On 2 March 2018, the Court of First Instance (CFI) published reasons for its decision in Lasmos Limited v Southwest Pacific Bauxite (HK) Limited [2018] HKCFI 426. Harris J held that where a disputed debt is alleged to have arisen from a contract that contains an arbitration clause that covers any dispute relating to the debt, a winding up petition that relies on that debt should generally be dismissed. This case represents a departure from earlier decisions in Hong Kong towards the English and Singaporean approach relating to the impact of an arbitration clause on a winding up petition.

Background

On 27 October 2017, Lasmos Limited issued a petition (Petition) to wind up Southwest Pacific Bauxite (HK) Limited (Company), relying on a statutory demand which sought payment of some USD260,000 said to have arisen under a management service agreement (Agreement).

The Company declined to pay the debt on the grounds that there was a bona fide dispute on substantial grounds as to what sums were payable. The Agreement contains an arbitration clause: "If the Dispute is not settled by mediation within 10 Business Days of the start of the mediation process in clause 17.4, any party may by written notice to the other parties refer the dispute to arbitration…"

The Company issued a summons to strike out the Petition, which was heard by Harris J in the CFI. The CFI had to consider the impact of the arbitration clause in the Agreement on the Petition. Harris J, in his decision, considered authorities in Hong Kong, England and Singapore.

Harris J noted that in Hong Kong, the previous position had been that the courts would need to determine whether there was a bona fide defence to the debt on substantial grounds to decide whether a winding up petition should be dismissed1, and would not dismiss or stay a petition merely because there is an arbitration clause in the agreement, though it may be relevant to the exercise of the court’s discretion2.

On the other hand, the position taken by the English courts differed. In the judgment of the English Court of Appeal in Salford Estates (No 2) Ltd v Altomart Ltd (No 2)3, it was held that although the mandatory stay provisions in the Arbitration Act 1996 did not apply to a winding up petition, where the petition relies on a disputed debt that is subject to an arbitration clause, the court ought to exercise its discretion and dismiss or stay the petition to compel the parties to abide by their chosen method of dispute resolution. To conduct a summary judgment type analysis of the liability for a disputed debt when parties have agreed to resort to arbitration would be inconsistent with the legislative policy of the Arbitration Act 1996. Salford Estates (No 2) has been applied by the Singapore High Court in an injunction application4, which was sought to restrain the presentation of a winding up petition, on the grounds that there was a dispute in respect of the debt that was governed by an arbitration clause.

Harris J explained his view that the Salford Estates (No 2) approach is the correct way forward:

  1. Class remedy argument not relevant: the true purpose of issuing a petition is to recover a debt owed to the petitioner, and the fact that a winding up order is a class remedy is not relevant to the question to be arbitrated, which is whether a debt is owed.
  2. Benefit of a winding up order remains: under exceptional circumstances, for instance, where assets of the company had gone missing, a petition could still be issued for provisional liquidation and stayed to arbitration. Another example justifying early presentation of a petition is to engage the clawback provisions under the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32) (CWUR).

Harris J therefore departed from the earlier decisions in Hong Kong and held that (a) if a company disputes the debt relied on by the petitioner; (b) the contract under which the debt is alleged to arise contains an arbitration clause that covers any dispute relating to the debt; and (c) the company takes the steps required under the arbitration clause to commence the contractually mandated dispute resolution process and files an affirmation in accordance with Rule 32 of the Companies (Winding Up) Rules (Cap 32H), demonstrating the foregoing, a winding up petition should generally be dismissed, without requiring the company to otherwise establish a bona fide defence on substantial grounds. Harris J added that for the reasons stated in the preceding paragraph, there may be exceptional cases in which a stay is more appropriate, and that failure to comply with Rule 32 of the CWUR may result in a winding up order.

Implications

The decision in Lasmos may not surprise those who have been following recent developments in the corporate insolvency space. The overall change in position appears to be derived from the decision in Fulham Football Club (1987) Ltd v Richards5, where the English Court of Appeal held that a petition for unfairly prejudicial conduct does not invoke a class right that could only be determined by the court. Fulham was considered in Quiksilver6, wherein the petition arose from a shareholder dispute seeking a winding up order on just and equitable grounds. Following Fulham, Harris J found that since the only interested persons in the petition were the two shareholders, both of whom were parties to the petition, the nature of a winding up order as a class remedy was not relevant. His Lordship took the view that "the correct approach is to identify the substance of the dispute between the parties and ask whether or not that dispute is covered by the arbitration agreement".

Lasmos clearly demonstrates an extension from Quiksilver, expanding the jurisprudence in respect of shareholder’s petitions to petitions on insolvency grounds. To Harris J, the fact that a winding up order is a class remedy is not relevant to how the question of whether the debt exists is to be determined. The parties’ choice of dispute resolution should be respected. Following Lasmos, for a disputed debt that is subject to an arbitration agreement, in the absence of exceptional circumstances, winding up relief will in practice be available to the creditor only after arbitration of the dispute. Arbitration, to which the parties have agreed, cannot in general be circumvented, as was once possible, by invoking the Court’s winding up jurisdiction. Readers should therefore take Lasmos into account when deciding the applicable jurisdictional regime to include in their contracts.

The full judgment can be found here.