Legal update: Arbitration clauses and insolvency proceedings revisited

Introduction

In a recent Court of Appeal judgment, But Ka Chon v Interactive Brokers LLC[1] (“But Ka Chon”), Tanner De Witt was successful in resisting an appeal by a debtor who had sought to set aside a statutory demand issued by a leading online trading platform, Interactive Brokers LLC.  The Court of Appeal’s[2] judgment upheld the decision of Deputy High Court Judge Kent Yee (“DHCJ Yee”) who had dismissed the debtor’s application at first instance. The judgment is of interest as it also addressed (albeit obiter) the 2018 decision in Lasmos Ltd v Southwest Bauxite (HK) Ltd[3] (“Lasmos”).

The issue

One issue in But Ka Chon and Lasmos concerns the interaction between arbitration clauses and the Court’s jurisdiction to wind up companies or make a bankruptcy order against individuals. The development in this area of law is important given that arbitration clauses are common in modern commercial contracts.

It should be noted that neither But Ka Chon nor Lasmos affects the existing position that there is no mandatory stay of winding up or bankruptcy proceedings in favour of arbitration. The cases are, however, relevant on how the Court will exercise its discretion to stay or dismiss a petition when the debt upon which the petition is based arises from a contract that is subject to an arbitration clause.

The position before Lasmos

Prior to Lasmos, the position of the Hong Kong cases was clear[4]. When facing a petition that was presented on insolvency grounds[5]and the debt relied upon arose from a contract containing an arbitration clause, the debtor was required to demonstrate to the Court that there is a “bona fide dispute in substance”[6] in order to persuade the Court to exercise its discretion to either stay or dismiss a petition[7]in favour of arbitration. It is submitted that there is a valid policy reason for this approach. Where a debtor is insolvent, the Court’s winding up jurisdiction is engaged and the Court is required to take into account the interest of all creditors of the debtor and not just the interest of the petitioner. Permitting a debtor to dismiss a petition with relative ease even when there is no “real” dispute to be arbitrated could have the effect of allowing an insolvent debtor to continue trading and incur further debts, thus prejudicing the rights of creditors as a whole.

Lasmos

In Lasmos, the Honourable Mr. Justice Harris (“Harris J”) departed from the previous Hong Kong authorities, citing English authorities that stemmed from the English Court of Appeal decision in Salford Estates (No 2) Ltd v Alomart Ltd[8] (“Salford”). In But Ka Chon, the Court of Appeal succinctly summarised the position of Lasmos to be as follows:

“62. Third, Lasmos (which followed Salford) decided that the discretion under the insolvency legislation should be exercised in only one way [when an arbitration clause is present]: the petition should “generally be dismissed” save in “exceptional circumstances”[9], upon satisfaction of these three requirements: if the petitioning debt is not admitted (it is settled law that this is regarded as a dispute sufficient for the purpose of arbitration, without regard to the quality of the dispute or substantive merits); the dispute is covered by an arbitration clause; and the alleged debtor has taken steps to commence arbitration”.

In other words, where an arbitration clause is present, unless the debtor actually admits the debt, a petition would usually be dismissed to permit the debtor to pursue arbitration.

But Ka Chon – First Instance

Mr. But was one of Interactive Brokers LLC’s customers. Amongst other instruments, he traded in currency futures contracts, including a contract relating to the differential between the Euro and the Swiss Francs (“CHF”). In January 2015, the Swiss National Bank unexpectedly lifted the “peg” that hitherto had existed as between the CHF and the Euro. The result was a rapid move in the market (even causing the collapse certain trading platforms such as the UK arm of Alpari).  Mr. But incurred substantial losses on his trading positions as a result. Mr. But refused to make up the resulting shortfall on his account and Interactive Brokers subsequently issued a statutory demand against him for such amount. Mr. But then took out an application to set aside the statutory demand pursuant to Rules 47 and 48 of the Bankruptcy Rules (Cap. 6A) (“BR”). He relied on a number of grounds claiming that there is a “bona fide dispute with substance” based on alleged misrepresentations made when he opened his account

As the underlying contract contains an arbitration clause, Mr. But also relied on Salford in his set aside application. Pausing here, it should be noted that although the Salford case was relied on by Mr. But, his first instance hearing took place before the handing down of the Lasmos decision. Lasmos was subsequently published whilst judgment on Mr. But’s application was still pending. Given the potential impact of the Lasmos decision on the issues being considered, the parties sensibly requested that a further round of written submissions be exchanged to deal with Lasmos. The Lasmos position was thus argued before DHCJ Yee (albeit by way of written submissions only).

Mr. But was unsuccessful in his application to set aside the statutory demand and DHCJ Yee held[10] that the alleged dispute was “thoroughly bad and has no merit”. Also, he held Lasmos was inapplicable on the basis that there was no dispute to be arbitrated. He further held that even if Lasmos was applicable, Mr. But would have, in any event, failed in the 3^rd requirement stated in Lasmos, not having taken steps to commence arbitration.

It appears that DHCJ Yee considered Lasmos to be inapplicable because Mr. But’s application was based on Rule 48(5)(b) of BR. This rule states that the Court may grant the application to set aside a statutory demand if the debt is disputed on grounds which appear to the Court to be substantial. By relying on this provisions, the decision “sought by the parties”[11] was whether there was a bona fide dispute on substantial grounds. It could be said that this provision creates a distinction between bankruptcy cases (where the provision applies) and winding up cases (where it does not). However this point was not dealt with by the Court of Appeal’s judgment (although it was argued).

But Ka Chon – The Appeal

Mr. But then appealed the decision of DHCJ Yee and the Court of Appeal (the Honourable Kwan V-P giving the leading judgment and the Honourable Cheung and Chu JJA concurring) agreed with the Court of First Instance’s finding that there is no “dispute” to be arbitrated, finding that the allegations of misrepresentation were ill founded. The Court of Appeal further held that even if the Lasmos approach were to be preferred, Mr. But had in any event failed to satisfy the 3^rd requirement (namely, to actually commence arbitration).  On that basis, the Court of Appeal was not (strictly speaking) required to comment on the Lasmos approach generally but the Honourable Kwan V-P, recognising the importance of this issue, nonetheless provided some important observations on an obiter basis.  The key points are as follows:

1. In the pre-Lasmos cases, the Court retains a discretionary power under the insolvency legislation to dismiss or stay a petition where the alleged debt is subject to an arbitration clause. In exercising the discretion, the Court will take into account all relevant circumstances, including the financial position of the debtor, the existence of other creditors, and the position taken by them[12];
2. The Lasmos approach is a “substantial curtailment” of a creditor’s statutory right to present a petition on the ground of insolvency. The Court of Appeal affirmed the recent decision of the Honourable Mr Justice Ng in Re Sit Kwong Lam (Debtor)[13] which held that it is contrary to public policy for a contract (i.e. an arbitration agreement) to preclude or fetter the exercise of the creditor’s statutory right[14];
3. The Court of Appeal referred to the Eastern Caribbean Court of Appeal’s decision in Jinpeng Group Ltd v Peak Hotels and Resorts Ltd[15] to not follow Salford on the basis that the traditional approach requiring the debtor to raise a bona fide dispute on substantial ground was “too firmly a part of BVI law”. Kwan V-P commented that the “position is the same as regards the insolvency legislation in Hong Kong”[16];
4. Salford was decided to give effect to a change in legislation in the Arbitration Act 1996 which the English Court held created an anomaly between winding up proceedings and writ actions. That anomaly never existed in Hong Kong as no similar change in legislation occurred. The Arbitration Ordinance (Cap. 341) and the Arbitration Ordinance (Cap. 609) had all along reflected the wording of the relevant provision in the Arbitration Act 1996[17]. The pre-Lasmos cases (having considered the wording of the Hong Kong statute akin to the Arbitration Act 1996) were satisfied that insolvency proceedings should be treated differently, namely that the Companies Court in Hong Kong could continue to deal with a dispute on the debt summarily because the petitioner invokes a class remedy available to all of the creditors[18]; and
5. As a result of the points above, Kwan V-P expressed that she had “reservations if the discretion under the insolvency legislation should be exercised only one way to substantially curtail the right of a creditor to present a petition”[19] but nonetheless commented that “considerable weight should be given to the factor of arbitration in the exercise of the discretion [to dismiss or stay a petition]”[20].

Remarks

Although the Court of Appeal’s comments on the Lasmos approach are obiter, it is nonetheless likely to be highly persuasive in the future. Whilst it is acknowledged that a party’s agreement to arbitrate should be given some significance, and that arbitration is encouraged to relieve time constraints on the judiciary, it is submitted that the observations in But Ka Chon are a welcome moderation of the Lasmos approach. It is anticipated that a petitioner will not be required to establish “exceptional circumstances” in order to present a petition where there is an arbitration clause, albeit that the Court will likely place more emphasis on the existence of an arbitration clause and steps that the debtor has taken to initiate or commence arbitration when exercising its discretion to stay or dismiss a petition.

Robin Darton / Tim Au

The above is not intended to be relied on as legal advice and specific legal advice should be sought at all times in relation to the above.

If you would like to discuss any of the matters raised in this article, please contact:

Robin Darton
Partner | E-mail

Tim Au
Solicitor | E-mail

Disclaimer: This publication is general in nature and is not intended to constitute legal advice. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.

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[1] [2019] HKCA 873

[2] The bench consisted of the Honourable Kwan V-P, the Honourable Cheung JA and the Honurable Chu JA

[3] [2018] 2 HKLRD 449

[4] See Hollmet AG & Anr v Meridian Success Metal Supplies Ltd [1997] HKLRD 828; Re Sky Datamann (Hong Kong) Ltd (unreported, HCCW 487/2001, 29 January 2002); Re Jade Union Investment Ltd (unreported, HCCW 400/2003, 5 March 2004); Re Southern Beauty Materials Holding (HK) Co Ltd (unreported, HCCW 281/2007, 13 February 2008); and Re Quicksilver Glorious Sun JV Ltd [2014] 4 HKLRD 759.

[5] For example on the basis that the debtor had failed to satisfy a statutory demand (hence it would be deemed insolvent) within the meaning of 178 of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32)

[6] See Hollmet AG v Meridian Success Metal Supplies Ltd [1997] 4 HKC 343

[7] Note that a statutory demand in personal bankruptcy can be “set aside” before a petition is presented. This is a statutory procedure found in the Bankruptcy Ordinance (Cap. 6) and the underlying procedure in Mr. But’s case.

[8] [2015] Ch 589

[9] See paragraph 30 of Lasmos on what constitutes “exceptional circumstances” (noting that it is not meant to be an exhaustive list). It includes situations that a petition should not be dismissed if there are grounds to appoint provisional liquidators if assets are found to have been misappropriated. It should be noted that Salford does not specify what amounts to “exceptional circumstances”

[10] The hearing was a heard in chambers (not open to public) thus the judgment was not published

[11] See §22 of But Ka Chon

[12] Paragraph 61 of But Ka Chon

[13] [2019] 2 HKLRD 924

[14] Paragraph 63 of But Ka Chon

[15] BVI HCMAP 2014/0025 and 2015/003, 8 December 2015

[16] Paragraph 66 of But Ka Chon

[17] Compare section 9 Arbitration Act 1996 against Schedule 5 Article 8 of the Arbitration Ordinance (Cap. 341) and Schedule 20 Article 8 of Arbitration Ordinance (Cap. 609).

[18] See paragraphs 68-69 of But Ka Chon

[19] See paragraph 67 of But Ka Chon

[20] See paragraph 68 of But Ka Cho