Hong Kong Court of Appeal considers the effect of exclusive jurisdiction clause on bankruptcy proceedings

A recent Hong Kong Court of Appeal decision examined a creditor's right to commence bankruptcy or winding up proceedings where the petition debt arises from an agreement containing an exclusive jurisdiction clause in favour of a foreign court: Guy Kwok-Hung Lam v Tor Asia Credit Master Fund LP [2022] HKCA 1297.

The Court of Appeal overturned the first instance decision which held that the exclusive jurisdiction clause was not a bar to the creditor's bankruptcy petition as none of the defences raised by the debtor disclosed any bona fide dispute. The Court of Appeal held that, where the debt on which a winding up or bankruptcy petition is based is disputed and the parties are bound by an exclusive jurisdiction clause in favour of a foreign forum, the petition should not be allowed to proceed pending the determination of the dispute in the agreed forum, unless strong reasons can be shown.

Equally interestingly, the Court of Appeal also made some (obiter) comments on a similar and often-debated topic: the interplay between arbitration clauses and winding up/bankruptcy petitions.

We discuss this decision in more details in this blog post. Although this case concerns a bankruptcy petition, the reasoning equally applies in the context of winding up proceedings.

Factual background

This case is an appeal against a bankruptcy order against a Mr. Lam, a Hong Kong resident and the founder of CP China Group, which provided aged care services. CP Global Inc (CP Global), a Cayman company, was the holding company of the CP China Group.

The petition debt arose from a credit and guaranty agreement (the Agreement) entered into between, among others, the petitioner Tor Asia Credit Master Fund LP (the Petitioner), CP Global and Mr. Lam. Pursuant to the Agreement, the Petitioner lent US$29.5 million (the Loans) to CP Global, and Mr. Lam personally guaranteed the full payment of the Loans as primary obligor.

The Agreement contains an exclusive jurisdiction clause in favour of the courts of New York "for the purposes of all legal proceedings arising out of or relating to this [Agreement] or the other [loan documents] or the transactions contemplated hereby or thereby".

The parties subsequently amended the Agreement to extend the maturity of the Loans three times. Each of the amendment agreements incorporated the exclusive jurisdiction clause in full. The Loans were also secured by various securities such as equity interests in companies beneficially owned by Mr. Lam.

CP Global had difficulties in making payments. Negotiations ultimately failed, and the Petitioner presented a bankruptcy petition in Hong Kong against Mr. Lam for the unpaid debts under the Agreement. Mr. Lam took out proceedings in New York, seeking a declaration that his obligations under the Agreement were invalid.

Decision in the Court of First Instance

The bankruptcy petition was heard before Linda Chan J and a bankruptcy order was granted. Linda Chan J held in the first instance decision that a contractual agreement between the parties does not fetter the jurisdiction of the Court to determine whether the company should be wound up, as the jurisdiction of the Court to wind up a company is conferred by statute. The Court would take the same approach in the context of bankruptcy petition. Linda Chan J went on to find that there was no bona fide dispute on substantial grounds in respect of the debt, and granted a bankruptcy order against Mr. Lam.

The appeal

Mr. Lam appealed against the bankruptcy order. The only grounds raised in the appeal was that the petition should have been dismissed or stayed because the petition debt was disputed, and that Mr. Lam had raised a cross claim. Both the dispute and the cross claim were subject to the exclusive jurisdiction clause.

The Lasmos approach

Lasmos Ltd v Southwest Pacific Bauxite (HK) Ltd [2018] HKCFI 426 (which we blogged here) was a hotly-debated decision of the Hong Kong Court of First Instance in 2018. There, the Court (Harris J) held that it would generally exercise its discretion to stay a winding up petition in respect of a debt pending arbitration if the following conditions were satisfied:

• the company disputes the debt relied on by the petitioner;
• the contract under which the debt is alleged to arise contains an arbitration clause that covers any dispute relating to the debt; and
• 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 demonstrates this to the Court.

Significantly, the Lasmos approach does not require a party resisting a winding-up petition to show that the debt is disputed on genuine and substantial grounds – which the Court usually requires before it will stay or dismiss a winding up petition.

The ratio of Lasmos was doubted by subsequent cases such as But Ka Chon (which we blogged here) and Dayang (which we also blogged previously)

Mr. Lam argued, by analogy, that the Court should have followed the approach laid down in Lasmos.  The Petitioner, on the other hand, argued that the Lasmos approach should not be extended to an exclusive jurisdiction clause, and that the Lasmos approach was itself unsound even in the arbitration context where it was developed.

The leading judgment

G Lam JA delivered the leading judgment of the Court of Appeal.

G Lam JA examined a line of cases on exclusive jurisdiction clauses and found that more recent decisions "give emphatic application to the principle that parties should be held to their bargain on how their disputes are to be resolved".

G Lam JA considered that, where the debt on which a winding up or bankruptcy petition is based is disputed and the parties are bound by an exclusive jurisdiction clause in favour of a foreign forum, the petition should not be allowed to proceed, in the absence of strong reasons, pending the determination of the dispute in the agreed forum. Examples of "strong reasons" include (among others): (i) the debtor may be incontestably and massively insolvent quite apart from the disputed petition debt; (ii) there may be a need to investigate potential wrongdoings; or (iii) dismissal or stay of the petition would be to deprive the petitioner of a real remedy or would otherwise result in injustice.

In reaching his decision, G Lam JA also considered the divergence of judicial opinion arising from Lasmos. Although G Lam JA did not expressly state whether Lasmos is the preferred approach (his remarks on Lasmos are obiter), as we will see, his reasoning appears to be in line with the Lasmos approach.

Instead of holding that the Lasmos approach should be extended to the context of exclusive jurisdiction clause, G Lam JA suggested that the approach in dealing with ordinary actions commenced in breach of an exclusive jurisdiction clause equally applied to winding up and bankruptcy proceedings.  The Hong Kong Court will generally stay a Hong Kong court action in the face of an exclusive jurisdiction clause in favour of a foreign court, unless there are "strong reasons" to allow the Hong Kong action to proceed. The fact that the plaintiff's case may be strong is not, in itself, a "strong reason", however. G Lam JA gave several reasons for extending this approach to insolvency/bankruptcy proceedings:

• Although insolvency/bankruptcy petitions are class remedies, the anterior question of whether the debt is due should still be resolved at the contractually agreed forum. Until the creditor is established as a creditor, he is not entitled to present a petition.
• There is a strong public policy to require parties to abide by their contracts. Prima facie parties should be held to their agreement as to how and where their differences are to be resolved.
• It would be an anomaly if a party bound by an exclusive jurisdiction clause in favour of a foreign forum cannot proceed with an ordinary action in Hong Kong for his claim but can resort to the more draconian measure of presenting a winding up/bankruptcy petition.

In the present case, as the debt was disputed by Mr. Lam, the Court held that the petition should not be allowed to proceed until the dispute was determined first in accordance with the parties' agreement as to jurisdiction.

The Court therefore allowed the appeal. The petition was dismissed rather than stayed, as it was not desirable to have insolvency petitions adjourned or stayed for lengthy periods.

Chow JA's opinion

Chow JA agreed with G Lam and Barma JJA that the appeal should be allowed, but preferred a narrower approach. Interestingly, Chow JA said that "[i]t is not, I understand, the judgment of G Lam JA that [the Lasmos approach] should be followed.

Chow JA was not prepared to accept the extension of the Lasmos approach to insolvency/bankruptcy proceedings for two reasons:

• it was not necessary for the Court in the present case to rule definitively on the correctness of the Lasmos approach;
• the modern approach to stay of legal proceedings in favour of arbitration is heavily influenced by the legislative policy of promotion of arbitration as an alternative dispute resolution mechanism. On the other hand, there is arguably not sufficient policy reasons to support a wholesale adoption of the Lasmos approach to the situation involving an exclusive jurisdiction clause.

Chow JA also expressed reservations as to G Lam JA's adoption of the Court's approach to stay an ordinary action based on an exclusive jurisdiction clause to winding-up and bankruptcy proceedings. Chow JA considered that such an approach "would effectively disregard the well-recognised distinction between an action on a debt and a bankruptcy/winding up petition based on a debt".

Chow JA, however, considered that the appeal could be disposed of on a narrower basis. The wording of the exclusive jurisdiction clause in this case (see above), on its true construction, was wide enough to apply to a bankruptcy/winding-up petition. It is a factor that should be taken into account in the exercise of the Court's discretion to dismiss/stay the winding up/bankruptcy proceedings. In Chow JA's view, the judge at the first instance adopted the wrong approach – by requiring that there must be shown a bona fide dispute of debt on substantial ground for the petition to be stayed/dismissed, the approach would effectively render the exclusive jurisdiction clause immaterial or irrelevant.

Comments and conclusion

It appears that the law in this area continues to be "in a state of flux" following this Court of Appeal decision. The fact that the members of the Court of Appeal preferred different justifications for the same result illustrates the difficulty in this area of law, where reasonable minds often differ. Doubts have often been cast on the Lasmos approach, but it appears that a definitive decision as to its correctness is yet again left to another day. It will be interesting to see whether the Petitioner will seek to appeal this decision to the Court of Final Appeal.

For now, the creditors will find it more difficult to undertake a bankruptcy/winding up petition in Hong Kong based on a debt which is subject to an exclusive jurisdiction clause in favour of a foreign court. Absent strong reasons, such debt must be adjudicated by the foreign court first before a bankruptcy/winding up petition can be undertaken.

Another aspect of this decision bears repeating: parties must pay attention to the drafting of exclusive jurisdiction clause in their contract. Depending on how it is drafted, it may or may not cover winding up/bankruptcy petitions. In this case, the wording "all legal proceedings arising out of or relating to this [Agreement]" was found to be wide enough to include a winding up petition brought on the basis of a disputed indebtedness under the Agreement.