Hong Kong Court of Appeal clarifies effect of arbitration clauses on insolvency proceedings

In highly-anticipated twin rulings, the Hong Kong Court of Appeal has confirmed the approach which should be taken when a debtor opposes insolvency proceedings on the basis of a defence or claim which is subject to an arbitration clause (Re Simplicity & Vogue Retailing (HK) Co., Limited [2024] HKCA 299; Re Shandong Chenming Paper Holdings Limited [2024] HKCA 352).

The practical effect of the decisions is that, generally, the arbitration agreement will be upheld, the insolvency proceedings stayed or dismissed, and the relevant defence or claim referred to arbitration (rather than resolved by the court as part of the insolvency proceedings), provided the debtor can demonstrate certain threshold requirements.  These are that (i) the relevant defence or claim advanced by the debtor does not border on the frivolous or an abuse of process and (ii) the debtor has a genuine intention to arbitrate the defence or claim (which should not be onerous in the case of genuine disputes).

A relevant defence or claim will include: (i) a dispute as to the petition debt itself; or (ii) a claim by the debtor against the petitioner which equals or exceeds the petition debt, such as to put in issue the status of the petitioner as a net creditor (regardless of whether such claim is subject to a legal right of set-off or is a mere "cross-claim").

The court retains a discretion to assume jurisdiction and determine the relevant defence or claim when it considers it appropriate based on a "multi-factorial" assessment of all the circumstances, including where it considers there to be "strong reasons" or "countervailing factors" at play.  This would include the risk of the debtor's insolvency affecting third parties as well as a failure by the debtor to demonstrate the threshold points mentioned above (although the courts have stressed that these are non-exhaustive examples).

The decisions of the Court of Appeal provide welcome clarification of the approach to arbitration clauses in the insolvency context.  There had previously been conflicting first instance decisions on this issue, as well as uncertainty as to whether the approach should be the same as that for exclusive jurisdiction clauses which was laid down by the Court of Final Appeal in its landmark decision in Re Guy Kwok Hung Lam [2023] HKCFA 9 (reported here).

The Court of Appeal has now confirmed that the approach in Guy Lam should be applied to arbitration clauses, and hence that the approach to arbitration causes and exclusive jurisdiction clauses in the insolvency context is aligned.

In doing so, the Court of Appeal expressly rejected the application in the arbitration context of the approach traditionally adopted by the Hong Kong courts, pursuant to which a winding-up order would generally be granted unless there was a "bona fide dispute on substantial grounds".  This necessarily involved the court in making a substantive determination on the merits which was "akin to giving summary judgment", in the words of the Court of Appeal in Re Shandong Chenming.  The Court of Appeal held that it was "clear" that the traditional approach "would not be appropriate" where an arbitration clause applied, having regard to the statutory framework for arbitration and the strong case for upholding parties' contractual bargains to resolve disputes by arbitration.

The Court of Appeal adopted the requirement that the debtor should have a genuine intention to arbitrate from Lasmos Ltd v. Southwest Pacific Bauxite (HK) Ltd [2018] HKCFI 426, a first instance decision which had diverged from the traditional approach and held that (providing such an intention could be demonstrated) insolvency proceedings would be stayed or dismissed and the dispute referred to arbitration unless there were "exceptional circumstances".

There is potentially scope for debate as to precisely where the current approach sits on the spectrum between the traditional approach and the Lasmos approach in practical terms, including as to the precise difference between (i) a defence or claim which is not advanced bona fide on substantial grounds and (ii) a defence or claim which borders on the frivolous or an abuse of process.  Any further decisions touching on such issues will no doubt be watched with interest.

A Herbert Smith Freehills team led by partner Jojo Fan was instructed by the successful petitioner in Re Simplicity & Vogue Retailing (HK) Co., Limited [2024] HKCA 299.  For more details, see the team’s post on our “Asia Disputes Notes” blog here.