Introduction

In Simplicity & Vogue Retailing (HK) Co., Limited [2023] HKCFI 1443, the Court of First Instance (CFI) made a winding-up order against the Company, clarifying that the court maintains discretion to dismiss or stay a petition in bankruptcy and insolvency matters despite the presence of an arbitration clause. Significantly, this was the first case considering the landmark decision in Re Guy Kwok Hung Lam¹ (Guy Lam, previously discussed here) handed down in May 2023 by the Court of Final Appeal.

Background

The Company guaranteed payment obligations in respect of certain convertible bond instruments, which the issuer failed to fulfil on maturity. Since the Company was not able to pay the redemption amount, a petition was filed for a winding-up order to be made against the Company (the Petition). However, the Company failed to file an affidavit in opposition in time, and the court granted leave for the affidavit to be filed, conditional on the Company’s payment of debt into court (the Condition). Ultimately, the payment did not occur and the Company sought an extension of three months to comply with the Condition and an adjournment of the Petition.

The CFI’s Ruling

The Honourable Madam Justice Linda Chan found that there was no credible evidence that the Company would be able to comply with the Condition, even if time were granted, since it was clear that it did not have the financial means to pay the debt. Since there was no basis to extend time or adjourn the Petition, the Petitioner was entitled to a winding-up order as of right.

For completeness, the court considered the two grounds of opposition advanced by counsel: (1) there is a bona fide dispute as to whether the Guarantee has been discharged given variations of the principal contract between the Petitioner and the Issuer (Discharge ground); and (2) the dispute should be referred to arbitration in light of the arbitration clauses present in the relevant agreements (Arbitration ground). The Discharge ground was deemed wholly without merit since the Guarantee expressly provided that there will be no discharge even if the principal contract was varied. The court swiftly moved on to examine the Arbitration ground.

In bringing the Arbitration ground forward, the Company relied on the approach in Lasmos Limited v. Southwest Pacific Bauxite (HK) Limited², a decision by the CFI holding that a petition should be dismissed if, among one of the three requirements, a company takes steps under an arbitration clause to commence dispute resolution processes (Lasmos, previously discussed here). The Petitioner contended that Lasmos did not assist the Company’s case, since the Company had not taken steps to commence arbitration. On a side note, doubt has been cast on Lasmos in But Ka Chon v. Interactive Brokers LLC³, where the Court of Appeal had reservations if the discretion under the insolvency legislation should be exercised only one way under the Lasmos approach to substantially curtail the statutory right of a creditor to present a petition.

Nonetheless, the Company did not contradict the Petitioner’s claims but submitted that the Petition should still be dismissed in light of Guy Lam. Guy Lam decided that, absent a “strong cause” such as insolvency affecting third parties and the dispute bordering on the “frivolous or abuse of process”, the court should decline exercising its jurisdiction when an exclusive jurisdiction clause (EJC) exists in the underlying agreement. However, this was rejected by the court based on the following reasons:

• The ratio in Guy Lam only applied to EJCs rather than arbitration clauses.
• Relevant to the analysis above, the principle governing the exercise of the court’s discretion to dismiss or stay a petition if the petitioning debt contained an arbitration clause was guided by But Ka Chon and Sit Kwong Lam v. Petrolimex Singapore Pte Ltd⁴. Thus, Guy Lam did not apply.
• Although the judgment in Guy Lam considered the circumstances that there were no supporting creditors when deciding to dismiss the winding-up petition, it shall not be read as a general rule that applied to cases involving an arbitration clause in the agreement which gave rise to the petitioning debt.
• There was no reason why the Companies Court should adopt a mechanistic approach to invariably refuse to consider the merits of the defence and require parties to litigate their dispute in arbitration or fetter the exercise of its discretion in exercising its bankruptcy and insolvency jurisdiction in this way. Even when an arbitration clause is involved in relation to the petitioning debt, the court held that there is no proper basis to require the parties to refer their “dispute” to arbitration in the absence of any genuine “dispute” in respect of the debt. The court will therefore consider whether the defence is one which can readily be shown to be wholly without merit in determining whether it “borders on the frivolous or abuse of process” even if the Guy Lam approach applies.

Commentary

The CFI’s decision in Simplicity is significant in clarifying the court’s approach in petitioning debts involving arbitration clauses after Guy Lam, crystallising the position that a mere arbitration clause is not enough to bypass the court’s discretion in exercising its bankruptcy and insolvency jurisdiction. Despite the tendency of the courts to recognise and uphold contractual machinery in a commercial context, parties should still note that it will not be possible to rely on an arbitration clause to automatically obtain dismissal or stay of a petition and the requirements in Lasmos must still be satisfied, i.e. (1) the company disputes the debt relied on by the petitioner; (2) the contract under which the debt is alleged to arise 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.

While Simplicity took a restrictive approach in relation to the applicability of Guy Lam to cases involving an arbitration clause as opposed to an EJC, it demonstrated the court’s willingness to consider the merits of the “defence” for the purpose of considering whether there is any genuine “dispute” to be resolved by arbitration in the first place, which appears to be in addition to the requirements in Lasmos above. It will also be interesting to see how Guy Lam may be applied to any subsequent cases that involve an EJC in a bankruptcy and insolvency context, where a creditor may have decided to bankrupt or wind up a debtor in Hong Kong despite the presence of an EJC based on an assessment that, for example, any dispute of the debt is frivolous amounting to abuse of process.

Acknowledgements to intern Christine Lee for her contribution to this article.

1. [2023] HKCFA 9↩
2. [2018] 2 HKLRD 449↩
3. [2019] 4 HKLRD 85↩
4. [2019] 5 HKLRD 646↩