In Shandong Chenming Paper Holdings Ltd [2023] HKCFI 2065, the Honourable Mr. Justice Harris in the Court of First Instance (CFI) stayed a winding up petition presented by the company because of an agreement to arbitrate.

The parties, Arjowiggins HKK2 Ltd and Shandong Chenming, entered into a joint venture agreement in 2005. The relationship between the parties broke down and in 2010 the respondent applied to the mainland court for a judicial dissolution of the joint venture (JV) company. Arjowiggins then commenced arbitration proceedings in Hong Kong in October 2012, alleging breach of the JV contract by the respondent. A damages award in favour of the applicant was issued in 2015.

Shandong Chenming failed to pay and Arjowiggins issued a statutory demand in October 2016 and a winding-up petition in June 2017. Shandong Chenming disputed the court's jurisdiction all the way to the Court of Final Appeal, but lost (see Hogan Lovells alert Hong Kong Court of Final Appeal confirms mere threat of winding-up is enough to confer jurisdiction).

Shandong Chenming then began a second arbitration citing a cross-claim which it claimed in excess of the amount awarded in the first arbitration. On 25 October 2022, the company issued a summons seeking a dismissal or adjournment of the petition.

Guidance from above

Both the petitioner and the company agreed that a recent Court of Final Appeal (CFA) decision Re Guy Kwok-Hung Lam [2022] HKCFA 9 would have a bearing on the issue (see Hogan Lovells alert Petition barred - Hong Kong CFA confirms primacy of exclusive jurisdiction clause in bankruptcy). In that decision, the CFA confirmed that the court should respect the effect of the parties' agreement (in that case an exclusive jurisdiction clause, EJC) in bankruptcy proceedings, just as it does in ordinary civil actions.

Harris J summarised that the requirement for a debtor "to demonstrate a bona fide defence on substantial grounds in order to defeat a petition, is not appropriate where an EJC is involved".

Harris J said the same was true in the case of an arbitration clause. This was an approach he had set out in his 2018 decision Lasmos Limited v Southwest Pacific Bauxite [2018] HKCFI 426, which the Court of Appeal (CA) had cause to question the following year (see Hogan Lovells alert Hong Kong Court of Appeal queries approach to winding-up petitions where arbitration is involved).

Elsewhere in the CFI, however, the Honourable Madam Justice Linda Chan was viewing things somewhat differently. In Simplicity & Vogue Retailing (HK) Co., Limited [2023] HKCFI 1442 and Re NT Pharma International Co Ltd [2023] HKCFI 1623, she expressed doubts about whether the CFA ruling in Guy Kwok-Hung Lam applies where an arbitration clause is present.

In Simplicity, Linda Chan J dismissed an argument founded on Lasmos that the petition should be stayed because of the presence of an arbitration clause in a bond instrument and guarantee, since the company had taken no steps to commence arbitration.

She said that in her view, the ratio in Guy Kwok-Hung Lam applied only to EJCs, not arbitration clauses.  Even if Guy Kwok-Hung Lam did apply, the court would still have the discretion to evaluate whether a defence "borders on the frivolous or abuse of process". The court made the winding-up order.

Likewise in Re NT Pharma International Co Ltd [2023] HKCFI 1623, the court noted that a request for arbitration had been filed late on in proceedings. Linda Chan J ruled that the company should not be allowed to withhold payment of a debt of nearly US$4 million until determination of its cross-claim in arbitration.

Harris J though in Shandong Chenming had no doubt that the Lasmos approach “applies to arbitrations just as it has been expressly found to apply to EJCs (this is not in dispute) and that, secondly, the judgment applies to disputed debts and cross-claims”.

Room for manoeuvre

So where does this leave creditors wanting to issue winding up proceedings when faced with unmeritorious and late applications to arbitrate?

It was clear from Guy Kwok Hung-Lam that, in the case of an ordinary EJC, parties should be held to their bargain, absent countervailing factors such as the risk of insolvency affecting third parties or a dispute that borders on the frivolous or abuse of process.

In Shandong Chenming, Harris J said that there was nothing to suggest from Guy Kwok Hung-Lam, that different principles should apply in the case of defences and cross-claims. In this regard, he referred to the Singapore Court of Appeal judgment of AnAn Group (Singapore) Pte Ltd [2020] SGCA 33; [2020] 1 SLR 1158, which (i) does not distinguish between claims and cross claims; and (ii) holds the parties to their contractual bargain to arbitrate, provided that the dispute is not raised by the debtor as an abuse of the court’s process.

Harris J noted that "although the Petitioner asserts that there is no merit in the cross-claim and complains that it is being advanced years after it obtained the judgment on which the Petition is founded, the Petitioner does not go so far as to suggest that the present case is sufficiently obviously an abuse as to bring it within that rare category in which the court will consider rejecting the debtor's opposition despite the existence of an arbitration clause - it not being in dispute that merits and delay are not of themselves capable of bringing a case within that category".

The question as to the limits of the court's discretion to investigate whether there is indeed a bona fide dispute over the debt on substantial grounds, remains in play for the present.

However, it is to be noted that both the CA and CFA drew on the reasoning of Lasmos in respect of arbitration clauses, and were of the view that the same principles and approach applied to both an EJC and an arbitration clause.

There are some things that can be done whilst this degree of uncertainty exists. From the point of view of the debtor, applications to arbitrate must be genuine and filed in good time. Concrete steps should be taken to show as evidence to the court of a genuine intention to arbitrate.

A creditor seeking a winding-up petition should come to court with a complete understanding of the factual matrix. Although it is uncertain whether the court will have discretion to proceed with a winding-up (even where an arbitration clause is present), the creditor will want the court to use the discretion to the fullest and take into account any bad faith or impropriety on behalf of the debtor.

The situation may be less than ideal but calm heads and good legal advice can eventually win through.

Authored by James Kwan, Byron Phillips, Jonathan Leitch, and Nigel Sharman.