Key takeaways
The Hong Kong Court of Final Appeal (“CFA”) has held that a bankruptcy petition should usually be dismissed where the petition debt is governed by an exclusive jurisdiction clause in favour of a foreign court (the EJC test) without the debtor needing to show that the debt is bona fide disputed on substantial grounds (the non-EJC test): Re Guy Kwok Hung Lam [2023] HKCFA 9 (4 May 2023). The CFA’s reasoning also applies to winding-up petitions.
However, the CFA recognised that the petition may be allowed to proceed despite the EJC where the petitioner shows exceptional circumstances, including where the petitioner shows that the debtor’s dispute in respect of the debt is frivolous or an abuse of process. This exception may mean that the EJC and non-EJC tests could lead to the same result in many cases. If a dispute is not “substantial”, is it not “frivolous”? If a dispute is not “bona fide”, is it not “an abuse of process”?
Background
A person has standing to present a bankruptcy or winding-up petition if a debtor owes them a debt in respect of which there is no bona fide dispute on substantial grounds. The petition is liable to be dismissed if the debtor can show such a dispute.
In recent years, common law courts have grappled with whether this approach applies where the petition debt is subject to an EJC in favour of a foreign court or an arbitration agreement. This is because, in broad terms, this approach may be inconsistent with the parties’ agreement to have disputes determined by a foreign court or arbitral tribunal.
In this case, a creditor petitioned for the bankruptcy of the debtor based on a debt that arose from a Credit Agreement with an EJC in favour of the New York Courts.
The debtor sought the dismissal of the petition. By the time the matter reached the CFA, it was not in dispute that the debtor had failed to satisfy the test for dismissing the petition under the non-EJC test. That is, while the debtor disputed the debt, the debtor had not shown the dispute was bona fide and on substantial grounds. As such, the question was whether the petition was liable to be dismissed because the debt was subject to an EJC in favour of the New York Courts.
Effect of an EJC
The CFA found that where an EJC is involved, the court should usually decline to hear the dispute unless the petitioner showed strong reasons otherwise. This is because the parties have, by the EJC, agreed that all disputes regarding the petition debt should be determined by a foreign court. As such, it would be inconsistent with this agreement for the court to apply the non-EJC test, which would involve a summary determination of whether the debtor has bona fide and substantial grounds to dispute the debt.
The CFA also recognised there could be exceptional circumstances where the court may decide to hear the petition despite the EJC, such as where: (a) there is a creditor community at risk of the debtor’s insolvency, which may be evidenced by other creditors having also presented petitions against the debtor; and (b) the debtor’s dispute in respect of the debt is frivolous or an abuse of process.
Will the EJC test lead to a different outcome to the non-EJC test?
As a result of the CFA’s ruling, when determining the fate of a petition debt subject to an EJC, the burden has now shifted from a debtor having to show a bona fide dispute on substantial grounds, to the petitioner having to show exceptional circumstances, which may include that the debtor’s dispute is frivolous or an abuse of process.
It remains to be seen whether, aside from the shift in burden, the EJC and non-EJC tests will lead to different results in many cases. There may be a fine line between a dispute that is bona fide and on substantial grounds (the non-EJC test) and one that is not frivolous or an abuse of process (the EJC test). The term “substantial” under the non-EJC test was defined as meaning “not frivolous” in Re Hong Kong Construction (Works) Limited1. In a similar vein, it is difficult to see how a dispute that is not raised “bona fide” could be anything other than an abuse of process.
This shift in burden has important consequences for a creditor contemplating presenting a bankruptcy or winding-up petition in respect of a debt subject to an EJC. It is usually prudent for any creditor, whether the debt is subject to an EJC, to correspond with the debtor about the debt before presenting the petition to find out whether and on what grounds the debtor disputes the debt. However, in the case of a debt subject to an EJC, it is vitally important for the creditor to tease out from the debtor as much detail as possible about any potential dispute so as to provide evidence to satisfy the court that the debtor’s dispute is frivolous or an abuse of process.
Debts subject to an arbitration clause
The CFA expressly stated that it was not addressing the interaction between arbitration clauses and bankruptcy and winding-up petitions. That said, the CFA’s ruling in respect of an EJC points to a similar approach favouring the dismissal of petitions, and perhaps even more strictly so, given the non-discretionary stay required by the Arbitration Ordinance2.