Hong Kong Court of Appeal Addresses the Effect of Exclusive Jurisdiction Clauses on Insolvency Proceedings
On 30 August 2022, the Hong Kong Court of Appeal overturned the Court of First Instance's decision in the case of Guy Kwok-Hung Lam v Tor Asia Credit Master Fund LP and held that a creditor's bankruptcy petition presented in Hong Kong should not be allowed to proceed where the petitioned debt was disputed and arose from an agreement with an exclusive jurisdiction clause in favour of a foreign court.
This is the first reasoned decision in Hong Kong addressing the effect of exclusive jurisdiction clauses on insolvency proceedings. Whilst the case arose from a bankruptcy petition, the same principle should also apply to winding up petitions.
Background
The appellant, Mr Guy Lam (the Appellant), is a guarantor of certain terms loans advanced by Tor Asia Credit Master Fund LP (the Respondent) to CP Global Inc. (CP Global), a company wholly owned by the Appellant.
It is agreed in the Credit and Guaranty Agreement made between the Respondent, CP Global and the Appellant among others (the Agreement) that, among other things, the Agreement shall be governed by the laws of the State of New York and that certain courts in New York would have exclusive jurisdiction for all legal proceedings arising out of or relating to the Agreement (the Exclusive Jurisdiction Clause).
Subsequently, the Respondent took the view that there were events of default under the Agreement and started bankruptcy proceedings against the Appellant in Hong Kong. The Appellant opposed the bankruptcy petition and also commenced proceedings in the United States against the Respondent to seek a declaration that there had been no event of default that has not been waived, and the Appellant also cross-claimed against the Respondent.
The only ground of appeal raised by the Appellant is that the bankruptcy petition should have been dismissed because the petition debt is disputed and he has a cross-claim, and both the dispute and the cross-claim are subject to the Exclusive Jurisdiction Clause. The Court of First Instance held that there was a settled understanding of the law that an exclusive jurisdiction clause does not prevent a winding up or bankruptcy petition from being presented in an appropriate jurisdiction, and a creditor could present a winding up or bankruptcy petition if there was no bona fide dispute on substantial grounds in respect of the debt. Since the court found no bona fide dispute, it made a bankruptcy order against the Appellant.
Appeal Decision
The Appellant's appeal was allowed by the Court of Appeal. In the judgment of the Honourable Mr Justice G Lam JA, with which the Honourable Mr Justice Barma JA agrees, His Lordship looked into cases from different jurisdictions and considered the following issues (a) the approach to stay ordinary actions based on exclusive jurisdiction clause; (b) the effect of arbitration clauses on winding up petitions; (c) is the Exclusive Jurisdiction Clause engaged; and (d) should the approach in ordinary actions be applied to winding up and bankruptcy proceedings.
Effect of Exclusive Jurisdiction Clause on Ordinary Actions
The principle in Hong Kong is that the court has a discretion whether to stay an action brought in breach of an exclusive jurisdiction clause to refer disputes to a foreign court. However, that discretion should be exercised by granting a stay unless there is a strong cause for not doing so.
Effect of Arbitration Clauses on Winding Up Petitions
The Honourable Mr Justice G Lam also referred to the case of Lasmos, a judgment of the Court of First Instance concerning winding up proceedings where the underlying contract contains an arbitration clause. The Lasmos case held that if (1) a company disputes the debt relied on by the petitioner; (2) the contract under which the debt is alleged to arise contains an arbitration clause that covers any dispute relating to the debt; and (3) the company takes the steps required under the arbitration clause to commence the contractually mandated dispute resolution process and files an affirmation confirming this; then the petition should generally be dismissed.
Is the Exclusive Jurisdiction Clause Engaged
The Honourable Mr Justice G Lam decided that the Exclusive Jurisdiction Clause is engaged by the disputes raised in the bankruptcy proceedings. His Lordship was of the opinion that whilst seeking a bankruptcy order may not by itself be proceedings within the scope of the Exclusive Jurisdiction Clause, a petition for such an order on the basis of a disputed indebtedness under the Agreement does fall within the legal proceedings arising out of or relating to the Agreement. In a case of disputed indebtedness, if the Hong Kong court were to decide on whether the various defences and cross-claims raised by the Appellant had substance and should be taken into account, it would in effect be a judicial determination of the parties' rights and obligations under the Agreement.
Should the Approach in Ordinary Actions Be Applied to Bankruptcy and Winding Up Proceedings
Having considered the various case authorities, His Lordship held that when dealing with bankruptcy/winding up proceedings, if the underlying contract contains an exclusive jurisdiction clause in favour of a foreign court, the court should adopt the same approach as it does when considering whether to stay an ordinary action which involves an exclusive jurisdiction clause in favour of a foreign court. In other words, in such a situation, a bankruptcy or winding up petition should be stayed or dismissed unless there are strong reasons to the contrary. The court also gave some examples of these "strong reasons", which include situations where:
- the debtor is incontestably and massively insolvent apart from the disputed debt;
- the debtor will be a menace to commercial society if allowed to continue to trade;
- there are other creditors seeking a winding up order whose debts are not subject to any jurisdiction agreement;
- the assets may be in jeopardy;
- there is a need to investigate potential wrongdoings; and
- the effect of a dismissal or stay will be to deprive the petitioner of a real remedy or result in injustice otherwise.
Applying the above to the facts, His Lordship considered that there was a dispute which ought to be determined first in accordance with the parties' agreement on jurisdiction, i.e. the Exclusive Jurisdiction Clause. As the Respondent did not advance any strong reason to the contrary, the Respondent's petition was dismissed.
Comment
This case clarifies the court's position on the effect of an exclusive jurisdiction clause in favour of a foreign court on bankruptcy and winding up proceedings. The Court will adopt the same approach as it does when considering whether to stay an ordinary action, albeit the Honourable Mr Justice Chow JA has reservation about this approach in his judgment. On the other hand, the Court has not decided that the Lasmos approach in respect of arbitration clauses should be followed.
This case serves as a reminder that when drafting exclusive jurisdiction clauses in favour of a foreign court, parties should bear in mind that the clause may impact any insolvency proceedings which a party may commence against its counterparty in the Hong Kong courts if the clause is sufficiently wide. If an existing agreement contains an exclusive jurisdiction clause in favour of a foreign court which is wide enough to cover disputed debts in the context of insolvency proceedings, unless there are good grounds which suggest otherwise, creditors should commence an action and get judgment in the agreed forum before starting insolvency proceedings in Hong Kong, otherwise one will run the risk that the insolvency proceedings may be stayed or even dismissed.
