Navigating the crossroads between arbitration and insolvency proceedings: the Hong Kong Court of Appeal applies Guy Lam principles in a winding up case involving an arbitration clause

Can a creditor obtain a winding up order against a debtor company if the underlying dispute over the debt is subject to an arbitration agreement between the parties? This has been a looming question since the landmark Court of Final Appeal decision in Re Guy Kwok Hung Lam [2023] HKCFA 9 (Guy Lam; which we blogged about here), as several subsequent Court of First Instance decisions diverged on whether Guy Lam's approach regarding exclusive jurisdiction clauses should apply equally to arbitration clauses (see our blog posts on Simplicity, Shandong Chenming and Inversion Productions).

Recently, in Simplicity & Vogue Retailing (HK) Co., Limited [2024] HKCA 299, in which Herbert Smith Freehills acting on behalf of the Petitioner successfully dismissed the Company's appeal, the Court of Appeal finally cleared the clouds of uncertainty and confirmed that Guy Lam's approach should also apply in winding up proceedings involving an arbitration agreement.

Background

The appeal followed the Petitioner's successful winding up petition against the Company, which was presented by the Petitioner upon the Company's failure to repay the redemption amount payable pursuant to a corporate guarantee and a bond instrument. Both agreements contained an arbitration clause referring any underlying disputes to arbitration (see our blog post on the Court of First Instance decision here).

The First Instance Judge granted the winding up order mainly on the basis that the petition was not disputed, as the Company did not file any evidence in opposition to the petition and failed to comply with the condition for an extension of time to do so. The Judge also dismissed the Company’s further application for extension of time to comply with the condition.

The Company's main ground of appeal was that the Judge erred in failing to apply the principles as laid down in Guy Lam and to refer the dispute over the petitioning debt to arbitration pursuant to an arbitration clause.

The Court of Appeal's decision

The key issue for the Court of Appeal to consider was therefore whether a debtor seeking to stay or dismiss a petition is required to demonstrate a bona fide dispute of the petition debt on substantial grounds if the dispute is subject to an arbitration clause.

In dismissing the Company's appeal, the Court of Appeal confirmed that Guy Lam's approach should apply, and accordingly, the Court has a discretion in determining whether there is a bona fide dispute of the debt on substantial grounds, even where the parties have agreed to submit any dispute to arbitration.

As a starting point, the parties' arbitration agreement should be respected and upheld. In other words, the Court in exercising its discretion should decline jurisdiction on the petition debt (including the jurisdiction to determine whether there is a bona fide dispute of the debt on substantial grounds), unless there are countervailing factors such as the risk of insolvency affecting third parties and a dispute that borders on the frivolous or abuse of process.

Importantly, the Court of Appeal has clarified that the Court's exercise of discretion involves a "multi-factorial" approach. As such, the Court may decline to hold the parties to the agreed dispute resolution mechanism (whether that be an arbitration clause or an exclusive jurisdiction clause) where the defence is one which is frivolous or an abuse of process.

In addition, the third requirement laid down in Lasmos Ltd v Southwest Pacific Bauxite (HK) Ltd [2018] HKCFI 426 (see our blog post on the case here) continues to be relevant. As such, debtors are also required to demonstrate a genuine intention to arbitrate, rather than raising an arbitration clause as a tactical move.

Applying the above principles, the Court of Appeal upheld the First Instance Judge's ruling that there was no dispute in respect of the petition debt. Further, even if there was, the Company’s defence bordered on the frivolous or abuse of process and would have met the high threshold for the exception to the general rule that parties should be bound by their agreement to arbitrate.

Key takeaways

The Court of Appeal helpfully clarified the approach in respect of winding up cases involving an arbitration clause. This is a welcome development given the significant debate that had arisen from the conflicting Court of First Instance decisions since Guy Lam.

In particular and as clarified in Re Simplicity, it is now clear that a debtor seeking to oppose a winding up petition in reliance on an arbitration clause must essentially demonstrate a defence that does not border on the frivolous or constitute an abuse of process and a genuine intention to arbitrate. In the absence of either, the debtor will not be allowed to invoke an arbitration clause as a tactical move to obstruct or impede the winding up proceedings.

 Herbert Smith Freehills’ Jojo Fan, Trevor Ho and Siqi Huang represented the successful Petitioner.

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