With growing competition and global market uncertainties in recent years, businesses may experience operational and financial challenges, resulting in debt defaults. A creditor is entitled to petition for the bankruptcy and liquidate the debtor’s assets in order to try to achieve a maximum recovery. Statistics published by the Official Receiver’s Office noted 7,062 petitions for compulsory liquidation and bankruptcy between January and October 2019. In this client alert, we discuss two significant and recent judgments in respect of insolvency law given by the Hong Kong* courts.

1. Will the existence of an arbitration agreement affect the commencement of insolvency proceedings?

In the recent case of But Ka Chon v Interactive Brokers LLC [2019] HKCA 873, Hong Kong’s Court of Appeal considered whether the right of a creditor to utilise bankruptcy and liquidation proceedings is limited by an arbitration clause in a debt-related contract. As many commercial agreements contain arbitration clauses, the judgment has important implications for creditors’ rights and the relief available.

The agreement entered between the appellant (a client of a brokerage company, the debtor) and the respondent (a brokerage company, the creditor) provided that disputes between the parties should be resolved through arbitration. As the appellant did not repay the sums overdue in the margin account, the creditor applied for bankruptcy of the appellant in the Hong Kong Courts. The appellant sought to persuade the Court of Appeal to dismiss the statutory demand issued by the creditor, one of the grounds being that the parties had agreed to arbitration.

The Court of Appeal dismissed the appeal, taking the opportunity to consider the first instance judgment in Lasmos (Re Southwest Pacific Bauxite (HK) Ltd [2018] 2 HKLRD 449) in 2018. In Lasmos, the First Instance Court held that where three criteria are satisfied, unless there are exceptions, a creditor’s winding up petition should generally be dismissed if:

  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 and files an affirmation in accordance with the winding up rules demonstrating this.

In But Ka Chon, although the Court of Appeal did not overrule Lasmos and acknowledged that the Court should follow the underlying policy in favour of arbitration, the Court of Appeal, as an obiter, queried whether the ruling in Lasmos would significantly limit the statutory right of a creditor to make use of bankruptcy and liquidation proceedings to protect its interests. In its ruling, the Court of Appeal held that, even if the principle in Lasmos was adopted, the appellant had failed to satisfy the third criterion above, namely, the appellant had not commenced arbitration proceedings. Hence, the Court of Appeal dismissed the appellant’s appeal.

But Ka Chon implies that where parties already have an arbitration agreement in place, a creditor is still entitled to apply to the Courts for the liquidation or bankruptcy of the debtor. Hong Kong Courts have the discretion to stay or dismiss a petition for bankruptcy or liquidation and strike a balance between a creditor’s protection of its own interests and respect for arbitration proceedings. Whether the debtor takes steps to commence the arbitration is an important consideration.

2. The Hong Kong Courts recognise for the first time a non-common law jurisdiction, namely Japanese bankruptcy proceedings

In Re Mr Kaoru Takamatsu [2019] HKCFI 802, the Hong Kong Courts, for the first time, recognised bankruptcy proceeding commenced in Japan, and vested the trustee in bankruptcy with equivalent powers under Hong Kong law, including the power to manage the assets of the bankrupt and to request documents from third parties. This precedent is conducive to the enforcement of a debtor’s assets in Hong Kong by foreign trustees in bankruptcy or liquidators from non-common law jurisdictions.

In this judgment, the judge made reference to two criteria for the recognition of foreign bankruptcy proceedings by the Hong Kong Courts:

  1. the foreign bankruptcy proceeding requesting recognition must be commenced in the country of incorporation of the company or domicile of the individual; and
  2. the liquidation and bankruptcy laws of such country must be taken on behalf of creditors generally and have a similar insolvency regime to Hong Kong.

This case confirmed the similarities between the insolvency regime in the bankruptcy proceedings in Japan and Hong Kong. Since legal rights enjoyed by trustees in bankruptcy in the two jurisdictions were similar, the Hong Kong Court was willing to recognise the trustee in bankruptcy appointed by the Japanese Courts. This undoubtedly provides creditors from various civil law system countries a new way for enforcing debt security in Hong Kong.