Put Off the Evil Day – When Can an Exclusive Jurisdiction Clause Stop a Bankruptcy Petition?

In Re Guy Lam Kwok Hung [2023] HKCFA 9, the Court of Final Appeal clarified when a debtor can resist a bankruptcy petition based on an exclusive jurisdiction clause (EJC) in his contract with the petitioner creditor. It is important to appreciate the Court’s reasoning and how it can be applied to various factual scenarios.

The Court emphasised a multi-factorial approach to answering the question. Where the debtor disputes the debt but such dispute falls within an EJC, the Court has to assess the public policy interest in holding parties to their contractual bargain. The balancing exercise comes into play. There are two countervailing policy objectives, which are (a) the public interest underpinning the legislative scheme for making bankruptcy orders on insolvent individuals; (b) the notion of party autonomy whereby the parties should be held to their contractual bargain on jurisdiction. While the indicative test is the existence of a strong cause for departing from an EJC, the Court emphasised that it should not obscure the range of relevant considerations, including:

1. What are the debtor’s grounds to dispute the debt? The more obviously insubstantial the grounds for disputing the debt, the more the public policy underpinning the legislative scheme comes into prominence. A dispute that ‘borders on the frivolous or abuse of process’ is unlikely to earn the Court’s sympathy (paragraphs 101 and 105 of the Judgment);
2. Are there any other creditors? The significance of the public policy to bankrupt insolvent individuals is much diminished where the bankruptcy petition is brought by one creditor against another and there is no evidence of a creditor community at risk (paragraph 102);
3. Are any such other creditors pursuing the debtor? If there are other creditors but they are not pursuing the debtor, the public interest is unlikely to be adversely affected by delaying a petition until the resolution of the parties’ dispute under the EJC (paragraph 103);
4. Does the EJC cover a bankruptcy petition? The Court referred to the ‘larger considerations of public policy’, which presumably involve international comity and whether the Hong Kong bankruptcy court should defer to a foreign bankruptcy court.

With reference to the Court’s approach, we will outline the facts of this case.

 

The case of Re Guy Kwok Hung Lam

Mr Lam is the guarantor of certain term loans to a Company which he controlled. The lender of the loans considered the Company had defaulted and demanded Mr Lam to honour his guarantor obligations. As Mr Lam did not meet the demand, the lender (as Petitioner) commenced bankruptcy proceedings against Mr Lam.

Mr Lam asked the Court to decline jurisdiction, on the basis of an EJC in his Credit and Guaranty Agreement with the Petitioner whereby he gave his guarantee. The EJC provides for the exclusive jurisdiction of the New York courts in relation to all proceedings arising out of or in relation to the Agreement.

At first instance, Linda Chan J made a bankruptcy order, on the basis that Mr Lam could not demonstrate a bona fide dispute on substantial grounds in relation to the petition debt.

Mr Lam appealed. The Court of Appeal unanimously dismissed the petition. The majority (G Lam JA and Barma JA) held that, if the dispute about the petition fell within the scope of an EJC, the petition should not be allowed to proceed without ‘strong reasons’. In effect, the majority adopted the well-established approach to staying an ordinary action based on an EJC (ie the requirement of strong reasons, in order to depart from the EJC) to determining bankruptcy proceedings with regard to an EJC. Chow JA agreed with the outcome but did not consider an EJC should be given conclusive weight. His Lordship considered that, if the bankruptcy petition falls within the EJC, the Court should consider a wide range of factors in deciding whether to dismiss a petition.

The Petitioner appealed. The appeal was unanimously dismissed by the Court of Final Appeal. Mr Justice French NPJ delivered the Judgment, with whom the entire panel agreed. His Lordship held that an EJC does not oust the Court’s jurisdiction to make a bankruptcy order. The Court has the discretion to grant or dismiss the petition. The EJC brings into consideration the public policy interest of the insolvency legislation vis-à-vis holding the parties to their contractual bargain. Essentially, the Court had undertaken a summary judgment determination of the ‘threshold question’ (ie whether there is a debt, without bona fide dispute on substantial grounds) which the parties had agreed would be determined in another forum. It is at this stage that the Court applies the ‘multi-factorial’ approach described above.

Applying to the case, Mr Lam has raised numerous substantive grounds of dispute, including that the Petitioner is a ‘fully secured creditor’, the term loans contravened the Money Lenders Ordinance, the Petitioner cannot enforce the term loans by reasons of estoppel and/or waiver, Mr Lam has a genuine counterclaim in conspiracy against the Petitioner with damages exceeding the debt, etc. The petition is brought by one creditor and there is no evidence of a creditor community at risk. Even if the petition maybe delayed by the determination in New York court, the absence of other creditors indicates the public interest is unlikely to be adversely affected by such delay. In the ordinary case of an EJC, absent countervailing factors such as risk of insolvency affecting third parties and a frivolous dispute or abuse of process, the Petitioner should be held to its contractual bargain under the EJC.

The Court of Final Appeal agreed to the approach of the majority of the Court of Appeal. The petition was therefore dismissed.

 

Commentary

This case provides helpful guidance to determining the Court’s bankruptcy jurisdiction where an EJC exists. Where the debtor’s dispute to the debt falls within the scope of the EJC, the Court must grapple with the public policy interest of making a bankruptcy order vis-à-vis holding the parties to their contractual bargain.

We anticipate the Court will adopt a similar approach to both personal bankruptcy and corporate winding up petitions where an EJC exists.

Where an EJC exists and the agreed dispute resolution mechanism has not been followed, the petitioning creditor will need to provide a ‘strong cause’ to persuade the Court to make a bankruptcy (or winding up) order. ‘Strong cause’ is a flexible concept which is not rigidly defined. The Court emphasised that it should take into account multiple factors, including the nature and strength of the debtor’s disputes, the existence of any other creditor, whether such other creditor is taking enforcement action, and others.

In preparation of transaction documents, contractual parties should have in mind these legal principles, in deciding whether to insert an EJC. A non-exclusive jurisdiction clause or hybrid clause (for example, negotiation-mediation-court action) will provide greater flexibility for the potential creditor in its enforcement action. On the flip side, an EJC offers more certainty with regard to the future dispute resolution mechanism.

Where an EJC exists, creditors must be very careful before commencing an insolvency petition. The safe course is of course to obtain a judgment or summary judgment in accordance with the EJC. Where the civil action is unlikely to yield meaningful outcomes, the creditor (as intended petitioner) should be prepared to provide, if the Court inquires, comprehensive evidence to persuade the Court to make a bankruptcy order. It will be helpful to obtain intel on other creditors’ position and any enforcement action by them.

From the debtor’s perspective, an EJC will provide a strong procedural safeguard against a bankruptcy or winding up order. But this is not conclusive, for the Court to look into the entire circumstances to assess whether the order should be made.