Bankruptcy Petition Dismissed: Court Reaffirms Low Threshold for Demonstrating Debtor’s Intention to Arbitrate In Resisting a Bankruptcy Petition

 

Introduction

In a recent case HCB 6058 / 2024, Howse Williams’ corporate and regulatory team worked with Jenkin Suen SC and Kaiser Leung of Des Voeux Chambers and successfully assisted a client (“Debtor”) in opposing a bankruptcy petition founded on an alleged liability under a Guarantee Agreement containing an HKIAC-arbitration clause. The Court applied established principles from landmark authorities such as Re Lam Kwok Hung Guy (“Re Guy Lam”) and Re Simplicity & Vogue Retailing (HK) Co., Limited (“Re Simplicity”), while addressing the unique factual circumstances where the petitioning creditor was the natural claimant and the Debtor had, through his solicitors, requested the Petitioner to commence arbitration and proposed candidates for the arbitral tribunal. 

Reaffirming that the threshold for demonstrating a genuine intention to arbitrate is relatively low when the petitioning creditor is the natural claimant, the Court held that commencement of arbitration is not the only way to demonstrate such genuine intention. This decision further strengthens Hong Kong’s pro-arbitration approach and clarifies that, in bankruptcy proceedings, the burden remains on the petitioning creditor to initiate the agreed dispute resolution mechanism of arbitration.

 

 

Background

 

The Debtor is a director of a company (“Company”) which entered into a series of agreements with the Petitioner, including an Investment Agreement under which the Company was obliged to pay certain dividends on specified dates. Pursuant to a Guarantee Agreement, the Debtor guaranteed the Company's due and punctual performance of its obligations under the Investment Agreement. The Petitioner alleges that the Company defaulted in the payment of dividends, giving rise to a liability under the Guarantee of approximately HK$29 million. A statutory demand was served on the Debtor in late 2020, with the bankruptcy petition subsequently issued in 2024, almost four years later (“Petition”).

 

On its face, the case appears to be a straightforward claim of enforcing an alleged debt under the Guarantee Agreement. However, the core issue lies in the arbitration clause within the Guarantee Agreement, which provides that disputes between the Debtor and the Petitioner arising therefrom shall be referred to arbitration. The question is, therefore, whether the Petition should be dismissed or stayed pending arbitration.

 

Principles governing bankruptcy or winding-up proceedings

 

The Court of Final Appeal established, in Re Guy Lam[1], that where a petition debt is pursuant to an agreement subject to an exclusive jurisdiction clause in favour of a foreign court, absent countervailing factors such as the risk of insolvency affecting third parties and a dispute that borders on the frivolous or abuse of process, the petitioner and the debtor ought to be held to their contract (that the dispute be first resolved in a foreign court).

 

Subsequent authorities have applied the Re Guy Lam approach in cases concerning an arbitration clause. In Re Simplicity[2], the Court of Appeal held that the parties’ arbitration agreement should be respected; and although the Court has the discretion to assume jurisdiction over the dispute based on a “multi-factorial” approach, the Court will generally do so only where there are “strong reasons”, including where the dispute “borders on the frivolous or an abuse of process”. It also confirmed that it remains incumbent on the Debtor to demonstrate a genuine intention to arbitrate (e.g. typically taking the steps required under the arbitration clause of by issuing a Notice of Arbitration). In Re Mega Gold Holdings Ltd [3], which involved an arbitration clause, Recorder Richard Khaw SC observed that establishing a defence as “frivolous” or an “abuse of process” requires show that the defence is bound to fail and hence does not warrant further investigation at trial, which is a high factual threshold. In determining a winding-up petition, the Court only conducts a preliminary assessment and, unless a plain and obvious case is made, should generally decline to exercise insolvency jurisdiction, but require the dispute to proceed by way of an arbitration.

 

Despite the subsequent decision by the Privy Council in Sian Participation Corpn (in liquidation) v Halimeda International Ltd[4] which adopted a different approach (namely that a winding-up order founded on a debt that is not disputed on genuine and substantial grounds – even if subject to an arbitration agreement or exclusive jurisdiction clause – does not contravene the objectives of arbitration), the position in Hong Kong continues to be governed by the principles laid down in Re Guy Lam and Re Simplicity, which retain the broader threshold inquiry and a more restrictive exercise of discretion in favour of upholding contractual dispute-resolution mechanisms.

 

Decision

 

In this case, the Petitioner argued that the Debtor was trying to delay matters and did not have a genuine interest in progressing an arbitration to determine whether the Debt is payable, hence there was no basis for the Court to stay the Petition or subject the Debtor’s defences only to the frivolous threshold. Harris J rejected such argument as being inconsistent with the principles laid down in Re Guy Lam and Re Simplicity.  

 

His Lordship held that, despite the Debtor only requested the Petitioner to commence an arbitration eight months after the Petition was issued, based on the actions taken, namely inviting the Petitioner to submit the dispute to arbitration and proposing arbitrator candidates, requesting the Petitioner (as the natural claimant) to commence the arbitration, contending that otherwise the Debtor would likely bear the burden of proof and likely lose his right to seek security for costs, and eventually serving a notice of arbitration (prior to the hearing of the Petition), the Debtor has demonstrated a genuine intention to arbitrate.

 

Harris J also held that the estoppel by representation put forward by the Debtor cannot be dismissed as frivolous. As such, the Petition was dismissed.

 

Significance and Takeaways

 

Harris J made a number of observations on the issue of establishing a genuine intention to arbitrate by a debtor:

 

1. If before the Petition had been issued the Debtor had requested the Petitioner to agree to submit the dispute to arbitration, that would have sufficed to demonstrate the necessary intention to hold the Petitioner to his bargain and for the dispute over the debt to be arbitrated.
2. Service of a notice in opposition (to a petition) stating that the debt is disputed and that the dispute should be arbitrated will commonly be sufficient to show a genuine intention to arbitrate if coupled with a clear and reasoned proposal that the claimant creditor commence the arbitration process.
3. The fact that a debtor does not express an intention to arbitrate until after a petition is presented does not mean that the arbitration clause ceases to be relevant. But the sooner that the debtor makes plain his desire to arbitrate the more straightforward the matter becomes; and the later the debtor seeks to rely on the arbitration clause there will be more room for argument.

 

Consistent with post-Re Guy Lam authorities, the Court in this case reaffirmed that the threshold for demonstrating a genuine intention to arbitrate is relatively low when resisting a bankruptcy petition. The absence of steps taken by the Debtor prior to the commencement of bankruptcy proceedings is not fatal. Formal commencement of arbitration by the Debtor, such as filing a Notice of Arbitration, may not be necessary, recognising that the petitioning creditor would be the natural claimant.

 

This case is a continuation of a series of significant rulings following Re Guy Lam; and presents substantial challenges due to its unusual fact patterns and the potential defences involved.

 

The Howse Williams team was led by corporate partner Christopher Yu and regulatory partner William Wong, with support from associates Jennifer Lui, Pinky Chan and Amy Cheung.

 

 

 

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Howse Williams is a leading, full service, Hong Kong law firm. We combine the in-depth experience of our lawyers with a forward thinking approach.

 

Our key practice areas are corporate/commercial and corporate finance; commercial and maritime dispute resolution; clinical negligence and healthcare; insurance, personal injury and professional indemnity insurance; employment; family and matrimonial; trusts and wealth preservation; wills, probate and estate administration; property and building management; banking; fraud; distressed debt; investment funds; technology, media and telecommunications; virtual assets; financial services/corporate regulatory and compliance.

 

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Disclaimer: The information contained in this article is intended to be a general guide only and is not intended to provide legal advice. Please contact [email protected] if you have any questions about the article.