Hong Kong court clarifies whether exclusive jurisdiction clause prevents it from hearing bankruptcy petition | Denton

An exclusive jurisdiction clause (EJC) is a term in a contract limiting the resolution of disputes under that contract to one agreed jurisdiction or forum. It was unclear whether an EJC could be invoked to challenge debt in bankruptcy proceedings. It is well established that a good faith debt dispute based on substantial grounds is sufficient to defeat a petition for bankruptcy or liquidation. Recently, the Court of Appeal clarified the position on whether an ECJ was a good faith debt dispute on substantial grounds in the landmark decision of Guy Kwok-Hung Lam vs. Tor Asia Credit Master Fund LP CACV 393/2021 [2022] HKCA 1297.

Facts

A loan agreement (OK), entered into between a secured creditor (petitioner) and the debtor (appellant), contained an ECJ that each party would submit to the exclusive jurisdiction of the courts of New York “for the purposes of all legal proceedings arising out of or relating to this Agreement of loan.” Based on an alleged event of default, the creditor issued a legal demand for the remaining sum. The creditor then filed for bankruptcy against the debtor in Hong Kong after the legal demand remained without answer.

The debtor disputed the petition debt on five grounds. In particular, there was no event of default existing under the agreement as a result of the creditor’s waiver of such default or on the basis of estoppel against the creditor, and the petition debt was subject to a CJE. At trial, Linda Chan J agreed with the petitioner that “there is an established understanding of the law that an EJC does not prevent a petition for liquidation or bankruptcy from being brought in an appropriate jurisdiction.” The general principle that so long as there is a bona fide dispute based on serious grounds regarding the debt, a creditor has the power to initiate insolvency proceedings was cited. The existence of a CJE was interpreted as a simple factor to be taken into account.

Call

On appeal, the Court of Appeal was asked to determine whether the motion should have been dismissed or stayed. The appellant argued that Linda Chan J should have dismissed the motion by applying Harris J’s approach in Pacific Southwest Bauxite (HK) Ltd. [2018] HKFI 426 (Lasmos approach). The Lasmos approach provides that a liquidation petition must generally be dismissed if three conditions are met: (1) the company disputes the alleged debt; (2) the contract giving rise to the alleged debt contains an arbitration clause which covers any dispute relating to the debt; and (3) the company takes the steps required under the arbitration clause to begin the dispute resolution process provided for in the contract. However, the petitioner argued that the Lasmos approach was only applicable under arbitration clauses, unlike an ECJ. Therefore, the creditor argued that it was a “well-established interpretation of the law” that the question for the court remained whether the debt was bona fide contested on serious grounds.

The appellant was successful in his appeal. Judge G Lam reviewed cases from several common law jurisdictions and identified the following considerations in his judgment: (1) the ECJ-based approach to a stay of common actions; (2) the effect of arbitration clauses on liquidation petitions; (3) whether the EJC was engaged; (4) whether the common stock approach should be applied in insolvency proceedings; (5) if there is a dispute to be resolved within the agreed framework; (6) whether the Lasmos approach would interfere with the creditor’s legal right to file for bankruptcy or liquidation due to insolvency; and (7) the effect of ECJs on insolvency proceedings.

Stay

With respect to question (1), the Court of Appeal confirmed that a stay of proceedings would only be refused if the debtor had no arguable defence. This defeats the merits of the creditor’s case – even if the creditor were highly likely to succeed, the merits of the creditor’s case should be neither relevant nor significant in determining the proper forum. The mere fact that a case would be stronger in a certain jurisdiction would be an absurd reason, encouraging forum shopping. The terms of the agreement must be respected and the choice of forum by the parties in their jurisdiction agreements must be respected.

Has the EJC been triggered?

Regarding question (3), the creditor argued that a petition was not a legal proceeding and therefore the EJC was not triggered. The Court of Appeal disagreed and held that in ruling on the motion, the court must necessarily settle the dispute and determine whether the appellant’s cross-defendant claims were well founded. This would in itself amount to a judicial decision as to the rights and obligations of the parties under the Agreement. If the Hong Kong courts were to make such a decision, the petition would become a summary judgment-type proceeding. It would be inappropriate for the courts of Hong Kong to make a summary judgment-type determination of liability for the debt, particularly where the parties had expressly agreed that disputes under the Agreement should be exclusively resolved by the courts of New York.

The Court of Appeal further distinguished between seeking an insolvency order from a party to an agreement and seeking such an order on the basis of a disputed debt under an agreement. . The latter, which was the present case, fell squarely under the EJC.

The effect of an ECJ on insolvency proceedings

On issue (4), the Court of Appeal held that the same approach as in ordinary actions should be taken to respect party autonomy. Even in the context of insolvencies, an EJC should normally be implemented unless there are strong reasons to oppose it. However, to retain some flexibility, the Court of Appeal was reluctant to define what may constitute serious grounds. Examples cited include: the debtor being unquestionably and massively insolvent apart from the disputed debt; the existence of other creditors seeking liquidation whose debts have not been the subject of an ECJ; the assets being at risk; and the petitioner would be deprived of a meaningful remedy if the petition was not heard.

Since there was no suggestion of insolvency on the appellant’s part, other than the petitioner’s claim, or any other valid reason, the petition was considered a mere fight between debtor and creditor – there was no reason to deviate from the EJC.

Conclusion

Bankruptcy and liquidation petitions are a class action. If there is a dispute as to the debt, an EJC would generally be upheld and the Hong Kong courts would be likely to grant a stay or dismiss the petition even if the merits of that dispute were weak. This is to avoid the anomalous situation of making a summary judgment type determination of liability for the debt in an insolvency proceeding.

Go forward

Where creditors intend to initiate insolvency proceedings in Hong Kong, despite the existence of an ECJ excluding Hong Kong, creditors should first check whether the wording is broad enough to cover all court proceedings . If the wording covers insolvency proceedings, then creditors should take particular care that the debtor does not dispute the debt before initiating these proceedings. Creditors must also provide strong and compelling reasons for initiating proceedings in the non-EJC forum. Absent such reasons, it is likely that the courts of Hong Kong would dismiss or suspend such proceedings, pending determination of the dispute in the agreed forum specified in the EJC.

EJCs are often an afterthought when preparing agreements. However, after this unprecedented decision, caution should be exercised before entering into contracts with the EJCs. The parties must ensure that their intentions are faithfully reflected in the provisions, in particular with regard to an ECJ. If creditors want to provide flexibility or give themselves more options, they can negotiate asymmetric jurisdiction clauses, i.e. allowing the creditor to sue the debtor in any jurisdiction but limiting debtor to sue the creditor in a single exclusive jurisdiction. Alternatively, the parties may agree to non-exclusive jurisdiction clauses.

Hugo Lotrainee within the litigation team, is one of the authors.

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