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Winding-up Without a Debt: Should the Hong Kong Courts Run Around in Circles with The Privy Council?
(This article was published in the August 2024 Issue of the Hong Kong Lawyer)
In Sian Participation Corp v Halimeda International Ltd [2024] UKPC 16, Ltd the Privy Council made a U-turn on the interplay between arbitration and insolvency by re-affirming the “Traditional Approach” as a matter of law of the British Virgin Islands: notwithstanding any arbitration agreement that governs a winding-up petition debt, the petition should only be stayed or dismissed if the company demonstrates that there is a bona fide dispute on substantial grounds. The Privy Council considered it serious enough to kill two more birds with the same stone by (1) overruling as a matter of English law Salford Estates (No 2) Ltd v Altomart Ltd (No 2) [2015] Ch 589 that where an unadmitted underlying debt of a winding-up petition is subject to an arbitration agreement, a winding-up petition shall be dismissed or stayed save in wholly exceptional circumstances (“Salford Estates Approach”), and (2) adopting the same underlying policy in relation to arbitration clauses and exclusive foreign jurisdiction clauses.
Sian no doubt came as a bolt from the blue, leaving the common law arbitration community in complete shock, not only because for nearly a decade the Salford Estates Approach has not received any major negative treatment by English courts, but also because the Salford Estates Approach has been essentially adopted (albeit with modifications) by the highest courts in other common law jurisdictions, such as Singapore Court of Appeal in AnAn Group (Singapore) PTE Ltd v VTB Bank [2020] SGCA 33 and the Hong Kong Court of Final Appeal in Guy Kwok-Hung Lam v Tor Asia Credit Master Fund LP [2023] HKCFA 9 (“Guy Lam CFA”)(delivered by French NPJ, the former Chief Justice of Australia). Now that the English courts have made a sharp turn, should Hong Kong courts follow suit?
This article seeks to critically examine the reasoning in Sian. With respect, it will be argued that the Privy Council merely defeated a straw man but failed to answer the fundamental question – whether there is a qualifying debt to trigger the winding-up regime for the court to exercise any discretion in the first place. It will be respectfully submitted that the court does not have any final say when the petition debt is governed by an arbitration clause (at least insofar as any factual dispute is concerned) or an exclusive foreign jurisdiction clause, and
so the court cannot determine whether there is indeed a qualifying debt. As a sequel of our article “Lasmos and Beyond: Have the Cake and Eat It Too?” in the May 2020 issue, it is suggested that the Salford Estates Approach is the only irresistible logical approach for the Hong Kong courts to adopt.
Extremity of Sian: Hard Facts Make Bad Law?
Sian was a typical loan recovery case where the respondent applied for liquidation of the appellant for the appellant’s failure to repay the facility, whereas the appellant claimed that it
had a cross-claim against the respondent.
At the outset, it must be pointed out that Sian is extremely extraordinary in the sense that the appellant accepted that the petition debt was not disputed on genuine or substantial grounds given that the appellant did not appeal against such facet of the first instance decision. It was on that basis that the Privy Council took the practical view that to require the creditor to go through an arbitration in that case may just add delay, trouble and expense for no good purpose (Sian, [92]).
In practice, this kind of open acknowledgment of no genuine or substantial dispute on the debt is extremely rare. The more common scenario is that the debtor raises certain disputes
on the debt which the court deems non-genuine and non-substantial. If the petition debt is governed by an arbitration clause, could the court be so confident that any arbitral tribunal
must necessarily reach the very same conclusion as the court would, such that there must be a qualifying debt to trigger the winding-up regime?
Winding-up Without a Debt?
Clearly the courts have no power to wind up companies at their whim. In the insolvency statutes around the common law jurisdictions, there are specific gateways under which a company may be wound up. For example, under section 177 of the Hong Kong Companies
(Winding-up and Miscellaneous Provisions) Ordinance (“HK Winding-up Ordinance”), a company in Hong Kong may be wound up for being unable to pay debts. If a creditor wishes to prove the inability to pay a particular debt, he may either rely on the deeming provision
under section 178 of the HK Winding-up Ordinance by a statutory demand of a liquidated debt of HK$10,000 or more, or fall back on strict proof of the debt (Cornhill Insurance plc v Improvement Services Ltd [1986] 1 WLR 114). Therefore, if the ground to wind up a company is solely on its inability to pay the petition debt, then logically the making of a winding-up order must necessarily involve the determination of the existence of the “debt”.
Hence in Guy Kwok-Hung Lam v Tor Asia Credit Master Fund LP [2022] 4 HKLRD 793 (“Guy Lam CA”), the Hong Kong Court of Appeal held that firstly, there is indeed judicial determination of a company’s indebtedness in the bankruptcy proceedings ([68]); secondly, until the creditor is established as “a creditor”, he simply has no locus standi present any petition ([77]). In the same vein, in Guy Lam CFA, French NPJ did not rule out the possibility of a mandatory stay of the bankruptcy proceedings in favour of arbitration ([91]).
The Privy Council attempted to dispel this clear logic by explaining that to make a winding-up order is “only a provisional assumption that the company is insolvent, which may turn out to be untrue, without that invalidating the liquidation process”. With all due respect, such a contention is only a straw man – when the winding- up petition is concerned with the petition debt in particular, the real question is not whether the company is or is not “insolvent” overall (which position may fluctuate until all assets are realised), but whether there is or is not a qualifying debt that triggers the winding-up regime. The “most spectacular recent example” of the substantial net surplus of the Lehman Brothers International Europe Ltd is neither here nor there. The Privy Council did not cite any case authority whatsoever to support the proposition that the non-existence of the petition debt does not invalidate the liquidation process. Likewise, none of the pre- Salford case authorities cited by the Privy Council actually supports that illogical proposition.
In Re Vitoria [1894] 2 QB 387, the English Court of Appeal was concerned with whether a creditor can petition to bankruptcy on the strength of a judgment debt again if its first petition on the very same judgment debt had been dismissed on procedural grounds. Obviously the first bankruptcy petition proceedings should not be conflated as an appeal of the underlying judgment debt, so it was on that basis that the English CA granted the bankruptcy order on the second occasion. What the English CA did not say, however, is that the court has power to bankrupt someone even if there is no qualifying debt at all; on the very contrary, there was a clear unreversed judgment debt in that case to justify the bankruptcy order.
In Tanning Research Laboratories Inc v O’Brien [1990] HCA 8, the High Court of Australia held that any disputed debt by the liquidator may be referred to the court or to arbitration. That is uncontroversial. However, that case did not concern a petition debt governed by an arbitration clause. In any event, the High Court of Australia also did not suggest that the non-existence of a petition debt would not invalidate the liquidation process.
In Re Menastar Finance Ltd [2003] BCC 404, the English High Court considered a challenge by one creditor against the liquidator’s acceptance of the proof of a judgment debt upon which the winding up petition was originally based. Since the challenge was dismissed in the end, that case certainly does not support in any way the proposition that a company may be wound up without a qualifying debt. Whilst it is true that the liquidator and ultimately the Companies Court may look behind a judgment debt, they may do so only if there is evidence of fraud or collusion or miscarriage of justice. Thus, investigating a judgment debt is the exception rather than the general rule. More importantly, there is no reason why the application of the principle “fraud unravels all” should stop at the judgment debt without invalidating the liquidation process.
Which Institution Has the Final Say?
One might ask: if the court may wind up a company without a judgment where the court has jurisdiction over the petition debt, why could it not do so where the petition debt is governed by an arbitration clause or an exclusive foreign jurisdiction clause? Obviously, where the court has jurisdiction over the petition debt, and holds that the debtor has no genuine or substantial dispute over the debt, one can safely presume that the court would be consistent in reaching exactly the same conclusion that there is indeed a debt even if disputed by the liquidator in the end, save in wholly exceptional circumstances as set out in Re Menastar.
This presumption is not safe anymore in the case of an arbitration clause or an exclusive foreign jurisdiction clause.
It is respectfully submitted that the ultimate test to determine whether the court may make a winding-up order without a judgment or an arbitral award is this: Which institution – the local court, the arbitral tribunal, or the foreign court – has the final say on the substantive merits of the petition debt? Whilst the Privy Council appears to equate arbitration clauses with exclusive foreign jurisdiction clauses on this issue, in which case the arbitral tribunal or the foreign court would have exclusive jurisdiction (Sian, [66]), it is respectfully suggested that there is one critical nuance.
In the arbitration statutes around the common law jurisdictions, a substantive appeal mechanism is usually preserved under limited circumstances unless the parties agree otherwise. For example, under paragraphs 5 and 6 of Schedule 2 to the HK Arbitration Ordinance, a party to a Hong Kong arbitration may appeal to the court against an arbitral award on a point of law where the award is “obviously wrong”. Therefore, if the existence of the petition debt involves a pure question of law, arguably the court has the final say, for the court could take the extreme view that any contradictory arbitral award would be “obviously wrong” on the pure question of law. However, this appeal mechanism does not apply to questions of fact, and in any event, does not exist for foreign judgments, in which cases the court has no final say on the existence of the petition debt.
Where the court has no final say on the substantive merits of the petition debt, it follows that the court cannot determine the existence of the petition debt, the pre-requisite for granting a winding-up order on the basis of the petition debt. No wonder no English court has yet found circumstances so “exceptional” to justify a winding-up order (Shaun Matos, “Arbitration Agreements and the Winding-Up Process: Reconciling Competing Values” (2023) 72 ICLQ 309, 313), even though the Salford Estates Approach reserves that mere possibility.
Balancing Public Policies
The Privy Council took pains to stress that to require the creditor to go through an arbitration where there is no genuine or substantial dispute on the debt just adds delay, trouble and expense for no good purpose (Sian, [92]). Yet, it begs the question as to which institution – the local court, the arbitral tribunal or the foreign court – shall have the final say as to whether there is a genuine or substantial dispute, or not. Although liquidation is an important statutory process to bring about an efficient realisation of the company’s assets and their fair distribution among all its stakeholders (Sian, [32]), it is also a draconian process that causes serious disruptions to the business and irreversible damage to the company. Balancing against the legitimate interest of the company and its effect on the economy as a whole, the liquidation class remedy should not be lightly invoked except under clear and uncontroversial circumstances that fall squarely within the black letter law.
Even if one is not entirely convinced that the mandatory stay provision in the arbitration statutes (e.g. section 20 of the HK Arbitration Ordinance) is engaged, it would constitute a “denying the antecedent” fallacy (i.e. If A then B; not A therefore not B.) to say that the court may not or should not adopt a default position to stay or dismiss a winding- up petition when the debt is governed by an arbitration clause or an exclusive foreign jurisdiction clause (Sian, [75]). With respect, the proper question is not whether the court’s exercise of discretion is “fettered” (Sian, [82], citing Re Asia Master Logistics Ltd [2020] 2 HKLRD 423) or “curtailed” (Sian, [83], citing But Ka Chon v Interactive Brokers LLC [2019] HKCA 873), but whether it makes sense for the court to adopt such a default position, having regard the company’s ability to pay its “debts”. In our respectful submission, it does make perfect logical sense for the court to adopt a default position to stay or dismiss the petition when it cannot possibly have the final say on the existence of the petition debt, so as to achieve consistency and to balance the legitimate business interest of the company and the interest of the economy as a whole.
Hong Kong Approach: For Better or Worse?
The Salford Estates Approach could be said to be first “localised” in Hong Kong in Re Southwest Pacific Bauxite (HK) Ltd [2018] 2 HKLRD 449 (“Lasmos Approach”), albeit with modifications. One major difference between the two approaches is that the Lasmos Approach adds an additional requirement that the debtor company takes steps to commence the contractually mandated dispute resolution process. So far the Lasmos Approach has not been officially endorsed, whether in Guy Lam CA or Guy Lam CFA or otherwise. In Re Simplicity & Vogue Retailing (HK) Co., Limited [2024] HKCA 299, the Court of Appeal took the view that the additional requirement in the Lasmos Approach is not onerous for the debtor to demonstrate that there is a genuine intention to arbitrate.
As argued in our previous article, it is difficult to justify the additional requirement in the Lasmos Approach. The lack of onerousness plainly does not justify the imposition of a legal requirement. Besides the concerns already raised, whether the debtor company has or has not taken the contractually agreed steps does not change the fact that the local court has no final say on the substantive merits of the petition debt if it is governed by an arbitration clause or an exclusive foreign jurisdiction clause. Similar concerns are shared by, for example, Shaun Matos, who exposed the absurdity in attaching deference to the arbitral tribunal instead of the arbitration agreement (“Reconciling Competing Values”, 330).
In Guy Lam CFA, the top court in Hong Kong adopted the “multi-factorial” approach, attempting to balance the “strong cause” of arbitration clause or exclusive foreign jurisdiction clause in favour of a stay or dismissal of a petition against other “countervailing factors” such as disputes bordering on the frivolous or abuse of process. With respect, such a formulation is dangerous and open to manipulation and should be avoided, for it breeds a tendency to be seen as “old wine in a new bottle” – see Sun Entertainment Culture Limited v Inversion Productions Limited [2023] HKCFI 2400 for example, where DHCJ Le Pichon ordered the winding-up on the basis of the “frivolous nature of the defence”, thereby judging the substantive merits of the defence though Her Ladyship may not have the final say due to the applicable arbitration clause.
Conclusion
Undoubtedly this issue of interplay between arbitration and insolvency is a vital one. As the Privy Council acknowledged, the overwhelming majority of winding-up petitions concern debts (Sian, [27]). It is unfortunate that the Privy Council ran away from the logical Salford Estates Approach and returned to the Traditional Approach, in total disregard of the statutory requirement of a qualifying debt before any possible winding-up, when the court does not and cannot have any final say on the substantive merits of the petition debt. It is understandable that the court wishes to preserve the winding-up regime for debts governed by an arbitration clause (Sian, [93]), yet let us not forget that there are other gateways in the insolvency statutes that the court can wind up a company in a more natural and logical way, for example, by reference to balance sheet insolvency, or justice and equity. The court need not twist the logic to do the impossible. It is hoped that the English courts will turn around again in time, and the HK courts will make logical contribution to the development of this area of the common law.
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