The Hong Kong Court of Appeal extends Re Guy Lam approach to cross-claims subject to arbitration agreement

In Re Simplicity & Vogue Retailing (HK) Co Ltd [2024] HKCA 299 (Simplicity; which we blogged about here), the Court of Appeal confirmed that the Court of Final Appeal's approach in Re Guy Kwok Hung Lam [2023] HKCFA 9 (Guy Lam; see our blog post here) should apply in winding up cases involving an arbitration agreement. As such, the starting point is that the parties’ arbitration agreement should be respected and upheld, although the Court has the discretion to assume jurisdiction over the dispute based on a “multi-factorial” approach.  The Court will generally do so only where there are “strong reasons”, including where the dispute borders on the frivolous or an abuse of process.

But what if the debtor company does not challenge the petition debt itself but only raises a cross-claim that falls within the scope of an arbitration agreement between the parties? The Court of Appeal in Re Shandong Chenming Paper Holdings Ltd [2024] HKCA 352 (Shandong Chenming) helpfully confirmed that Guy Lam's approach equally applies in such case. We have previously blogged about the first instance decision here and the leave to appeal decision here.

Background

Shandong Chenming concerns a series of disputes arising from a joint venture agreement between the Petitioner and the Company, which contains an HKIAC arbitration clause. The Petitioner commenced winding up proceedings against the Company, which in response applied to dismiss or stay the proceedings on the basis of a cross-claim advanced against the Petitioner in an arbitration commenced pursuant to the arbitration clause. Under the cross-claim, the Company claimed damages in an amount exceeding the remainder of the petition debt.

Harris J at first instance held that Guy Lam's approach applied and stayed the winding up proceedings pending determination of the cross-claim in the arbitration. The Petitioner appealed.

The Court of Appeal's Decision

The Court of Appeal accepted the Petitioner's contention that Guy Lam's approach applies by analogy to cases where a petition debt falls within an arbitration agreement, for the reasons set out in the Court of Appeal's judgment in Simplicity, which was handed down on the same day as the present judgment and in which Herbert Smith Freehills represented the successful petitioner (see our blog here). The key issue left for the Court to determine was accordingly whether Guy Lam's principles are also applicable where a debtor relies on a cross-claim that is subject to an arbitration agreement to resist the winding up petition.

In that regard, the Court acknowledged that the reasoning in Guy Lam strictly speaking does not concern a “mere cross-claim” (i.e. a claim which cannot be invoked as a transaction set-off to the petition debt) and is therefore not binding on the Court of Appeal in that aspect. Nonetheless, the Court of Appeal held that Guy Lam's approach should be extended to cross-claims and as such, the Court has a discretion to decline jurisdiction where the petitioner has an undisputed debt but is faced with a cross-claim (as well as a claim of set-off).

In coming to this conclusion, the Court followed the English practice and commented that there is no real difference in principle between mere cross-claims and disputes of debt as grounds of opposition in winding up proceedings. In particular, whether the petition debt is disputed (or whether there is a cross claim) is only one factor that informs the exercise of the Court’s winding up jurisdiction, which essentially involves a consideration of the overall relationship between the parties to see whether the petitioner is a net creditor having an interest in having the debtor wound up (regardless of whether the creditor's claim is subject to a legal right of set-off or is a mere cross-claim).

Accordingly (and as in the case of a dispute as to the petition debt), where a cross-claim or set-off subject to an arbitration agreement is raised by the debtor to resist the winding up petition, the Court should ordinarily hold the parties to their arbitration agreement and exercise its discretion to decline jurisdiction, unless the dispute borders on the frivolous or an abuse of process.

Applying Guy Lam's approach, the Court of Appeal did not find on the facts of the present case that there was any abuse of process on the part of the Company in raising its cross-claim, nor did the Petitioner so contend. While the Court considered that delay in raising a cross-claim may amount to abuse of process in certain circumstances, particularly where it was an attempt to stave off a winding up, the Court considered that in this case the Company had sufficiently explained its delay in bringing its cross-claim. Accordingly, the Petitioner's appeal was dismissed.

Comment

This case helpfully clarifies that where a debtor company does not dispute the petition debt itself but raises a dispute that puts in issue the status of the petitioner as a net creditor (whether by way of a cross-claim or set-off), the Court will generally uphold the forum agreement, and dismiss or stay the proceedings (unless such cross-claim or set-off borders on the frivolous or an abuse of process).

This case should be read together with the Court of Appeal's decision in Simplicity, as the Court of Appeal has confirmed in these significant twin-rulings the general 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. These decisions provide welcome clarification of the approach to arbitration clauses in the insolvency context.

For more information, please contact Jojo Fan, Partner, Rachael Shek, Partner, Trevor Ho, Senior Associate, Siqi Huang, Associate or your usual Herbert Smith Freehills contact.