One topic that has received quite a lot of attention in the Courts over the past few years is how insolvency interacts with arbitration clauses. The question is: can insolvency steps proceed in Court on the basis of a debt which is disputed, where parties agreed to arbitrate such disputes?
In this post, we set out the state of play in Hong Kong, Singapore and England, and what you should look out for when drafting your agreements and deciding how strategically to deploy dispute resolution strategies.
England
The first of the recent decisions on this topic came in the case of Salford Estates (No. 2) Ltd v Altomart Ltd. There, the English Court said that while a stay of insolvency proceedings is not mandatory, the Court should stay such proceedings if a debt is disputed, save in wholly exceptional circumstances. In doing so, the Court should not investigate whether or not the debt is bona fide disputed on substantial grounds. In short, “don’t investigate, stay insolvency”.
Singapore
Singapore has adopted a pro-arbitration approach to the question, similar in most respects to the position in England. That is, provided the alleged debtor can show that on the face of things (i.e. on a prime facie basis), a valid arbitration agreement between the parties exists; the alleged debt is disputed and comes within the scope of the arbitration agreement; and there is no evidence the alleged debtor is seeking to dispute the claim for purely strategic purposes (i.e. as an abuse of process); the insolvency petition will be dismissed (cf. An An Group [2020] SGCA). The Court’s rationale was informed by a desire to avoid any attempt by an impatient creditor to use the insolvency regime as a means of circumventing a pre-existing valid agreement to arbitrate.
Hong Kong
While the position is certain in England and Singapore, in Hong Kong the approach of the courts has varied.
The earlier Hong Kong authorities focussed on the fact that when a creditor applies for winding up, he is seeking a class remedy. As such, the question of whether there is a disputable debt is not subject to the normal consequences of parties having agreed to resolve disputes by arbitration – instead, there is a class concern. In the 2018 case of Lasmos Ltd v. Southwest Pacific Bauxite (Hk) Ltd, Mr. Justice Harris took a different approach influenced by Salford. In Lasmos, the Court determined that barring exceptional circumstances, winding up petitions should generally be dismissed if:
- The target company disputes the debt;
- The underlying contract has an arbitration clause covering the debt;
- The target company has taken some steps to commence the dispute resolution process, even if that means preliminary steps like mediation.
So essentially – while the Courts have a discretion as to whether an insolvency petition can proceed, it should only be exercised in one direction – to dismiss a winding up petition – if the parties have taken any steps to arbitrate. The Court should not examine whether there is a bona fide dispute or a bona fide defence.
In 2020 there were a number of first instance decisions in Hong Kong which declined to follow the Lasmos approach and took the traditional approach of examining whether there was a bona fide dispute on substantial grounds regardless of the existence of the arbitration clauses. The position in Hong Kong is uncertain and waits further clarification from Court of Appeal.
So what should you do?
The planning for this issue should start at the time that contracts are drafted, not left to the time when disputes arise. While we are very much in favour of arbitration as a process, it should not be looked at as the “default” option in every single situation and may be slower than bringing insolvency proceedings. You need to balance:
- The ability to commence insolvency proceedings especially if this is a real likelihood.
- Whether the national court is a fair, neutral alternative to arbitration.
- The relative enforceability of a judgment or arbitration award in relevant jurisdictions where your counterparty’s assets are located.
One option may be to carefully draft in a carve-out from the arbitration clause for insolvency proceedings.
At the time a dispute arises, the other piece of the puzzle to consider is whether to commence insolvency or arbitration proceedings – think carefully with your legal team (us?) about which process to commence, and when. You also need to be careful to ensure that the commencement of unsuccessful insolvency proceedings is not used as the basis for an argument that the arbitration clause has been waived, thus allowing the counterparty to resist arbitration or start its own national court proceedings.
