Briefings

Lasmos Limited v. Southwest Pacific Bauxite (HK) Limited: Navigating the tension between private dispute resolution and insolvency class actions, March 2018

In Lasmos Limited v. Southwest Pacific Bauxite (HK) Limited¹, the Hong Kong Court of First Instance dismissed a winding-up petition based on an unsatisfied statutory demand.

In his judgment, the Honourable Mr Justice Harris concluded that, where the underlying debt is subject to an arbitration agreement, if the company disputes the debt, the Court should generally dismiss the petition without requiring the company to establish a bona fide defence on substantial grounds as had been the position previously.

This judgment represents a significant departure from the previous position under Hong Kong law, and brings it broadly into line with English and Singapore law on the subject.

The case

Lasmos Limited (the "Petitioner") petitioned for the winding-up of Southwest Pacific Bauxite (HK) Limited (the "Company") pursuant to section 178(1)(a) of the Companies (Winding Up and Miscellaneous Provisions) Ordinance, Cap. 32 on the basis of an unsatisfied statutory demand.

The statutory demand related to a debt the Petitioner alleged had arisen under a contract for the supply of services to the Company. The contract in question contained an HKIAC arbitration clause. The Company did not allege that nothing was payable (it had previously paid US$100,000 for the services) but it did dispute –on bona fide grounds, it said – what further sums were payable. On this basis, it invited the court to dismiss the petition.

Harris J's judgment

In his judgment, Harris J conducted an extensive review of the Hong Kong², English³ and Singapore⁴ authorities and examined the different approaches taken by courts in these jurisdictions when determining a petition based on a debt arising out of a contract containing an arbitration clause.

Harris J observed that (historically, at least) under Hong Kong law, the Court would apply the same test - regardless of whether or not the underlying agreement from which the debt arose contained an arbitration clause; namely, whether or not there was a bona fide defence on substantial grounds.

Harris J contrasted this position with the position in English law, where the approach is different in the case of a debt arising out of contract containing an arbitration clause. He observed that, unlike in Hong Kong, such a winding-up petition in England would be dismissed, where the debt on which it was based was "not admitted" by the company.

He also highlighted the contrast with the Singaporean position,, where a petition would be dismissed if there were a prima facie dispute in relation to an alleged debt subject to an arbitration clause and the company has prima facie complied with the dispute resolution clause (i.e. commenced arbitration).

Following this analysis, Harris J concluded that the Hong Kong authorities had mistakenly assumed that, due to the nature of winding-up proceedings as a class remedy, the normal consequences of the parties having agreed to resolve their disputes by arbitration should not apply, once the court's winding-up jurisdiction is invoked.

In other words, the class interests engaged by the insolvency process displace the private agreement between the petitioner and the company to submit their disputes to arbitration.

In Harris J's view, these previous decisions proceeded on a series of assumptions that failed to make important distinctions including between; on the one hand, the petitioner's status as a creditor of the company and, on the other hand, the collective class interests of the company's creditors as a whole in the winding-up remedy itself.

Specifically, he said that the question of whether or not the disputed debt is owed to the petitioner – and whether or not it is therefore a member of the class of the company's creditors – is entirely separate to the question of whether or not the class remedy of a winding-up order should be granted.

On this basis, he concluded that, whilst winding-up is a class remedy, this fact is not relevant to the method of determining whether or not the debt in question is in fact owed to the Petitioner. In circumstances in which the parties have agreed to arbitrate any disputes, the parties' agreement in relation to the method of determination must be respected.

Harris J's conclusions

Harris J therefore held that the court should generally dismiss a winding-up petition if:

1. the 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 arbitration proceedings and files an affirmation demonstrating this.

On the basis that the Company satisfied these conditions, Harris J dismissed the petition. He did, however, conclude that - in any case - the Company had established a bona fide defence on substantial grounds.

He also accepted that there will be "exceptional circumstances" in which dismissal will not be appropriate and a winding-up order will be made – or at least certain parts of the proceedings may be pursued - notwithstanding the existence of an arbitration clause (e.g. where the petitioner can show a risk of a dissipation of the company's assets, necessitating the appointment of provisional liquidators).

Our perspective

Harris J's judgment represents a significant departure from the previous position under Hong Kong law, bringing it broadly into line with the law in England and Singapore.

Now, where a debt underlying a petition arises out of a contract containing an arbitration agreement, as long as the company opposing the petition disputes the debt, the Court should generally dismiss the petition.

This decision is likely to be welcomed by the arbitration community and cited as additional evidence of Hong Kong's pro-arbitration stance. In particular, the decision limits the ability of a petitioner to seek, for tactical reasons, to bypass the arbitration agreement by presenting a winding-up petition.

However, it is unlikely to be the last chapter on the subject.

In this respect, although the English, Singaporean and Hong Kong approaches are now substantially similar, there does appear to be a slight difference of emphasis in each jurisdiction on the test for what constitutes a dispute. In particular, insofar as the Hong Kong position is concerned, there is scope for further argument as to what is meant by "disputes", e.g. is it akin to "not admitted" (as in England and Wales), or must there be a "prima facie dispute", albeit falling short of a bona fide dispute on substantial grounds (as in Singapore)?

Moreover, the exact scope of the "exceptional circumstances" and, in particular, their theoretical underpinning (based, as the Judge's reasoning substantially was, on the standing of a creditor to present a petition) are not particularly clear. We suspect they may well generate significant further litigation.

However, the fallback finding of a bona fide dispute on substantial grounds renders the judgment unlikely to be appealed, which means it may be some time before the decision is considered by a higher court.

Footnotes

1. [2018] HKCFI 426
2. Hollmet AG v Meridian Success Metal Supplies Ltd [1997] 4 HKC 343; Re Sky Datamann (HK) Ltd (unrep., HCCW 487/2001) (29 January 2002); Re Jade Union Investment Limited (unrep., HCCW 400/2003) (5 March 2004); Re Southern Materials Holding (H.K.) Co Ltd (unrep., HCCW 281/2007) (13 February 2008); Re Quiksilver Glorious Sun JV Ltd [2014] 4 HKLRD 759
3. Salford Estates (No. 2) Limited v Altomart Limited [2014] EWCA 1575 Civ
4. BDG v BDH [2016] SGHC 211