Hong Kong’s Court of Appeal extends ‘Guy Lam Principle’ to arbitration agreements in Winding-Up Proceedings
Simplicity & Vogue Retailing (HK) Co., Limited [2024] HKCA 299
In Re Guy Kwok Hung Lam [2023] HKCFA 9 (Guy Lam CFA), the Hong Kong Court of Final Appeal dismissed a bankruptcy petitioner’s appeal and laid down a landmark principle that where the underlying dispute of the petition debt is subject to a foreign exclusive jurisdiction clause (EJC), the Court should dismiss the petition in favour of the jurisdiction stated in the EJC unless there are countervailing factors (the Guy Lam Principle). Hill Dickinson successfully represented the Respondent in that case.
In our article on Guy Lam CFA (link below), we considered whether the Guy Lam Principle also applies to arbitration clauses. However, whether a creditor can obtain a winding-up order against a debtor company when the underlying disputed petition debt is subject to an arbitration agreement remained uncertain.
In Simplicity & Vogue Retailing (HK) Co., Limited, the Court of Appeal has now confirmed that the Guy Lam Principle regarding EJCs also applies to arbitration clauses.
The background facts
By a corporate guarantee (Corporate Guarantee) between Simplicity & Vogue Retailing (HK) Co., Limited (the Company) as the guarantor and the Petitioner as the beneficiary, the Company guaranteed the repayment of a certain convertible bond instrument (the Bond Instrument). Both the Corporate Guarantee and the Bond Instrument contained an arbitration clause governing the resolution of disputes.
The issuer failed to repay the redemption amount payable under the instrument on maturity. The Petitioner sought to recover the sum by presenting a winding up petition against the Company (the Petition).
The Company did not provide evidence opposing the Petition in time and failed to comply with the conditions for an extension of time to do so. The First Instance Court granted the winding-up order as the Petition was not disputed. The Company appealed against the winding-up order, mainly on the ground that the Court erred by not applying the Guy Lam Principle and not referring the dispute over the petition debt to arbitration pursuant to the arbitration clause in the Corporate Guarantee.
The Court of Appeal decision
The Court of Appeal dismissed the Company’s appeal but confirmed that the Guy Lam Principle does apply to winding-up proceedings involving an arbitration agreement. The Court followed Guy Lam CFA and considered that it does have a discretion to decline jurisdiction to determine whether the petition debt is disputed in good faith on substantial grounds.
As a general principle, an arbitration agreement should be respected and upheld. The Court should exercise its discretion to decline jurisdiction over the petition debt, including determining the existence of a bona fide dispute, unless countervailing factors are present, such as the risk of insolvency affecting third parties or a defense which bordered on the frivolous or abuse of process.
While the established approach does not apply where the petition debt is subject to an EJC or arbitration clause, the question of whether there is a bona fide dispute over the debt on substantial grounds is still relevant to, and forms part of, the “multi-factorial” approach that the Court adopts when deciding whether to exercise its discretion.
The Court also confirmed (per Lasmos Ltd -v- Southwest Pacific Bauxite (HK) Ltd [2018] HKCFI 426) that the company in question should take the required steps to commence proceedings (arbitration or court) as provided for in the dispute resolution provision and should provide confirmation that it has done so. Requiring the debtor to demonstrate a genuine intention to arbitrate was not onerous and prevented abuse of process. Debtors must demonstrate a genuine intention to arbitrate rather than relying on the arbitration clause as a tactical move. Additionally, the Court might exercise its discretion to grant a short adjournment to allow the debtor to commence arbitration.
It is worth noting that in Guy Lam, the debtor had commenced legal proceedings against the creditor in New York pursuant to the EJC governing the petition debt for, among other things, a negative declaration, while the debtor had not taken any steps towards commencing arbitration in Simplicity.
In conclusion, the Court of Appeal upheld the First Instance Court’s ruling that there was no dispute regarding the petition debt. Additionally, even if there was a dispute, the Company’s defense was considered to be frivolous or an abuse of process.
Comment
The Simplicity decision was handed down at the same time as the Court of Appeal’s judgment in Arjowiggins HKK 2 Limited -v- Shangdong Chenming Paper Holdings Limited [2024] HKCA 352, another case in which the debtor company sought to stay or dismiss the winding-up proceedings and refer the petition debt to arbitration. The Court of Appeal in Shangdong Chenming confirmed that the Guy Lam Principle also applies to any set-off or pure crossclaims that are subject to an arbitration agreement between the parties.
The Court of Appeal’s decisions in Simplicity and Shangdong Chenming have helpfully clarified the proper approach to winding-up cases involving arbitration clauses. They have resolved the previous debate arising from what appeared to be conflicting decisions from the Court of First Instance since Guy Lam CFA. In summary, while a debtor company seeking to invoke an arbitration clause in order to oppose a winding-up petition based on an arbitration clause does not need to demonstrate a bona fide dispute of the petition debt on substantial grounds, it must have, in essence, a defense that is not obviously frivolous or an abuse of process.
Although the requirement to take effective steps to commence arbitration, which essentially shifts the burden of commencing legal actions from the creditor to the debtor, is not without criticism, the debtor company will also need to demonstrate to the Court a genuine intention to arbitrate the dispute. It should, therefore, also take prompt steps to actually commence the arbitration proceedings and provide evidence of this to the Court in the winding-up proceedings.
If the debtor company fails to meet these criteria, the Court can exercise its discretion to prevent insolvent debtor companies from relying solely on the existence of an arbitration clause as a tactical ploy to try and obstruct winding-up proceedings.
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