Tensions between Insolvency and Arbitration
Re HongKong Bai Yuan International Business Co., Ltd  HKCFI 960
HCCW 219/2021, Hon Linda Chan J in Court, 1 April 2022
ACTATRADE SA (“Petitioner”) and HongKong Bai Yuan International Business Co., Ltd (“Company”) entered into a series of contracts for the sale and purchase of methanol, including a Clarity Contract and a Honesty Contract. Subsequent dispute arose between the Petitioner and the Company, with the Petitioner alleging the Company for failing to repay the outstanding purchase price for methanol (“Debt”) under the Clarity Contract. The Petitioner lodged a petition for the winding up of the Company (“Petition”) on the basis that the Company had failed to comply with a statutory demand.
The relevant contract provided for all disputes, including those pertaining to the Debt, to be referred to CIETAC arbitration. The Company commenced arbitration with the CIETAC under the Honesty Contract before the Petitioner’s statutory demand but not under the Clarity Contract.
The Company sought to dismiss the Petition on the grounds that (a) there was a bona fide dispute on substantial grounds in respect of the Debt which should be referred to the CIETAC arbitration in accordance with the arbitration clause under the Clarity Contract and that (b) the Company had a cross claim against the Petitioner for its alleged breach under the Honesty Contract, which is larger than the Debt.
Hong Kong courts have adopted the approach that a petition may be dismissed if the company is able to demonstrate a bona fide dispute of the petitioned debt on substantial grounds (as shown in But Ka Chon v Interactive Brokers LLC  4 HKLRD 85 (“But Ka Chon”)). As observed by Kwan VP in But Ka Chon, the Companies Court would in the exercise of discretion under the insolvency legislation give considerable weight to the fact that there is an arbitration agreement between the parties and other relevant circumstances.
In opposing the Petition, the Company argued that the Petitioner should not be allowed to subvert the arbitration agreement between the parties by serving a statutory demand instead of commencing arbitration as agreed in contract. In particular, it was submitted that the Court should follow the Singaporean and the English approach, which applies the prima facie standard applicable to a mandatory stay of an action to winding up proceeding even though the latter proceeding is not arbitrable under the relevant Arbitration Act.
Irrespective of the differing approaches in Singapore/ England and Hong Kong courts, the Court held that the discretion is not exercised only one way as discussed in in Re Southwest Pacific Bauxite (HK) Ltd  2 HKLRD 449 (“Lasmos”), whereby the petition should “generally be dismissed” save in “exceptional” or “wholly exceptional circumstances” once the company satisfies the 3 requirements (i.e. (a) the debt is not admitted, (b) the dispute is covered by the arbitration clause, and (c) the company has taken step to commence arbitration).
Whether there is a bona fide dispute in respect of the Debt
The Company alleged that it was entitled to withhold payment of the Debt pending the determination of the cause of certain discoloration of the methanol, i.e., whether the discoloration was due to the fault of the Petitioner and/or the carrier.
The Court held that the Company had failed to show that there was a bona fide dispute (or a dispute on substantial grounds) on the Debt which requires determination of the CIETAC tribunal for the following reasons: Firstly, the Company had not identified any contractual provision that entitled it to withhold payment of the Debt. Secondly, the condition for payment of the Debt under the Clarity Contract had been fulfilled. Finally, the discoloration issue had already been settled between the carrier and the owner of the Cargo. The Company had not identified any basis or adduced any evidence to show that it had suffered any loss from the discoloration issue or that the Petitioner caused the discoloration.
Furthermore, the Court was of the view that the Company’s failure to take any step to commence arbitration in respect of the Clarity Contract is further evidence that it had no bona fide dispute in respect of the Debt.
Whether the Company has a serious cross-claim against the Petitioner
The Company’s contention of having a serious cross-claim against the Petitioner under the Honesty Contract was also rejected by the Court for the following reasons:
a) From the available evidence, the Company had evinced an intention not to perform the Honesty Contract, whereby the Petitioner was entitled to terminate the Honesty Contract and mitigate its loss by reselling the methanol under the Honesty Contract to another buyer.
b) The evidence adduced by the Company shows that the loss suffered by the Company was not caused by the alleged breach of the Honesty Contract.
Even if the Company does have a serious cross-claim against the Petitioner, the Court held that there was no valid basis for the Company to withhold payment of the Debt pending determination of its cross-claim:
a) There is no provision under the Clarity Contract which confers a right on the Company to retain the Debt, whether as a security or otherwise; and
b) The cross-claim arose out of the Honesty Contract has nothing to do with the Clarity Contract.
In light of the foregoing, the Court made an order the Company to pay the Debt within 14 days and that the costs of and occasioned by the Petition be paid to the Petitioner, to be taxed if not agreed.
In refusing to follow the Singapore/ England approach as argued by the counsel for the Company, the Court adopted the traditional approach instead. While the court would give considerable weight to the existence of an arbitration agreement between the parties in the exercise of its discretion, the Court placed more emphasis as to whether the debtor is able to show a genuine dispute on the debt requiring the determination of an arbitral tribunal. As shown from the present case, the existence of an arbitration agreement pertaining to the debt itself is not a sufficient ground for seeking a stay or dismissal of a winding up petition.
In delivering the judgment, it is our view that the Court wrongfully ruled on the merits of the Company’s cross-claim (which was a matter for the CIETAC arbitral tribunal to decide) and erred in holding that when there is a serious cross claim against the Petitioner (which is greater than or equal to the petitioned debt), the Company is still required to show a valid basis to withhold payment of the petitioned debt pending determination of its cross-claim. To clarify the unsettled principles when the petitioned debt is subject to an arbitration clause, the judgment is currently subject to appeal by the Company.
It remains to be seen whether the Court of Appeal would adopt the Singapore/ English approach as aforementioned or formulate an unique Hong Kong approach that maintains Hong Kong’s pro-arbitration stance without usurping her insolvency legislation.