The number of international arbitrations involving the Hong Kong International Arbitration Centre doubled between 2004 and 2008. The number of winding up petitions is also currently on the rise because of the poor global economic environment. This article discusses conflicts that may arise between the statutory insolvency regime and the contractual rights of parties to arbitrate their disputes in Hong Kong.
Can Arbitration Be Used To Circumvent Statutory Insolvency Regimes?
Courts in Hong Kong support party autonomy and almost always give effect to arbitration clauses. Article 8 of the UNCITRAL Model Law (applicable to international arbitrations pursuant to section 6(1) of the Hong Kong Arbitration Ordinance) states that a court must stay a court action1 if there is a valid arbitration agreement and the party applies for the stay prior to that party’s first court filing on the substance of the dispute. The court may refuse to stay the court proceedings only if the arbitration agreement is null and void, inoperative or incapable of being performed.
The court’s power of stay to uphold arbitration agreements is automatic and does not require an examination of the merits of the case. One exception however appears to be when a party opts to file a winding up petition. In such circumstances, recent decisions show that the courts will not stay valid winding up petitions in circumstances where there is also an underlying arbitration agreement.
In a recent Hong Kong case, Re Sinom (Hong Kong) Limited,2 the Court of First Instance confirmed that neither the existence of an arbitration clause nor the commencement of arbitration prevents the court from dealing with a winding up petition. In this scenario, the court will allow the winding up petition to proceed, provided that it is satisfied that the creditor can establish that the sum claimed is due—i.e., there is no bona fide dispute in relation to the substance of the debt on which the winding up petition is based.3 This principle was first established in Re Jade Union Investment Limited4 decided in early 2004.5 In that case, the creditor made a winding up petition against Jade Union shortly before the commencement of arbitration proceedings. The winding up petition was made on the basis that Jade Union was deemed to be insolvent, as it failed to comply with a statutory demand for an outstanding payment served by the creditor.
During the hearing on the winding up petition, Jade Union asserted that the court should not consider the winding up petition because of the existence of an arbitration clause in the contract that provided that any dispute or difference between the parties should be referred to arbitration. The court was not persuaded by Jade Union’s argument and held that neither the existence of an arbitration clause in the contract nor the commencement of an arbitration, of themselves, demonstrated that there was a bona fide dispute in relation to the amount claimed.
The court also explained that permitting a winding up petition to proceed in these circumstances did not have the effect of circumventing the provisions in the Arbitration Ordinance relating to the stay of proceedings. A winding up petition is quite different from an ‘action’ between the parties, in which the parties seek the court’s determination as to their respective rights and liabilities. By a winding up petition, a creditor merely invokes the court’s jurisdiction under the Companies Ordinance to wind up a company on one or more of the grounds set out in the Ordinance. In doing so, the creditor exercises a class right available to all of the company’s creditors. Even if a winding up order is made, the creditor is still obliged to submit a proof of debt, along with other creditors of the company, and the liquidator will then decide how much the creditor is entitled to receive from the assets of the company. It follows that by making a winding up order the court does not thereby adjudicate the petitioner’s rights to recover any particular amount from the company.
Is Leave of the Court Required To Proceed Against an Insolvent Party in Arbitration?
Section 186 of the Companies Ordinance provides that when a winding up order has been made, or a provisional liquidator has been appointed, no action or proceeding against the company can be begun or continued except by leave of the court. It is well recognized in Hong Kong that “action or proceeding” encompasses arbitrations, so leave of the court is required to proceed against an insolvent party in arbitration.
The legal principles on the exercise of the court’s discretion under Section 186 are set out in the case of Re B+B Construction Company Limited (In Liquidation):6
- the court will exercise its discretion on the basis of what is right and fair according to the circumstances of each case, this involves a balancing exercise;7
- if the issue can be conveniently decided in the course of the winding up, will be refused in the absence of special circumstances, as there is a positive benefit in having the issue decided by the liquidator since this should be less expensive and quicker than an independent action and the liquidator is obliged to act even-handedly as between each class of claimant so prejudice would not normally be caused to any particular class of claimant;8
- however proceedings will be allowed to be commenced or continued where an action is the most convenient method of trying a question, and particualrly so when the questions would involve substantial issues of facts that are in dispute and also matters of law of complexity;9 and
- leave is more likely to be granted where the company in liquidation is insured in respect of the claim made against it as the judgment will be funded to the limit of the cover by the insurance company and the costs of the action will be borne by the insurance company.10
Can Parties Obtain Security for Costs Against Impecunious Parties?
Pursuant to Section 2GB(1) of the Arbitration Ordinance, the arbitral tribunal may make orders or give directions requiring a claimant to give security for the costs of the arbitration.
The Ordinance does not specify the grounds upon which the arbitral tribunal will consider when deciding whether to grant security for costs.11 It is generally accepted that the respondent (i.e., the party applying for security for costs) has to establish to the arbitral tribunal’s satisfaction that the claimant will be unable to pay his costs if the claim is unsuccessful, or that there will be serious difficulties in enforcing an order for costs against the claimant.12 The merits of the underlying dispute between the parties are not always relevant in deciding whether to grant security for costs.13 It is therefore probable that the respondent can obtain security for costs against an impecunious claimant, provided that the threshold test cited above is satisfied.
1. An exception to this mandatory power of stay relates to Labour Tribunal proceedings—the court has a discretion to order the stay of proceedings upon satisfaction of certain requirements (Section 6(2) of the Arbitration Ordinance).
2. HCMP73/2009, 5 August 2009.
3. It is well-established in Hong Kong that where a winding up petition is based on a debt, the said petition will be dismissed by the court if the allegedly insolvent company is able to establish that the debt relied upon is genuinely disputed on substantial grounds.
4. HCCW 400/2003, 5 March 2004.
5. This case was approved by later cases, e.g. Re City Top Engineering Limited (HCCW 1035/2004, 20 April 2006) and Re Southern Materials Holding (H.K.) Company Limited (HCCW 281/2007, 13 February 2008).
7. Re Aro Co. Ltd  1 Ch 196; Re Axona International Credit & Commerce Ltd  2 HKC 675; Re King’s Dyeing & Weaving Factory Ltd (No. 2)  HKC 621.
8. Re Exchange Securities & Commodities Ltd & Ors.  BCLC 186.
9. Re King’s Dyeing & Weaving Factory Ltd (No. 2)  HKC 621.
10. Bristol & West Building Society v. Trustee of the property of Back and another (bankrupts)  1 BCLC 485.
11. Section 2GB(3) of the Arbitration Ordinance states that “an arbitral tribunal must not make an order requiring a claimant to provide security for costs only on the ground that the claimant - (a) is a natural person who is ordinarily resident outside Hong Kong; or (b) is a body corporate that is incorporated, or an association that is formed, under a law of a place outside Hong Kong, or whose central management and control is exercised outside Hong Kong.”
12. Ma, J., & Kaplan, N. (2003). Arbitration in Hong Kong: A practical guide. Hong Kong: Sweet & Maxwell Asia, p380.
13. Azov Shipping Co. v Baltic Shipping Co (No. 2)  1 All ER (Comm) 716.