In Lasmos Ltd v. Southwest Pacific Bauxite (HK) Ltd (02/03/2018, HCCW 277/2017),  HKCFI 426 (“Lasmos“), the Court of First Instance held that a winding-up petition based on a disputed debt may be dismissed if there was an arbitration clause in the underlying agreement, upon which arbitration has commenced.
This decision broadens the traditional ground of dismissal, which previously required the subject company to demonstrate that it had a bona fide defence on substantial grounds to the underlying debt. The decision also clarifies the circumstances where winding-up proceedings will prevail.
We highlight below some of the key implications and considerations for parties and creditors when negotiating contracts and handling disputes.
What it means for you
Lasmos demonstrates that Hong Kong courts continue to support arbitration and will uphold party autonomy in the choice of a particular dispute resolution mechanism. However, while the existence of an arbitration clause could be a factor that constrains a creditor’s ability to pursue winding-up proceedings, the court provided the following guidance for creditors and respondents:
- Winding-up petitions will not be stayed automatically in favour of arbitration if the debt is liquidated and it is not disputed or disputable.
- Even where the debt can be disputed, a petition may be appropriate and preferred over arbitration in certain circumstances, and the Court has a discretion to decide whether to allow the petition to proceed.
- Where a company wishes to apply to set aside or stay a petition in favour of arbitration, it should follow the process and steps specified under the arbitration clause and file an affirmation in accordance with Rule 32 of the Companies (Winding Up) Rules, Cap 32H. Otherwise, the Court may exercise its discretion and decide that in the absence of any evidence being filed in time by the company, it should be wound up immediately or conditions should be imposed for allowing evidence to be filed out of time.
Key Points from Lasmos
In Lasmos, the subject company was a joint-venture company. The petitioner, a shareholder of the company, issued a petition to wind-up the company on the grounds of insolvency based upon non-satisfaction of a statutory demand. The statutory demand sought payment of a debt arising under a services agreement, which contained an arbitration clause.
Traditionally, a company seeking to dismiss a petition for winding-up based on a disputed debt needed to demonstrate a bona fide defence on substantial grounds and the existence of an arbitration clause in the underlying agreement was of itself insufficient to satisfy this requirement.
In Lasmos, Harris J followed his approach in an earlier 2014 decision where the relevant company successfully stayed a petition on unjust and equitable grounds for arbitration. Among other things, Harris J took the approach of identifying the substance of the dispute and whether or not that dispute is covered by the arbitration agreement.
In Lasmos, Harris J expressed the following views:
- Whilst a winding-up order would grant remedy to creditors as a class, a creditor issues a petition to recover its own debt, not out of some altruistic concern for the company’s creditors as a class. There is a material distinction between the purpose of a creditor presenting a petition and the interests of the general class of unsecured creditors. There was no reason why a creditor seeking a winding-up order meant the court would bypass the normal consequences of the parties having agreed that any dispute between them be resolved by arbitration, where there was a dispute over the debt.
- The court should hold a creditor to his contractual bargain concerning the choice of dispute resolution process (i.e. to resolve any dispute by arbitration if there is an arbitration clause).
- Notwithstanding the above, the existence of an arbitration clause in the underlying agreement does not prevent a creditor from invoking the collective insolvency process before the arbitration is finally determined, if the circumstances justify it, e.g. the creditor can demonstrate a prima facie case for a winding up and a risk of misappropriation of assets or some other matter, which would normally justify the court appointing provisional liquidators.
Harris J dismissed the petition because:
- The subject company had disputed the debt relied upon by the petitioner;
- The contract under which the debt is alleged to have arisen contained an arbitration clause covering disputes relating to the debt; and
- The company had taken the steps required under the arbitration clause to commence the contractually mandated dispute resolution process (which may include preliminary stages, e.g. mediation) and had filed a supporting affirmation.
As an obiter comment, Harris J added that the company would have established a bona fide dispute on substantial grounds, should the decision be appealed.
Actions to Consider
You should bear in mind the following when negotiating your agreements (and arbitration clauses) or considering how best to handle and resolve disputes that may arise:
- At the drafting stage:
a. Use precise, unequivocal language when drafting the agreement and dispute resolution clauses.
b. Carefully review the scope of the dispute resolution clauses (e.g. forum, governing law, types of disputes covered).
c. Be mindful that pre or post-contractual discussions (e.g. any off-the-cuff remark about the arbitration clause being a mere formality) will be non-binding if there is an entire agreement clause.
Seek legal advice when drafting and executing the agreement.
2. At the disputes stage:
a. Seek legal advice to ascertain whether it is more appropriate to commence winding-up or arbitration proceedings, for instance whether the claim is monetary for liquidated damages and what other relief is sought.
b. Consider whether there are any grounds to challenge the arbitral tribunal’s jurisdiction especially based on the ground of non-conformity with antecedent steps (e.g. negotiations) set out in the arbitration clause. If so, you should consider taking steps to raise these points formally as soon as possible.
Failure to take the above precautionary steps may result in unintended and costly consequences, particularly if you are entering into or resolving a dispute stemming from cross-border business transactions.