Hong Kong Court of Final Appeal provides clarity on the effect and implications

In its recent judgment in Guy Kwok-Hung Lam v Tor Asia Credit Master Fund LP [2023] HKCFA 9, the Court of Final Appeal of Hong Kong has provided guidance as to how an exclusive jurisdiction clause in a financing agreement impacts on the ability to bring a bankruptcy or winding up petition in Hong Kong.  In light of prior inconsistent judgments on the issue, the CFA decision provides welcome clarity as to the impact of exclusive jurisdiction clause on insolvency proceedings and when it may still be appropriate to commence them. 

Background

The debt in issue arose from a credit and guaranty agreement entered into between Tor Asia Credit Master Fund LP as lender, CP Global Inc (of which Lam was the sole shareholder and director) as borrower, and Lam as guarantor.  Under the agreement, Tor advanced term loans of USD29,500,000 to CP Global, which Lam guaranteed.

The agreement contained an exclusive jurisdiction clause for the exclusive jurisdiction of the courts of New York "for the purposes of all legal proceedings arising out of or relating to this Loan Agreement or the other Loan Documents or the transactions contemplated…".  The subsequent amendment agreements entered into between the parties for the purpose of extending the maturity date of the loan incorporated the exclusive jurisdiction clause.

In June 2020 Tor filed a bankruptcy petition against Lam for debts owing under the agreement that had been guaranteed by him.  In April 2021, while the petition was pending, Lam commenced proceedings in New York against Tor seeking a declaration that there had been no event of default under the agreement and consequential relief including damages.  The petition was heard by the Hong Kong Court of First Instance in June 2021, which made the usual bankruptcy order in respect of Lam.  

Lam appealed on the basis that the bankruptcy petition should have been dismissed or stayed given that the debt was disputed and ought to have been resolved before the New York courts in accordance with the exclusive jurisdiction clause.  The Court of Appeal delivered its judgment in August 2022, upholding the appeal and setting aside and the bankruptcy order and dismissed the petition.  The leading judgment, delivered by G Lam JA, held that a winding up or bankruptcy petition on the basis of a disputed debt under the relevant exclusive jurisdiction provision would fall within the meaning of "legal proceedings arising out of or relating to the agreement".  The Court of Appeal was of the view that the parties should seek a determination of the dispute in accordance with their agreement on jurisdiction and therefore a petition will not be allowed to proceed unless there are "strong reasons" to the contrary pending the determination of the dispute in the agreed forum.

Tor obtained leave to appeal to the CFA on the question of what the proper approach of the Hong Kong courts should be in respect of a bankruptcy petition where (i) there is an exclusive jurisdiction clause in the underlying finance document; (ii) the lender has petitioned in Hong Kong for a bankruptcy order against the borrower; and (iii) the debt is disputed by the borrower.

The CFA's decision

Tor's appeal was dismissed and the CFA held that that approach of G Lam JA in the Court of Appeal was correct.  In its reasons, the CFA held that:

• The jurisdiction of the CFI in bankruptcy matters is conferred by the Bankruptcy Ordinance, which cannot be excluded by contract.  Parties may agree between themselves not to invoke the jurisdiction of the court, but that has no effect on its jurisdiction.  Likewise, the parties may agree to refer their disputes to a foreign court, but that does not affect the jurisdiction of the CFI.  What it does inform is the court’s discretion of whether to decline to exercise its jurisdiction.
• The discretion of a court to decline to exercise jurisdiction in favour of another forum may be exercised in certain classes of cases, including cases where a bankruptcy or winding up petition is based on a debt covered by an arbitration clause or exclusive jurisdiction clause.
• The established approach would be that, absent an exclusive jurisdiction clause or an arbitration provision, a petitioner will ordinarily be entitled to a bankruptcy order (or in the case of corporate insolvency, a winding up order) if the debt is not subject to a bona fide dispute on substantial grounds.
• However, that approach is not appropriate where an exclusive jurisdiction clause is involved.  In the ordinary case of an exclusive jurisdiction clause, absent countervailing factors such as the risk of insolvency affecting third party creditors or a dispute that borders on the frivolous or abuse of process, the petitioner and the debtor ought to be held to their contract, meaning that any dispute or debt arising from the underlying contract should be resolved in accordance with the exclusive jurisdiction clause.
• When determining the question, the court should consider the public policy underlying the statutory insolvency regimes, such as any curtailment of the creditor's rights if the creditor is denied from being able to pursue its interest by invoking the insolvency proceedings.  The CFA affirmed that the public policy against fettering a statutory right to present a winding up or bankruptcy petition and underpinning the legislative scheme of the court’s bankruptcy jurisdiction is still present, and the more obviously insubstantial the grounds for disputing the debt, the more it comes into prominence.  Further, the significance of the public policy underpinning the court's bankruptcy jurisdiction is more limited where the petition is brought by one creditor against another, and there is no evidence of a broader class of creditors being prejudiced if the petition is not allowed to proceed.

As this case concerns an exclusive jurisdiction clause, the CFA judgment left open whether the same approach should also apply to arbitration clauses, i.e. whether the Lasmos approach should be adopted.  Given the obiter discussions which considered Lasmos at some length and seemed to adopt the reasoning of Lasmos, arguably the same approach should extend to cover arbitration clauses.

Takeaways

Commencing a petition where there is an exclusive jurisdiction or arbitration agreement in place requires careful consideration, particularly in light of the costs implications involved and the impact a dismissal or stay may have on the enforcement strategy of the creditor.

In light of prior inconsistent decisions as to where the court would make an order to stay or dismiss the petition, the CFA decision provides greater clarity to creditors as to when it may still be appropriate to commence a petition where an exclusive jurisdiction clause or arbitration agreement is involved.  In particular, the CFA has made clear that in an ordinary case where there is an exclusive jurisdiction clause, the petitioner and the debtor ought to be held to their contract and resolve any dispute in accordance with that clause.  This will particularly be the case where, as here, the debtor has, or has made clear its intent, to commence proceedings to dispute the debt in the parties' chosen forum.

The exceptions to this principle will be limited.  If there are third party creditors not subject to a contractual dispute mechanism who are likely to be prejudiced, or the dispute invoked by the debtor is frivolous or an abuse of process, the court can still exercise its discretion to invoke the relevant personal or corporate statutory insolvency regime.  This will particularly be the case where there is evidence that the wider creditor community is at risk.

The commencement of an insolvency petition is a powerful tool and can often bring debtors to the negotiating table given the speed with which a winding up or bankruptcy order can be made.  However, given the potential costs implications and potential for delay if the petition is disputed and ultimately dismissed or stayed, creditors faced with an exclusive jurisdiction clause or arbitration agreement in the agreement giving rise to the debt should carefully consider:

• Is the debt the subject of a dispute where the debtor has commenced, or indicated it will commence, proceedings in accordance with the contractual dispute resolution clause e.g. an exclusive jurisdiction clause or arbitration clause?
• If so, whether any such dispute asserted by the debtor is clearly vexatious or an abuse of process, or is alternatively capable of some form of reasonable argument?
• Whether there are any third party creditors who are willing to appear in support of the petition, and potentially be substituted as petitioner if the court would otherwise hold the parties to the contractual dispute resolution clause?
• If there are any other extenuating factors which can be relied upon to assert that the discretion to make a bankruptcy or winding up order should be invoked, such as the risk of dissipation of assets or risks to the wider community of creditors that justify the court making the winding up or bankruptcy order?