If a respondent to an arbitration is determined insolvent, arbitration proceedings will most likely be stayed and, ultimately, discontinued. Two scenarios:

At the time of the winding-up petition

When a winding-up petition is presented against it, the insolvent company, or any of its creditors or contributories, may apply to court for a stay of all proceedings against the company in Hong Kong (Section 181 of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32) (“C(WUMP)O”)), including arbitration proceedings (Re UDL Contracting Ltd [2000] 1 HKC 390).

The general rule is that a stay should be granted unless there are exceptional circumstances, the driver being to maintain the status quo, and to prevent creditors from gaining priority over other class members. Even where a stay is refused (or is not sought), once the winding-up has commenced, no unsecured creditor will be allowed to gain an advantage over the general body of creditors. Therefore, even if a plaintiff gets judgment over the company, this does not enable an otherwise unsecured creditor to gain priority in the winding-up.

The rule that proceedings should be stayed does not affect arbitrations that have been commenced by the company against a third party, unless there is a counterclaim against the company (in which case, the counterclaim can be used to force a stay).

At the time of the winding-up order

Once the winding-up order has been made or a provisional liquidator has been appointed by the court, all actions against the company will automatically be stayed in order to prevent assets of the company from being dissipated. No action or proceeding, including an arbitration, may be commenced against the insolvent entity except with the leave of the court (Section 186 of C(WUMP)O).

In these circumstances, a party that wishes to continue an ongoing arbitration must seek leave from the court who will consider what is fair and just in the circumstances. For example, permission is likely to be refused if the claims in the arbitration could be included in the winding-up process. If there are substantial issues of fact in dispute, leave might be granted for the issues to be resolved in formal proceedings. Arbitration is also more likely to proceed if the company is insured so that any award rendered and/or the costs of the arbitration will be funded by the insurance company (see Re B+B Construction Co Ltd (unrep., HCCW 114/2001, [2003] HKEC 883)). Finally, note that permission may be granted retrospectively, i.e. to sanction an action that was commenced without leave after the winding-up order was made.

Can one initiate arbitration against an insolvent entity?

Arbitration may be commenced against an insolvent entity, but only with the permission of the court.

Where a winding-up order is made against a company or a provisional liquidator is appointed, arbitration could only be commenced or continued against the insolvent party with leave of the court.

As to whether the arbitration agreement will be binding upon the insolvency administrator, the general position in Hong Kong is that contracts are not automatically terminated by virtue of a party becoming insolvent. Accordingly, the instigation of insolvency proceedings should not, automatically, invalidate an arbitration agreement concluded prior to the insolvency.

As to the insolvency administrator’s powers generally, liquidators are permitted to bring or defend legal proceedings on behalf of the insolvent entity provided approvals have been obtained from the court or the “committee of inspection” consisting of creditors and contributories. Provisional liquidators may only conduct proceedings with the court’s permission.

Assuming leave is obtained for an arbitration to proceed, it is important to note that arbitral tribunals do not have jurisdiction to grant certain types of insolvency relief (e.g. such as the granting of a winding-up order or the appointment of administrators) because such matters fall within the jurisdiction of the Companies Court.

Further, arbitral tribunals cannot issue awards that would conflict with the insolvency proceedings. For example, a tribunal cannot penalise the insolvent party for failing to pay an amount owing under an arbitral award where the insolvent party is protected by a stay of actions or proceedings against it.

Can an insolvent entity commence arbitration?

An insolvency entity may commence arbitration, with the court’s permission.

Liquidators are permitted to bring or defend legal proceedings (including arbitration) provided sanction has been obtained from the court or the “committee of inspection” consisting of creditors and contributories. Provisional liquidators can only conduct legal proceedings with the prior permission of the court. However, if counterclaims are brought against the insolvent entity in the arbitration, this could potentially lead to the entire arbitration (including the claims brought by the insolvent party) to be stayed.

Traditionally, neither the existence of an arbitration clause in a contract between the disputing parties, nor the commencement of arbitration proceedings, would, by default, prevent insolvency proceedings from being commenced or heard. If a debtor wishes to resist the winding-up petition on the basis of an arbitration agreement, it will have the onus to establish before the Companies Court the existence of a bona fide dispute of substance in relation to the debt which the petitioner is seeking to enforce.

However, this position has become less certain following a recent decision of the Court of First Instance (Re Southwest Pacific Bauxite (HK) Ltd [2018] 2 HKLRD 449). It was held that unless there are exceptional circumstances, the winding-up application on the basis of debt arising from an agreement with an arbitration clause should be dismissed or stayed so long as:

• the debtor disputes the debt;

• the contract under which the debt arises contains an arbitration clause which covers any dispute relating to the debt; and

• the debtor has taken steps required under the arbitration clause to commence the dispute resolution process (this is referred to as the “Lasmos Approach”, which is essentially based on the approach taken by the English Court of Appeal in the case of Salford Estate (No 2) Ltd v Altomart Ltd (No 2) [2015] Ch 589).

The correctness of the Lasmos Approach has been questioned in subsequent Court of First Instance and Court of Appeal decisions (see Dayang; But Ka Chon v Interactive Brokers LLC [2019] HKCA 873). In particular, reservations have been expressed, albeit obiter, about the potential inroads into: (i) the court’s discretion to make a winding-up order; and (ii) a creditor’s right to present a winding-up petition, if the Lasmos Approach was followed.

While clarification from a higher court is required to settle the law in Hong Kong in light of the conflicting authorities, the prudent view is that an arbitration agreement governing the disputed debt will not alone be sufficient to resist insolvency proceedings, unless a bona fide dispute of substance can be shown. In determining whether there is a bona fide dispute, the court will not engage in an analysis of the factual issues but analyse whether the alleged disputes are substantiated with precise and substantial evidence (see Re Asia Master Logistics Ltd [2020] HKCFI 311).

Leave from the court is required to enforce an arbitral award in Hong Kong, regardless of whether the award is issued in Hong Kong or abroad.

Generally, in a compulsory winding up, any attachment or execution against the insolvent party obtained after the winding-up order is void. However, the court has power to order otherwise.

Assuming the court does not intervene, the arbitral award ranks as a proven but unsecured debt, i.e. it will become part of the general class of unsecured creditors that rank pari passu, behind secured and preferential creditors. The same analysis applies to domestic and foreign awards so long as enforcement is sought in Hong Kong. Thus, all things being equal, an arbitral award which has been recognised by the court ranks as an unsecured debt and therefore is second in priority ranking behind the insolvent party’s secured creditors.