Reconsidering the Lasmos approach to winding-up petitions involving arbitration clauses.

For a second time in two months, the Hong Kong Court of Appeal was asked to consider the correctness of the controversial approach adopted in the case of Lasmos Limited v. Southwest Pacific Bauxite (HK) Limited (2018) HKCFI 426 in dealing with winding-up petitions involving arbitration clauses. The issue was first brought to the Court of Appeal in the case of But Ka Chon v. Interactive Brokers LLC [2019] HKCA 873, [2019] HKEC 2473 earlier in July this year. The Court of Appeal had then expressed its reservations on the Lasmos approach but did not finally decide on its appropriateness.

In the most recent case of Sit Kwong Lam v. Petrolimex Singapore Pte. Ltd [2019] HKCA 1220, the Court of Appeal once again did not find it necessary to decide on the correctness of the Lasmos approach but warned against debtors’ opportunistic attempts to invoke the Lasmos approach in future.

This article will provide an update of the latest position and what you should know if you are considering to issue statutory demands or insolvency proceedings for debt recovery in Hong Kong or if you have been served with these proceedings and your contracts are governed by arbitration clauses.

The Lasmos approach

In Lasmos, the Honorable Justice Harris substantially departed from previous Hong Kong authorities and held that save for exceptional cases, a creditor’s winding-up petition should “generally be dismissed” where three requirements are met: -

  1. If a 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 (which might include preliminary stages such as mediation) and files an affirmation in accordance with rule 32 of the Companies (Winding-Up) Rules, Cap 32H, demonstrating this.

Before Lasmos, the debtor had to show that the petitioning debt was bona fide disputed on substantial grounds to dismiss an insolvency petition. The effect of this new approach is that the company is entitled to have the petition dismissed where there is an arbitration clause as long as the three requirements are met.

In But Ka Chon v Interactive Brokers LLC [2019] HKCA 873, the Court of Appeal did not find it appropriate to decide whether the Lasmos approach is correct because the third requirement under the approach was not met as the appeal court upheld the lower court’s finding that the debtor had not taken any steps to commence arbitration and had no genuine intention to commence arbitration.

Background of Sit Kwong Lam

The dispute in Sit Kwong Lam v. Petrolimex Singapore Pte. Ltd concerns a debt for payment of goods.

The debtor is the indirect controlling shareholder and chairman of a Hong Kong listed company, Brightoil Petroleum (Holdings) Limited (Brightoil Holdings) who executed a personal guarantee (Personal Guarantee) in favour of the petitioner, Petrolimex Singapore Pte. Ltd (“Petitioner”), to guarantee the punctual payment of goods purchased by a wholly-owned subsidiary of Brightoil Petroleum (Singapore) Pte Ltd (Brightoil Singapore).

The Petitioner and Brightoil Singapore subsequently entered into a settlement agreement (Settlement Agreement) to settle the outstanding payment for goods sold to Brightoil Singapore. Pursuant to the Settlement Agreement, Brightoil Holdings executed a parent company guarantee (PCG) in favour of the Petitioner and the debtor executed an addendum to the Personal Guarantee in favour of the Petitioner (PG Addendum).

Clause 4 of the PG Addendum provides that “[a]ll other terms and conditions of the [Personal Guarantee], including the arbitration clause, shall remain unchanged and the [a]ddendum shall constitute an integral part of the [Personal Guarantee].”

However, there was in fact no arbitration clause in the Personal Guarantee and an arbitration clause was only found in clause 7 of the Settlement Agreement between the Petitioner and Brightoil Singapore. Indeed, the Personal Guarantee provided that the Hong Kong courts have exclusive jurisdiction for dispute arising in connection with the Personal Guarantee.

The debtor argued that on a proper construction of the objective intention of the parties, there were various pointers showing that the parties intended the PG Addendum to be governed by an arbitration clause in the same terms as the Settlement Agreement; particularly, because they concerned a “single commercial relationship”. Alternatively, the debtor sought rectification of the PG Addendum on the basis of unilateral mistake.

Findings in Sit Kwong Lam

The Court of Appeal held that the trial judge was right in his construction of the relevant clauses in the PG Addendum and in holding that the arbitration clause in the Settlement Agreement had not been incorporated given the unambiguous wording in the addendum. The Court of Appeal held that the correction that ought to be made to cure the mistake in the clause (namely, referencing a non-existent arbitration clause in the Personal Guarantee) was by deleting “including the arbitration clause” in Clause 4 of the PG Addendum.

The Court of Appeal also rejected the debtor’s argument on unilateral mistake. It was found that the pertinent mistake was not merely on the non-existence of an arbitration clause in the Personal Guarantee but the non-existence of any provision in the Personal Guarantee (such as the exclusive jurisdiction clause) that would be wholly inconsistent with an arbitration clause. The Court of Appeal found that such mistaken belief by the debtor and knowledge on the Petitioner’s part is not made out on the facts.

Furthermore, the debtor did not mention any steps he had taken to commence the process of arbitration in his affirmations filed in the winding up proceedings and the third requirement under the Lasmos approach was hence not satisfied.

On these basis, the Court of Appeal dismissed the debtor’s appeal and once again deferred to make any rulings on the correctness of the Lasmos approach.

Comments on the Lasmos approach

In But Ka Chon, the Court of Appeal had expressed clear reservations on the Lasmos approach. In obiter, the Court of Appeal considered:

  1. Firstly that the jurisdiction of the court to order a stay insolvency petitions is founded on the discretion of the court and therefore it is questionable whether a firm rule to exercise the discretion in one way in favour of a stay and a curtailment of the statutory right conferred on a creditor to petition for bankruptcy or winding up on the grounds of insolvency, would be right and consistent with the legislative intent.
  2. Secondly, noting that the Eastern Caribbean Court of Appeal had already declined to adopt the same approach followed in Lasmos, the Court of Appeal expressed reservation as to whether it was sufficient for an applicant for stay or dismissal of insolvency petitions to show only that the debt was not admitted instead of a bona fide dispute on substantial ground.

In Sit Kwong Lam, the Court of Appeal did not add anything further to the earlier obiter observations but made the following clarifications to discourage debtors from making opportunistic attempts to invoke the Lasmos approach in future:

  1. For the court to exercise the discretion of dismissing or staying a creditor’s petition, it was not necessary that arbitration had been commenced by the time the insolvency proceedings were heard – all that was required of the debtor was that he had taken the steps required under the arbitration clause to commence the process of arbitration. However, the genuine intention to arbitrate must be demonstrated in an affirmation filed in accordance with rule 32 of the Companies (Winding-Up) Rules, Cap 32H.
  2. It was beside the point that there was no mention of the requirement of a genuine intention to arbitrate in the case of Salford Estates (No 2) Ltd v Altomart Ltd (No 2) [2015] Ch 589, the case upon which the Lasmos approach was based.
  3. The fact that the debtor had no substantive claim against the creditor was immaterial.

Take away points

It remains to be seen whether the Lasmos approach will finally be confirmed, rejected or moderated by the Court of Appeal. In the meantime, even though the treatment of the Lasmos case remains uncertain:

  • Petitioners should take heed that a party’s agreement to arbitrate will be given significant weight in insolvency proceedings. Before there is any ruling from the Court of Appeal, it is foreseeable that debtors will still continue to invoke the Lasmos approach in seeking to dismiss insolvency petitions and it is hence still worth considering whether any exceptional circumstances applies before issuing a statutory demand/ commencing insolvency proceedings such as:
    • Whether there are any risks of misappropriation of assets or any circumstances justifying the appointment of provisional liquidators?
    • Whether there are any concerns on fraudulent preference or circumstances to engage the avoidance provisions in the insolvency regime?
  • On the other hand, it remains important for debtors served with statutory demands and insolvency proceedings to seek prompt legal advice to determine if there is a bona fide and substantial dispute over the debt.
  • Furthermore, to fulfill the second and third requirements of the Lasmos approach which had been endorsed by the Court of Appeal in the two recent cases, debtors resisting statutory demands and insolvency proceedings should:
    • Check whether a valid arbitration clause was in place covering the dispute relating to the debt; and
    • Take timely steps to commence arbitration or comply with other dispute resolution process mandated by the contract to show a genuine intention to arbitrate. In the absence of any other mandated dispute resolution process required before commencing arbitration, sending only a letter before action to threaten arbitration and without serving a notice of arbitration will be insufficient to show intention to arbitrate.