Court of Appeal decided on the conundrum of exclusive jurisdiction clauses in insolvency proceedings
Re: GUY KWOK-HUNG LAM ( 林國雄) (Debtor) and Tor Asia Credit Master Fund LP (Petitioner (Creditor)), CACV 393/2021,  HKCA 1297
Before Hon Barma, G Lam and Chow JJA in Court
Date of Judgment: 30 August 2022
By a Credit and Guaranty Agreement (“the Agreement”) entered into between, among others, the Petitioner (Respondent of this appeal), the Appellant, and a company solely owned by the Appellant (“the Company”), the Respondent agreed to advance term loans to the Company (“Loans”), and the Appellant agreed to guarantee the full payment of all amounts due from Company. The Agreement contained Exclusive Jurisdiction Clause providing that the Agreement shall be construed in accordance with and governed by the laws of the State of New York and each party thereto submitted to the exclusive jurisdiction of the United States District Court for Southern District of New York and of the Supreme Court/appellate court of the State of New York.
The Company failed to repay the Loans within the specified time frame. The Respondent issued statutory demand under the Bankruptcy Ordinance and presented this bankruptcy petition against the Appellant (as the guarantee of the Loans) in Hong Kong.
The Appellant raised 5 grounds in opposition to the petition:
(1) The Respondent was fully secured as a creditor and as such cannot petition for Appellant’s bankruptcy;
(2) There was no extant event of default under the Agreement because of Respondent’s waiver or an estoppel against the Respondent;
(3) Because of the Exclusive Jurisdiction Clause, the Respondent should first sue in the courts of New York to establish the Appellant’s liability;
(4) The Respondent had breached the provisions of the Money Lenders Ordinance (Cap 163) and the Agreement was not therefore enforceable against the Appellant; and
(5) The Appellant had raised a cross-claim against Respondent in the Texas proceedings for damages exceeding the amount of Respondent’s petition debt.
In the Court of First Instance, Linda Chan J was inclined to agree with the Exclusive Jurisdiction Clause argument of the Respondent, and held that:
There is a settled understanding of the law that an exclusive jurisdiction clause does not prevent a winding up or bankruptcy petition from being presented in an appropriate jurisdiction.
Whilst generally the court would give effect to the contractual bargain of the parties, it does not take away or fetter the jurisdiction of the court to determine whether a company should be wound up if the creditor has locus to present the petition. Liability to be wound up by the court is part of the conditions of incorporation.
A creditor has locus to present a winding up or bankruptcy petition if there is no bona fide dispute on substantial grounds in respect of the debt.
An arbitration clause or an exclusive jurisdiction clause is only a factor to be taken into account when considering a winding up or bankruptcy petition.
An exclusive jurisdiction clause does not prevent the court from considering whether the creditor has locus to present the petition, because “unless and until the company/debtor is able to demonstrate to the Court that there is a bona fide dispute on substantial ground in respect of the debt, there is no proper basis for the company to contend that there is a dispute which must be litigated in accordance with the contractually agreed forum”. It would be “a pointless exercise” to require the creditor first to obtain an award or judgment in the agreed forum when there is no real dispute on the debt.
A bankruptcy order hence was made against the Appellant and the Appellant appealed to the Court of Appeal.
The Court of Appeal unanimously dismissed (Chow JJA on some different reasons) the bankruptcy petition against the Appellant on the ground that there was a dispute between the Appellant and the Respondent which should be first determined in accordance with the parties’ agreement in the Exclusive Jurisdiction Clause in the Agreement. It was held that:
1. A petition seeking an order for the winding up or bankruptcy of a party to the Agreement on the basis of a disputed indebtedness, would fall within legal proceedings arising out of or relating to the Agreement. In this context, the negative aspect of the Exclusive Jurisdiction Clause operates as an agreement not to present a bankruptcy petition unless and until the underlying dispute has been determined in the agreed forum.
2. It is not correct to say that on the hearing of a winding up petition there will definitely not be any determination of the dispute. The extent to which the court investigates the question whether or not the debt is disputed in good faith on substantial grounds is a matter of discretion. But where the court finds against the company, concluding that its defences do not raise any bona fide disputes on substantial grounds, there is no reason why that should not be regarded as a determination of the dispute which may give rise to an estoppel in relation to the issues decided.
3. The presence of an exclusive jurisdiction agreement between the parties in favour of another forum does not mean that the court is bound to stay or dismiss the petition. But, adopting the same approach as in ordinary actions, such an agreement should ordinarily be given effect unless there are strong reasons to the contrary. It follows that where the debt on which a winding up or bankruptcy petition is based is disputed and the parties are bound by an exclusive jurisdiction clause in favour of another forum precluding the determination of that dispute by the Hong Kong court, the petition should not be allowed to proceed, in the absence of strong reasons, pending the determination of the dispute in the agreed forum.
4. As in the case of ordinary actions, it is neither possible nor desirable to define what may constitute strong reasons. One can conceive of cases where the debtor may be incontestably and massively insolvent quite apart from the disputed petition debt, or it may for other reasons be a menace to commercial society if allowed to continue to trade, or there may be other creditors seeking a winding up whose debts are not subject to any jurisdiction agreement, or the assets may be in jeopardy, or there may be a need to investigate potential wrongdoings, or the effect of a dismissal or stay of the petition would be to deprive the petitioner of a real remedy or would otherwise result in injustice.
5. Under this approach the court retains flexibility to deal with the case as the circumstances require, taking into account other powers of the court that may become relevant, such as the power to allow the petitioner to be substituted by other creditors and the power to appoint a provisional liquidator or interim trustee.
6. In respect of creditors’ statutory right to petition for bankruptcy or winding up on the ground of insolvency, the Court was convinced that creditors’ rights are creatures of contract, not creatures of statute. There is no reason why a creditor’s voluntary surrender of rights to petition for winding up should be held unenforceable for being contrary to public policy.
There is an inherent conflict between party autonomy to choose exclusive jurisdiction clause (such as arbitration) and the statutory right of creditors to invoke the insolvency jurisdiction of the Courts. There are inevitably competing interest and a balance based on the specific facts of each case.
The traditional approach was a debtor opposing the petition is required to establish to the Court’s satisfaction the existence of a “bona fide dispute on substantial grounds” rather than mere assertions, for the Court to exercise its discretion to stay the winding-up petition in favour of arbitration. There is no automatic stay in favour of arbitration solely on the basis of the existence of an arbitration agreement (Re Simon (Hong Kong) Ltd.,  5 HKLRD 487]. In cases where the dispute in relation to the debt is governed by an arbitration clause, the English courts should dismiss or stay the winding-up application in favour of arbitration, unless there are “wholly exceptional circumstances” (Salford Estates (No. 2) Ltd v Altomart Ltd.  Ch 589).
The traditional approach was later varied in Re Southwest Pacific Bauxite (HK) Ltd,  2 HKLRD 449 where the Court of First Instance adopted a prema facie threshold and added a requirement of procedural steps. The court held that the winding-up petition should “generally be dismissed” if (i) the debt relied on by the petitioner is disputed by the company, (ii) the contract under which the disputed debt arose contained an arbitration clause covering the dispute relating to the debt, (iii) the company took the steps required under the arbitration clause to commence the contractually mandated dispute resolution process and filed an affirmation in accordance with Rule 32 of the Companies (Winding-Up) Rules (“Lasmos approach”).
In recent years, the Hong Kong court has been taken another approach departed from the Lasmos approach and effectively preferred the triable issue threshold under the traditional approach of “bona fide dispute on substantial ground”:
In Re Hong Kong Bai Yuan International Business Co., Ltd  HKCFI 960, the Court of First Instance ordered the respondent company to pay the debt owed to the petitioner within 14 days if it wished to avoid a winding up order, notwithstanding that the debt was governed by an arbitration agreement. The court held that, whether under the prima facie standard (as adopted by the Singapore and English courts) or a bona fide dispute on substantial grounds (as adopted by the Hong Kong courts), it would be incumbent upon the debtor to demonstrate that there was a genuine dispute on the debt which required the determination of an arbitral tribunal. It would be pointless to require the parties to resolve a dispute unless it was a genuine dispute.
As observed in But Ka Chon v. Interactive Brokers LLC  4 HKLRD 85, the court would, in the exercise of discretion, give considerable weight to the existence of an arbitration agreement and other relevant circumstances. The discretion was not exercised only one way as discussed in Lasmos.
This Court of Appeal decision has become the new leading case on the issue of exclusive jurisdiction clauses in insolvency proceedings which departed from the mainstream approach Hong Kong Court has adopted in the recent years. It is important for the creditors to consider whether they have “strong reasons” to sue in the non-contractual forum before they commence any action in Hong Kong. Although the Court of Appeal did not define “strong reasons” in the judgment, the examples given by the learned Judge did shed some light as to what “strong reasons” look like: the creditors would be seriously prejudiced if they must wait for the determination of the dispute in the contractual agreed forum. In our view, it is an even stronger case to apply the said approach to the arbitration clause.