagreed, and held that in deciding on the petition the court must necessarily determine the dispute and decide whether the appellant’s cross-claims had substance. That by itself would amount to a judicial determination as to the parties’ rights and obligations under the Agreement. If the Hong Kong courts were to make such determination, the petition would become a summary judgment type procedure. It would be inappropriate for the Hong Kong courts to conduct a summary judgment type determination of liability for the debt, particularly where the parties had expressly agreed that disputes under the Agreement were to be exclusively resolved in the New York courts.

The Court of Appeal further distinguished between seeking an order for the insolvency of a party to an agreement, and a petition for such an order on the basis of disputed indebtedness under an agreement. The latter, which was the present case, fell squarely within the EJC. 

An EJC’s effect on insolvency proceedings

On issue (4), the Court of Appeal held that the same approach as in ordinary actions should be adopted to respect party autonomy. Even in the context of insolvencies, an EJC should ordinarily be given effect unless there are strong reasons to the contrary. However, to retain flexibility, the Court of Appeal was reluctant to define what may constitute strong reasons. Some of the examples cited included: the debtor being incontestably and massively insolvent apart from the disputed debt; the existence of other creditors seeking a winding-up whose debts were not subject to an EJC; the assets being in jeopardy; and the petitioner would be deprived of a real remedy if the petition were not heard.

Given that there were no suggestions of any insolvency on the appellant’s part, other than the petitioner’s claim, or any other strong reasons, the petition was held to be a mere fight between the debtor and the creditor – there was no reason to depart from the EJC. 

Conclusion

Bankruptcy and winding-up petitions are a class remedy. If there is any dispute as to the debt, an EJC would usually be upheld and the courts in Hong Kong would be likely to grant a stay or dismiss the petition even where the merits of that dispute were weak. This is to avoid the anomalous situation of conducting a summary judgment type determination of liability for the debt in insolvency proceedings.

Way forward

Where creditors intend to commence insolvency proceedings in Hong Kong, despite the existence of an EJC excluding Hong Kong, creditors should first check if the wording is wide enough to cover all legal proceedings. If the wording covers insolvency proceedings, creditors should then take extra care to ensure that the debtor would not dispute the debt before commencing those proceedings. Creditors must also provide strong and cogent reasons for commencing proceedings in the non-EJC forum. In the absence of such reasons, it is likely the courts in Hong Kong would dismiss or stay any such proceedings, pending the determination of the dispute in the agreed forum specified in the EJC.

EJCs are often an afterthought when preparing agreements. However, after this unprecedented decision, caution should be taken before entering into contracts with EJCs. Parties should ensure that their intentions are accurately reflected in the provisions, particularly in relation to an EJC. If creditors want to ensure flexibility or give themselves more options, they can negotiate asymmetric jurisdiction clauses i.e. allowing the creditor to commence proceedings against the debtor in any jurisdiction but restricting the debtor to commencing proceedings against the creditor in only one exclusive jurisdiction. Alternatively, the parties can agree to non-exclusive jurisdiction clauses.

Hugo Lo, a litigation team trainee, is one of the authors.