No If, No But – Will an arbitration agreement always trump a winding-up petition?

In But Ka Chon v Interactive Brokers LLC [2019] HKCA 873, the Hong Kong Court of Appeal dismissed an appeal to set aside a statutory demand arising out of online forex futures trading debts. In doing so, Vice-President Kwan of the Court of Appeal made obiter comments on the circumstances in which a winding-up petition would be set aside where the parties to a contract had agreed to arbitration for dispute resolution.

Background

Mr But's margin account with Interactive Brokers ("IB") suffered a large loss when the Swiss Franc/Euro exchange rate was unpegged in 2015. IB issued a margin call but Mr But did not inject funds into his account to resolve the margin deficit. IB accordingly proceeded to liquidate Mr But's assets and positions and served a statutory demand on Mr But for the balance of the deficit plus interest at margin interest rates.

Mr But sought to set aside the statutory demand on the basis of (i) a counterclaim for misrepresentation and (ii) that the dispute should be arbitrated pursuant to an arbitration clause in his contract with IB. The application failed and Mr But appealed to the Court of Appeal.

Decision in the High Court

The High Court noted that the judgment in Re Southwest Pacific Bauxite (HK) Ltd [2018] 2 HKLRD 449 (known as the "Lasmos case") had departed from previous authorities and had adopted a new approach. This was to generally dismiss winding-up petitions where three requirements were met:

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 (which might include preliminary stages such as mediation) and demonstrates this to the Court.

The effect of the Lasmos case is that, where these three requirements are met, the company is entitled to have the petition dismissed without having to show that the petitioning debt is bona fide disputed on substantial grounds. Where there is an arbitration clause, it is sufficient to show that the debt is "disputed" and for that it is sufficient to show the debt is not admitted.

The High Court in But Ka Chon did not challenge the Lasmos approach, but simply found that the new approach was inapplicable to the instant case because the lower court judge had already adjudged on the dispute by way of Mr But's claim that he had been induced by IB's misrepresentations to enter into the contract. The misrepresentation claim was of no merit. There was therefore no genuine dispute to be arbitrated.

The judge also found that, even had the Lasmos approach been applicable, Mr But had not satisfied the third requirement in the Lasmos approach because he had not taken any steps to commence arbitration. The lower court judge therefore declined to set aside the statutory demand.

Decision in the Court of Appeal

The Court of Appeal agreed with the rationale of the judge below and found that it did not need to determine whether the Lasmos approach or previous approaches were applicable to the instant case. It held that, if the Lasmos approach was applicable, the third requirement of Lasmos would in any event not have been complied with based on the fact that Mr But had not demonstrated his genuine intention to arbitrate for more than two years after having first raised the possibility of commencing arbitration, and that no Notice of Arbitration was ever served on IB. The appeal was therefore dismissed.

Obiter commentary on the Lasmos approach

The Court of Appeal also made the following obiter observations on the Lasmos approach given the importance of this issue to insolvency proceedings:

1. Insolvency petitions do not fall into Article 8(1) of the UNCITRAL Model Law on International Commercial Arbitration (which is adopted in section 20 of the Arbitration Ordinance). There is no automatic, mandatory or non-discretionary stay on insolvency petitions where there is an underlying arbitration agreement.
2. The Court has a discretionary power under insolvency legislation whether to dismiss or stay a petition where the alleged debt arises out of a transaction containing an arbitration agreement. The Court will consider all relevant circumstances, including the financial position of the company, the existence of other creditors and the position taken by them.
3. The creditor has a statutory right to petition for bankruptcy or winding-up on the ground of insolvency.
4. The Lasmos case decided (following the English case Salford Estates (No 2) Ltd v Altomart Ltd (No2) [2015] Ch 589) that the discretion under the insolvency legislation should be exercised only one way (i.e. that the petition should "generally be dismissed" save in "exceptional" or "wholly exceptional" circumstances, upon satisfaction of the three requirements). It is settled law that the "petitioning debt not being admitted" means a dispute sufficient for the purpose of arbitration, without regard to the quality of the dispute or substantive merits.
5. The Lasmos approach constitutes a substantial curtailment of the creditor's statutory right to petition for bankruptcy. Separately, in the case of Sit Kwong Lam v Petrolimex Singapore Pte Ltd [2019] HKCFI 920, it has also been held that an arbitration clause which purports to restrict or fetter a creditor's statutory right to petition would not be allowed by the Court for public policy reasons.
6. The Eastern Caribbean Court has refused to adopt the Salford approach, as the BVI Court's statutory jurisdiction to wind up a company based on its inability to pay its debts as they fall due unless the debt is disputed on genuine and substantial grounds is too firmly a part of BVI law to now require a creditor exercising the statutory right to prove exceptional circumstances to establish his status to wind up a company. The statutory jurisdiction is satisfied once the creditor is applying on the basis of a debt that is not disputed on genuine and substantial grounds. The position is the same as regards the insolvency legislation in Hong Kong.
7. The Court of Appeal therefore has reservations if the discretion under the insolvency legislation should be exercised only one way to substantially curtail the right of the creditor to present a petition.
8. Considerable weight should be given to the factor of arbitration in the exercise of the Court's discretion.
9. Discretion should not be exercised in a way that would inevitably encourage parties to an arbitration agreement to seek to bypass the arbitration agreement/legislation by presenting a winding-up petition. The Court is not powerless to deal with such tactics. The discretion should also not invariably be exercised in favour of the creditor where the Court is satisfied that there is no bona fide dispute on substantial grounds.
10. Possible ways of exercising this discretion include requiring the debtor to establish in the normal way that there is a bona fide dispute on substantial grounds, failing which, the debtor can only expect a short adjournment to enable it to commence arbitration.\
11. The debtor cannot simply put up its hands and say: "You, the court, have no jurisdiction because of my contract." That is not what the contract says, and the Court is entitled to be satisfied that there is a proper dispute

Comments

The Court's obiter comments indicate the Court already has the tools it needs to deal with the tension between the creditor's right to petition for a debtor's bankruptcy and the parties' rights to agree to arbitration in a contract. Vice-President Kwan's analysis suggests that she believes that the Lasmos Case propounded an overly one-sided exercise of the Court's discretion. She has reiterated that, where the Court is satisfied there is no bona fide dispute on substantial grounds, the discretion should not invariably be exercised in favour of the creditor.

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