HONG KONG: COURT MAKES WINDING UP ORDER WHERE DEBTOR UNABLE TO PROVE BONA FIDE DISPUTE ON SUBSTANTIAL GROUNDS

The Hong Kong Court of First Instance has declined to prioritise an arbitration agreement where a debtor intended to dispute the existence of a debt without proving there was a bona fide dispute on substantial grounds.

Dayang (HK) Marine Shipping Co., Ltd v. Asia Master Logistics Ltd [2020] HKCFI 311; HCCW 14/2019

Background

The parties entered into a charterparty on 25 October 2018 by which Asia Master chartered a vessel M.V. “Aoli 5” from Dayang.

The Fixture Note obliged the owner to guarantee that the vessel be watertight and that all fitted gear be workable and in good condition throughout the charter period. It provided for the cost and duration of the hire, with disputes to be resolved by arbitration in Hong Kong under English law. Finally, it applied the New York Produce Exchange 93.

This was the substantive hearing of Dayang’s winding up petition based on the unpaid debt of US$360,919.76, which was originally dated 11 January 2019 then amended on 11 April 2019. Asia Master did not deny the existence of the debt but raised a counterclaim in relation to an alleged breach of Dayang’s obligations as per the Fixture Note and submitted that the dispute should be resolved by arbitration. On 22 February 2019, Asia Master’s counsel sent a letter to Dayang to state its preparedness to settle the dispute by arbitration.

In making its decision, the Court examined the nature of the dispute and any public policy implications.

Whether the debt was disputed in good faith and on substantial grounds

Deputy High Court Judge William Wong SC first observed that the breaches of obligations, for which Asia Master claimed Dayang should take responsibility, remained under investigation. Asia Master was unable to give particulars as to the duration of the alleged delay, the extent of the loss, and whether the counterclaim would exceed (and therefore extinguish) the debt. The Court held it was insufficient for Asia Master merely to state that Dayang ought to bear some responsibility when resisting its petition for winding up based on undisputed debts. The crux of the dispute was held to be whether Asia Master had a bona fide counterclaim on substantial grounds.

The Court accepted Dayang’s argument that, where the entire debt is not disputed (exceeding HK$10,000), it becomes irrelevant whether or not arbitral proceedings commence and the Court must exercise its discretion to wind up the respondent. Where a debtor challenges a petition on the grounds of a genuine and serious counterclaim, which is greater than or equal to the debt, the burden of proof shifts and the debtor must prove the claim is genuine, serious, and of substance. The Court noted similarities with the test for deciding whether a debt is disputed in good faith and on substantial grounds, citing Re Sinom (Hong Kong) Ltd I [2009] 5 HKLRD 487 and Re Alpha Building Construction Ltd, unreported, HCCW 283/2014.

The Court found that the lack of precise factual evidence to substantiate Asia Master’s counterclaim was problematic and indicated a prima facie lack of dispute to the debt. Where the underlying contract contains an arbitration clause that covers any dispute relating to the debt, the Court asked: i) is the Court obliged to stay or dismiss the winding up proceedings in favour of arbitration; and if not, ii) should the Court exercise its discretion to do so?

As to the first question, it is established in Hong Kong law that section 20 of the Arbitration Ordinance, which requires the Court to stay its proceedings if there is a valid arbitration agreement, applies only to actions and not to petitions for winding up.

The Court also held that question of its discretion to stay or dismiss a winding up petition was similarly uncontroversial. The Court pointed to section 180(1) of the Companies (Winding Up and Miscellaneous Provisions Ordinance) (Cap. 32). The Court studied two distinct approaches to show how this discretion should be exercised in a principled manner.

The “Salford-Lasmos Approach”

Asia Master relied on the principles in Salford Estates (No 2) Ltd v Altomart Ltd (No 2) [2015] Ch 589 and Re Southwest Pacific Bauxite (HK) Ltd [2018] 2 HKLRD 449. It contended that a winding up petition should generally be dismissed where:

• the contract underlying a debt contains an arbitration clause that covers any dispute relating to the debt;
• the company takes the steps required by the clause to commence the mandatory dispute resolution process; and
• the company files an affirmation in accordance with r.32 of the Commission (Winding Up) Rules (Cap. 32H. Sub. Leg.).

However, the judge held that this principle was not engaged as no notice of arbitration had been sent. Consequently, the arbitration proceedings had not been ‘commenced’.

The “Traditional Approach”

The judge noted that the differences between the “Traditional” and “Salford-Lasmos” approaches  were:

• under the “Traditional Approach”, there cannot be a dispute if it is shown that A is obviously right and B is obviously wrong. B must show a bona fide dispute on substantial grounds; mere assertions will not suffice;
• under the “Salford-Lasmos Approach”, all B has to do is simply deny A is right. There is no requirement for B to show a bona fide dispute on substantial grounds.

The “Contractual Justification”

Both the Salford and Lasmos judgments acknowledge the importance of protecting the parties’ freedom of contract. Specifically, the courts must protect the parties’ freedom to refer disputes to arbitration. However, the extent to which one’s contractual rights or obligations are (or ought to be) protected by the Court must depend upon the scope of those rights and obligations. This is a matter for contractual interpretation. The analytical starting point should therefore be to construe the agreement to arbitrate.

In the Court’s view, an arbitration clause imposes an obligation to have disputes that fall within its scope determined, or resolved, by arbitration. It also prevents any party from seeking to have such disputes determined or resolved in any other forum.

The Court went on to ask whether presenting a winding up petition to the Companies Courts amounts, per se, to a breach of an agreement to resolve disputes by arbitration. In the Court’s view, “the short answer…is unequivocally ‘no’… [T]he presentation of a winding up petition does not come within the scope of an agreement to arbitrate”.

Ultimately, the Court adopted the “Traditional Approach”.

Winding up as a discretionary remedy

The judgment asserts that there are no strong reasons to put an unprecedented fetter on the Court’s otherwise flexible discretion to make a winding-up order. The judge held:

• the conditions presented in the “Salford-Lasmos Approach” are antithetical to the nature of discretion and represent an unprecedented fetter on the Court’s discretion; and
• the inflexibility of this approach may prejudice the interests of creditors because it can compel the creditor to establish the existence of a debt by an action. This would then deprive it of all tangible remedies where the assets of the debtor have been dissipated by the time the action for debt has been completed by arbitration.

The Court referred to several authorities to demonstrate its discretion to allow winding up petitions, even where the debtor is able to prove a bona fide dispute on substantial grounds.

Public policy concerns: ousting the creditor’s right to wind up

While the judge observed that are no public policy objections to the “Salford-Lasmos Approach”, he maintained that its real issue is the impact on the Court’s discretion to make winding up orders rather than its effect on the petitioner’s “right” to petition to wind up.

Decision

The Court made a winding up order against Asia Master, finding:

1. to dispute the existence of a debt a debtor must show there is a bona fide dispute on substantial grounds; it cannot merely deny the debt. This test applies regardless of whether or not the debt has arisen from a contract incorporating an arbitration clause;
2. the Court must exercise discretion irrespective of whether there is an arbitration agreement;
3. commencing arbitration proceedings is not sufficient proof of the existence of a bona fide dispute on substantial grounds, but may constitute relevant evidence of such dispute; and
4. where a creditor petitions a winding up order on a debt where there is a bona fide dispute based on substantial grounds, it risks being liable to pay the debtor’s costs on an indemnity basis (and the tort of malicious prosecution).

Comment

Recent developments in relation to the issue of winding up petitions with respect to the existence of arbitration clauses / arbitration proceedings between the petitioner and the debtor have seen the Courts shift from the “Traditional Approach” (which is referred to by the Court in paragraph 57 of the judgment as being the need for the debtor to show “a bona fide dispute on substantial grounds” in order to persuade the court to stay or dismiss a winding up petition) to the “Salford-Lasmos Approach” (“Lasmos Approach” previously discussed here) and then back to a more moderate approach in the case But Ka Chon v Interactive Brokers LLC [2019] HKCA 873 (previously discussed here).  In light of such developments, it is notable that the Court in Dayang relied primarily on the “Traditional Approach” in deciding in favour of the creditor.

The Court also considered the “Salford-Lasmos Approach”.  The Court commented that even if the “Salford-Lasmos Approach” was applicable, it would still have held in favour of the creditor because the debtor did not, in failing to timely commence arbitration proceedings, hold a genuine intention to dispute the debt.

It is also notable that the Court spent more than three-quarters of this judgment in an analytical discourse over the recent developments in this area.  As noted by the Court at paragraph 135, “the Singaporean authorities have not been altogether successful in navigating a middle-ground between the Traditional Approach and the Salford-Lasmos Approach.  I suspect that similar problems would more or less arise if the same is attempted in Hong Kong”.  The Court was, therefore unable to come to a clear conclusion.  Nevertheless, the Court, in spending much time on dissecting the matter, has shown a clear intention to resolve this common issue.  Therefore, it is reasonable to expect that further developments in this area will be forthcoming.