Clearing up the cloud? Perhaps partly, as the Court of Final Appeal affirms the approach to dismissing bankruptcy proceedings in favour of the parties' agreed forum

If a debt arises from a contract that contains an exclusive jurisdiction clause (EJC) in favour of a foreign court, how will the Hong Kong court deal with a bankruptcy petition based on that debt? A highly anticipated judgment from Hong Kong's highest court suggests that the bankruptcy petition will likely be dismissed, and that the foreign EJC will be given effect. But, as we will discuss below, the Court seems to leave other possibilities open, depending on the facts in a particular case.

While the question of whether the same approach should apply to arbitration clauses was deliberately left open and remains unsettled, based on the reasoning of the judgment, the same approach can arguably extend to cover cases involving arbitration clauses.

Background

Guy Kwok-Hung Lam v Tor Asia Credit Master Fund LP [2023] HKCFA 9 concerns a credit agreement under which the appellant petitioner (Tor) advanced various term loans to a company with the respondent (Mr Lam) as personal guarantor. The agreement contained an EJC in favour of New York for all legal proceedings arising out of or relating to the agreement. Upon the default of the loans, Tor presented a bankruptcy petition to the Hong Kong court against Mr Lam.

The first instance judge found no bona fide dispute on substantial grounds in respect of the petition debt. The judge reasoned that it would be a pointless exercise to require the creditor to first obtain an award or a judgment from the agreed forum when there is no real dispute on the debt. On that basis, the judge granted the bankruptcy order.

Mr Lam appealed. One of the key issues for the Court of Appeal (CA) was whether the bankruptcy order should be set aside in light of the foreign EJC. In allowing the appeal, the CA upheld the effect of the foreign EJC and dismissed the bankruptcy petition on the basis that there was a dispute which ought to be determined first under the jurisdiction agreement. We wrote about the CA decision here.

Tor appealed to the CFA seeking a determination on questions relating to the effect of EJC in favour of a foreign court on a bankruptcy petition in Hong Kong.

The CFA decision

In dismissing the appeal, the CFA considered and endorsed the reasoning of the CA, highlighted the importance of contractual autonomy, and addressed the concern of fettering of creditor's statutory right.

As the starting point, the CFA confirmed that a foreign EJC does not affect the court's jurisdiction in bankruptcy matters, which is conferred by the Bankruptcy Ordinance. That said, the fact that the parties agreed to have all their disputes under the agreement giving rise to the debt be determined exclusively in another forum is highly relevant in the court's exercise of its discretion to decline jurisdiction to determine whether there is a bona fide dispute about the debt on substantial grounds.

After considering authorities from other jurisdictions, the CFA held that in the ordinary case of a foreign EJC, absent countervailing factors such as the risk of insolvency affecting third parties and a dispute that borders on the frivolous or abuse of process, the effect of the EJC should be upheld. In so holding, the CFA noted that the so-called "established approach" (i.e. the petitioner is entitled to a bankruptcy order if the petition debt is not subject to a bona fide dispute on substantial grounds) is not appropriate where a foreign EJC is involved.

The CFA went on to suggest that the exercise of discretion by the court to decline jurisdiction attracts a range of considerations, and the list of "strong reasons" (for not enforcing the foreign EJC) remains open. The court will take into account various factors including the public policy interest in holding parties to their agreements, and the public policy behind the bankruptcy regime. The latter diminishes when the petition is brought by one creditor with no evidence of the creditor community at risk, as in the present case.

Applying the above to the facts, the CFA dismissed the appeal noting that the petitioner was the only creditor and there was no evidence that the creditor's interest would be adversely affected.

Key takeaways

This case affirms the Hong Kong court's approach to upholding the private contract of the parties. As the law now stands, where there is a foreign EJC and in the absence of countervailing factors, the EJC should ordinarily be given effect, and the Hong Kong bankruptcy proceedings will likely be dismissed.

The CFA's judgment left open the possibility that countervailing factors may tip the balance in another direction. Examples of these are: (i) the risk of the debtor’s insolvency impacting third parties, (ii) the debtor's reliance on disputes that border on the frivolous, or (iii) an occurrence of an abuse of process. Clearly this list is not intended to be exhaustive.

Going forward, a creditor who wishes to present a bankruptcy (or winding up) petition on the strength of a disputed debt that arises out of an agreement containing a foreign EJC may find it more difficult to persuade the Hong Kong court to hear the petition unless there are strong reasons for doing so.

Creditors will need to carefully review their security including the scope of any EJC and consider what enforcement action is available to recover their debt.

Would the same approach apply to an arbitration clause? The test for dismissing a winding up petition in light of an arbitration clause was laid down in the Lasmos case (which we discussed in our previous blog post):

1. the company disputes the petition debt;
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 demonstrates that it has taken the steps required under the arbitration clause to commence the contractually mandated dispute resolution process.

The Lasmos approch has been hotly debated in subsequent cases, which the CA and CFA did consider and discuss at length in this case, although obiter. While the CFA was careful not to express a view on the correctness of the Lasmos approach, this decision adopted the reasoning behind Lasmos in upholding the importance of contractual autonomy, and addressing the concern of fettering of the statutory right of the creditor. It would be arguable that the same approach should apply to cases involving arbitration clauses.

Please see our earlier blog posts on this topic:

• Hong Kong: Court makes winding up order where debtor unable to prove bona fide dispute on substantial grounds
• No If, No But – Will an arbitration agreement always trump a winding-up petition?

For more information, please contact Gareth Thomas, Partner, Alexander Aitken, Partner, Jojo Fan, Partner, Peter Ng, Senior Associate, Cindy Lee, Associate, or your usual Herbert Smith Freehills contact.