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Winding-up, exclusive jurisdiction clauses and return of Lasmos

Posted on 17 October 2022

Hong Kong Streets at Night with Moving Lights

Key Takeaways

  • On 30 August 2022, the Hong Kong Court of Appeal dismissed a bankruptcy order because the debtor contested the petitioner’s debt and that debt was subject to an exclusive jurisdiction clause in favour of a foreign jurisdiction.
  • Crucially, the Court held that because of the exclusive jurisdiction clause, the debtor did not need to show a genuine and substantial dispute regarding the debt – the mere fact of a dispute was enough.
  • The Court of Appeal overturned the lower Court’s decision which had cast doubt on the Lasmos approach (previously reported here).
  • Parties should be held to their bargains to resolve their dispute according to the exclusive jurisdiction clause, which cannot be bypassed by a bankruptcy petition. The same should also apply to winding-up petitions.
  • For parties with an exclusive jurisdiction clause in favour of a foreign court, creditors should consider their enforcement options and whether potential insolvency proceedings may be covered by such a clause.

Background

The key appeal question was whether a creditor’s bankruptcy petition presented in Hong Kong should be allowed to proceed where the debt (i) is disputed by the debtor; and (ii) arises from an agreement containing an exclusive jurisdiction clause in favour of a foreign court.

The debt arose from a Credit Agreement with an exclusive jurisdiction clause in favour of the New York Court “for the purposes of all legal proceedings arising out of or relating to this” Credit Agreement.

The Court of First Instance in making a bankruptcy order held that the existence of an exclusive jurisdiction clause or an arbitration clause does not preclude the Court’s jurisdiction to determine a bankruptcy petition. There needs to be a bona fide dispute of the debt on substantial grounds.

Court of Appeal’s Decision

The lower Court’s decision was overturned unanimously. Lam JA delivered the leading judgment, with which Barma JA agreed. Chow JA agreed that the appeal should be allowed, but for different reasons.

Lam JA held that where a bankruptcy petition is presented on the basis of a disputed debt, the court’s consideration of the issue of the disputed debt was a legal proceeding falling within the scope of the exclusive jurisdiction clause.

The court should in such case adopt the same approach to bankruptcy petitions as it does to ordinary actions. Accordingly, the court should usually dismiss or stay proceedings and require the petitioner to obtain judgment from the forum agreed by the parties. This is subject to strong reasons to the contrary, which usually refer to events occurring after the parties’ agreement, and may include the debtor’s incontestable insolvency apart from the disputed debt, other creditors seeking a winding-up or the assets being in jeopardy.

Lam JA found that in this case:

  1. The parties had freely entered into the exclusive jurisdiction clause;
  2. The exclusive jurisdiction clause was engaged, as there was a dispute as to the alleged indebtedness and judicial determination as to the parties’ rights and obligations would be required; and
  3. The bankruptcy petition involves a fight between the parties – there was no real suggestion that the debtor may be insolvent, and no other creditor had taken part in the bankruptcy proceedings.

In these circumstances, and in the absence of strong reasons, the petition should not be allowed to proceed until the Petitioner had obtained a judgment from the New York Courts, being the forum agreed by the parties. In other words, the petitioner should be held to the exclusive jurisdiction agreement.

The Court of Appeal ultimately dismissed, rather than stayed, the petition, adding that it would not be desirable to have insolvency petitions adjourned or stayed for lengthy periods.

Impact of the decision

The Court of Appeal’s unanimous approach in this timely judgment is welcome. Whilst the Court of First Instance’s decision was said to be made on the basis of well settled common law authorities, in the Court of Appeal’s own words, “the law is in a state of flux”.

The lower Court’s decision emphasised that unless there was bona fide dispute of the debt on substantial grounds, it would be futile to require the petitioner to obtain a judgment from a foreign jurisdiction instead of hearing the petition. Chow JA in his Court of Appeal judgment expressed reservations about this approach, as it would effectively render the exclusive jurisdiction clause immaterial or irrelevant. Lam JA also cast doubt on this approach in his judgment.

By comparison, the Court of Appeal favours a more organic approach by placing importance on parties’ freedom to contract whilst being cognisant of the Court’s discretion when it comes to insolvency proceedings.

In light of this decision, parties should be aware of the implications of the exclusive jurisdiction clause in favour of foreign courts before commencing insolvency proceedings.

Future of Lasmos in Hong Kong

The Lasmos approach1 remains hotly contested in Hong Kong Courts and was discussed at length in the Court of Appeal’s judgment, although obiter.

The Lasmos approach considers any arbitration clauses agreed between parties as having a predominant influence over the Court’s discretion to hear insolvency petitions. It was suggested by the debtor in this case that the Lasmos approach should be extended to exclusive jurisdiction clauses. Without distinguishing between exclusive jurisdiction clauses and arbitration clauses, the lower Court called the correctness of the Lasmos approach into question and did not endorse it.

Lam JA held that it would be an anomaly for the insolvency court to conduct in effect a summary judgment type determination of a disputed debt without the petitioner being required to resolve the dispute in the agreed foreign jurisdiction. A consequence is that parties would be encouraged to bypass the agreed forum of dispute resolution by presenting a bankruptcy petition. In doing so, the Judge relied on the leading English authority Salford Estates2 amongst other authorities in the context of arbitration clauses. This appears to be a lifeline on the applicability of the Lasmos approach in Hong Kong.

Chow JA on the other hand did not agree with the above approach, instead dismissing the petition on narrower grounds. Chow JA considered that since the present case did not involve an arbitration clause, a finding on the correctness of Lasmos was not appropriate. The Court of Appeal has twice recently declined to make a finding for similar reasons.3 The Judge cautioned against a uniform approach being adopted to arbitration clauses and exclusive jurisdiction clauses, as there was legislative policy behind promoting arbitration as a means of dispute resolution.

Whilst the Hong Kong Courts’ approach towards Lasmos remains in a flux, the Court of Appeal’s decision provides clarity where a winding-up petition is based on a debt governed by an exclusive jurisdiction clause in favour of a foreign court.

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