Deal gone wrong

The appellant in this case was Mr Guy Kwok-Hung Lam, a Hong Kong resident who founded two groups of companies in the senior care business, CP China operating in mainland China and CP U.S. in the United States through various cross-shareholdings involving a Cayman Islands-incorporated group company, CP Global Inc.

A credit and guarantee agreement was entered into between, amongst others, the respondent, Lam and CP Global for term loans in the sum of US$29.5 million with Lam providing a personal guarantee and security for the loans. The agreement contained an exclusive jurisdiction clause, pursuant to which the parties agreed to submit to the exclusive jurisdiction of the New York courts for all legal proceedings arising out of or in relation to the agreement.

Lam later sought additional funding from another bank to refinance the loans, at the same time requesting an extension of the facility and deferral of interest. Concurrently , Lam requested an extension of the facility, the deferral of interest and the waiver of defaults. He also decided to transfer part of the funds obtained from a U.S. government-backed pay check protection programme to CP China. Lam took the view that the increase in debt in CP U.S., posed significant risks to the respondent's own security. As a result, immediate enforcement action was taken in respect of the loans.

Lam subsequently commenced proceedings in Dallas against the respondent to seek various declarations. The respondent filed an application to dismiss the claims on, amongst others, the ground that the commencement of proceedings in Texas was contrary to the exclusive jurisdiction clause.

The respondent ultimately presented a bankruptcy petition against Lam on 15 June 2020 in Hong Kong in respect of the unsecured part of the debt under the agreement.

The Court of First Instance decision

At first instance, the Honourable Madam Justice Linda Chan considered there was no bona fide dispute on substantial grounds in respect of the petition debt, hence the respondent had locus to present a bankruptcy petition.

The court would generally consider giving effect to the "contractual bargain" of the parties, including an exclusive jurisdiction clause. However, this was just one of the many factors in determining whether a creditor has locus to present the petition and "unless and until the company/debtor is able to demonstrate…there is a bona fide dispute on substantial ground in respect of the debt, there is no proper basis for the company to contend that there is a dispute which must be litigated in accordance with the contractually agreed forum". Chan J made the bankruptcy order.

The Court of Appeal decision

The Court of Appeal allowed the appeal, albeit deploying different legal reasoning.

Godfrey Lam and Barma JJA

Godfrey Lam J said it is established law that the court has the discretion whether to elect to stay an action brought in breach of an agreement and to refer the disputes arising thereunder to a foreign court, however the court should exercise its discretion to "ordinarily" grant a stay unless strong reasons to the contrary can be shown, and a departure from the "ordinary" rule can be justified.

On the other hand, the fact that a particular case lacks merits is not in itself a reason for not giving effect to an exclusive jurisdiction clause agreed by the parties. In the words of the court, "the strength of the claimant's claim on liability is either not a relevant consideration…or, if it is, it remains a matter of very little significance."

Lam JA also noted the position set out in Re Southwest Pacific Bauxite (HK) Ltd [2018] HKCFI 426 (the Lasmos case), that a winding up petition should be dismissed if it can be shown that there is a prima facie dispute that ought to be referred to arbitration under the agreement between the parties.

In considering these principles, Lam JA was of the view that the same approach should be adopted in winding up and bankruptcy petitions. A petition brought on the basis of an agreement which includes an exclusive jurisdiction clause should ordinarily be stopped unless there are strong reasons not to, as it would be an "anomaly" that a party bound by an exclusive jurisdiction clause in favour of a foreign forum would not be allowed to go to the foreign court for a winding up or bankruptcy, but could do so to begin an ordinary action. Opportunistic litigants may very well leverage this as a "standard tactic" to bypass their agreement.

Lam JA advocated the adoption of a flexible approach but said there could be strong reasons that may justify a departure from this rule. These could include that: (i) the debtor is incontestably and massively insolvent apart from the disputed petition debt; (ii) it would be a menace to commercial society if the debtor is allowed to continue to trade; (iii) there are other creditors seeking a winding up whose debts are not subject to any jurisdiction agreement; (iv) assets may be in jeopardy; (v) there is a need to investigate potential wrongdoings; and/or (vi) the effect of a dismissal or stay of the petition would be to deprive the petitioner of a real remedy or would otherwise result in injustice.

Applying such principles and assessing the facts of the case, Lam JA (with Barma J concurring) concluded that the agreement did confer exclusive jurisdiction on the New York courts.

Anderson Chow JA

Chow JA arrived at the same conclusion from an alternative angle. He did not find it necessary to opine on the correctness of the Lasmos approach and also had reservations towards Lam JA's adoption of the approach to stay ordinary actions based on an exclusive jurisdiction clause to winding-up and bankruptcy proceedings in "disregard [of] the well-recognised distinction between an action on a debt and a bankruptcy/winding-up petition based on a debt".

Instead, Chow JA believed that the legal test should be to ask "whether the bankruptcy/winding-up proceedings are caught by the relevant exclusive jurisdiction clause upon its true construction". For example, in this case, the exclusive jurisdiction clause in the Agreement covered a wide range of proceedings (i.e. all legal proceedings arising out of or relating to this Loan Agreement or the other Loan Documents or the transactions contemplated hereby or thereby) and hence bankruptcy proceedings are caught as well.

If the answer is no – the court should allow the petition to proceed. If the answer is yes – the court has the discretion to dismiss or stay the proceedings after taking into account a non-exhaustive list of considerations, which includes the exclusive jurisdiction clause. Hence, the lower court erred by formulating the test on the prerequisite of the existence of a bona fide dispute, which Chow JA believed, should only be one of the many factors to take into consideration.

Key takeaways

As the law currently stands, the court is prepared to ordinarily stay or dismiss a winding up / bankruptcy petition in favour of a foreign court on the basis of a widely-drafted exclusive jurisdiction clause and other relevant factors of consideration, unless there are strong reasons to refrain from doing so.

Creditors should take note of this decision when developing effective enforcement strategies.

Authored by Jonathan Leitch, Hillary Chung, and Nigel Sharman.