The CFA’s approach highlights the importance of party autonomy and the heavy weight that courts will generally place upon the contractual terms between the parties.
This serves as a reminder that businesses should pay close attention to the dispute resolution clauses in their agreements, particularly those pertaining to jurisdiction, governing law and method of dispute resolution.
We expect Hong Kong courts to take a similar approach towards winding up petitions against companies.
Businesses should bear in mind the following when reviewing dispute resolution clauses:
- Pay attention to the language and consider the suitability of both the substantive and procedural aspects of the designated forum and governing law.
- Seek legal advice on the implications of litigation versus arbitration, exclusive versus non-exclusive jurisdiction clauses, etc.
- Never underestimate the risk of having to take enforcement action against the other counterparties. Where possible, conduct proper due diligence as to their operations, assets, creditors, risk of default, etc., before you contract with them. Consider how to shape dispute resolution clauses to help mitigate your risks and maximize your leverage over counterparties.
In more detail
Re Guy Kwok-Hung Lam
Pursuant to a Credit and Guaranty Agreement ("Agreement"), the Appellant, as lender ("Creditor"), advanced term loans to a company controlled by the Respondent ("Debtor"), who acted as a guarantor to these loans. The Agreement contained an exclusive jurisdiction clause in favour of New York courts, which covered "all legal proceedings arising out of or relating to this [Agreement] or the other [loan documents] or the transactions contemplated".
The Creditor served a statutory demand on the Debtor, requiring him to pay the outstanding principal and interest. It then presented a bankruptcy petition as the Debtor did not comply.
While the bankruptcy petition was pending, the Debtor commenced court proceedings in New York against the Creditor, seeking a declaration that there had been no event of default under the Agreement. The Debtor then opposed the petition in Hong Kong by arguing, among other things, that the Creditor should be required to litigate the dispute in New York before coming to Hong Kong to invoke the bankruptcy regime.
Court of First Instance (CFI)
The CFI rejected the Debtor’s arguments and held that the established approach is to ask whether the debtor has demonstrated a bona fide dispute on substantial ground in respect of the debt ("Threshold Question").
The CFI held that the existence of an arbitration clause or an EJC is only a factor to be taken into account by the court when considering a winding up / bankruptcy petition.
The CFI held that there was no bona fide dispute on the facts and granted the bankruptcy order.
Court of Appeal (CA)
The Debtor appealed on the ground that the CFI should have dismissed or stayed the petition, as the petition debt was disputed and subject to the EJC and proceedings had been commenced in New York.
The three CA judges unanimously agreed, but for different reasons, that the bankruptcy order should be set aside. The majority of the CA held that the court should give effect to the EJC and dismiss the petition, unless strong cause for not doing so is shown.
Court of Final Appeal (CFA)
The CFA unanimously dismissed the appeal and endorsed the CA’s majority approach. The key takeaways are as follows:
- Where the underlying dispute of the petition debt is subject to an EJC, the court should generally dismiss the petition and hold the parties to their contract, unless there are countervailing factors (e.g., the risk of insolvency affecting third parties, a frivolous defence, or an abuse of process).
- The CFI’s bankruptcy jurisdiction, conferred by statute, cannot be excluded by contract. If the parties agree to refer their disputes to a foreign court, this will only inform the CFI’s discretion to decline to exercise jurisdiction, but not oust its jurisdiction.
- The CFI might exercise its discretion to decline jurisdiction in certain cases (e.g., where the dispute in a particular action was covered by an arbitration agreement or an EJC).
- The determination of the Threshold Question is an exercise of the court’s bankruptcy jurisdiction. The court could choose not to exercise its jurisdiction and refrain from determining the Threshold Question in, for example, a case where the parties have agreed to have their disputes resolved exclusively in another forum.
- The CFA noted the public policy considerations that were at play (e.g., upholding the legislative scheme for the bankruptcy jurisdiction, holding parties to their contract) and outlined some of the possible considerations (e.g., whether there was any evidence of a creditor community at risk).
This case illustrates the importance of having a dispute resolution mechanism that adequately addresses the circumstances and risks at hand, as it is clear from the CFA’s reasoning that parties will generally have to adhere to what the contract requires of them. This development may, however, encourage debtors to rely on an EJC to stall bankruptcy or insolvency proceedings. Whilst some may attempt to use contractual means to mitigate such risks and allow for greater flexibility, such as by opting for a non-exclusive jurisdiction clause, doing so may create other uncertainties, including the risk of having to face proceedings in unintended jurisdictions.