Show Respect – Court of Appeal Upholds Primacy of Exclusive Jurisdiction Clause in Bankruptcy Proceedings | Hogan Lovells
The case went wrong
The appellant in this case was Mr. Guy Kwok-Hung Lam, a Hong Kong resident who founded two groups of companies in the elderly care industry, CP China operating in mainland China and CP US in the United States by through various cross-shareholdings involving a Cayman Group company incorporated in the islands, CP Global Inc.
A credit and guarantee agreement was entered into between, among others, the respondent, Lam and CP Global for term loans in the amount of US$29.5 million, with Lam providing a personal guarantee and security for the loans. The agreement contained an exclusive jurisdiction clause, under which the parties agreed to submit to the exclusive jurisdiction of the courts of New York for all legal proceedings arising out of or in connection with the agreement.
Lam then requested additional funding from another bank to refinance the loans, while requesting an extension of the facility and deferral of interest. At the same time, Lam requested an extension of the facility, deferral of interest and waiver of defaults. It also decided to transfer some of the funds obtained from a US government-backed paycheck protection program to CP China. Lam was of the view that the increased debt in CP US posed significant risks to the Respondent’s own safety. Accordingly, immediate enforcement action was taken with respect to the loans.
Lam subsequently filed lawsuits in Dallas against the Respondent seeking various statements. The Respondent filed a motion to dismiss the claims on the grounds, among other things, that commencing proceedings in Texas was contrary to the exclusive jurisdiction clause.
The defendant eventually filed for bankruptcy protection against Lam on June 15, 2020 in Hong Kong regarding the unsecured portion of the debt under the agreement.
The decision of the Court of First Instance
At trial, the Honorable Madam Justice Linda Chan held that there was no bona fide dispute based on substantial grounds with respect to the debt of the petition, hence the respondent had the locus to petition for bankruptcy.
The court would typically consider giving effect to the parties’ “contract bargain”, including an exclusive jurisdiction clause. However, this was only one of many factors in determining whether a creditor has the locus to bring the petition and “unless and until the company/debtor is able to demonstrate…that it exists a good faith dispute on a substantial ground with respect to the debt, there is no valid reason for the company to claim that there is a dispute which must be litigated in accordance with the contractually agreed forum.” Chan J a issued the bankruptcy order.
The decision of the Court of Appeal
The Court of Appeal allowed the appeal, while deploying a different legal reasoning.
Godfrey Lam and Barma JJA
Godfrey Lam J said it is settled law that the court has the discretion to choose to stay an action brought in breach of an agreement and refer disputes arising therefrom to a foreign court, but the court should exercise its discretion to “usually” grant a reprieve unless serious 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 is unfounded 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 plaintiff’s claim of liability is not a relevant consideration…or, if it is, it remains a matter of very little importance.”
Justice Lam also emphasized the position set out in Southwest Pacific Bauxite (HK) Ltd case  HKCFI 426 (the Lasmos cases), that a petition for liquidation should be dismissed if it can be shown that there is a prima facie dispute which must be submitted to arbitration under the agreement between the parties.
In reviewing these principles, Justice Lam was of the view that the same approach should be taken in liquidation and bankruptcy petitions. A claim brought on the basis of an agreement containing an exclusive jurisdiction clause should normally be stopped, unless there are strong reasons not to do so, as it would be an “anomaly” for a party bound by an exclusive jurisdiction clause in favor of a foreign forum would not be allowed to sue the foreign court for liquidation or bankruptcy, but could do so to bring an ordinary action. Opportunistic litigants may very well take advantage of this as a “standard tactic” to circumvent their agreement.
Justice Lam advocated a flexible approach, but said there could be good reasons for departing from this rule. These could include that: (i) the debtor is unquestionably and massively insolvent apart from the disputed claim; (ii) it would be a threat to the trading company if the debtor were allowed to continue trading; (iii) there are other liquidating creditors whose debts are not subject to any jurisdiction agreement; (iv) the assets may be at risk; (v) there is a need to investigate potential wrongdoing; and/or (vi) the effect of a dismissal or stay of the petition would be to deprive the petitioner of a meaningful remedy or otherwise result in injustice.
Applying these principles and assessing the facts of the case, Judge Lam (with Judge Barma concurring) concluded that the agreement conferred exclusive jurisdiction on the courts of New York.
Anderson Chow JA
Justice Chow came to the same conclusion from another angle. It did not consider it necessary to comment on the accuracy of the Lasmos approach and also had reservations about Judge Lam’s adoption of the approach of suspending ordinary actions based on an exclusive jurisdiction clause for liquidation and bankruptcy proceedings in “contempt [of] the well-known distinction between a debt action and a debt-based bankruptcy/liquidation petition”.
Instead, Justice Chow held that the legal test should be to ask “whether the bankruptcy/liquidation proceeding falls within the relevant exclusive jurisdiction clause in its true interpretation”. 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 to the transactions contemplated herein or herein) and thus bankruptcy proceedings are also taken.
If the answer is no, the court must allow the motion to proceed. If the answer is yes, the court has the discretion to dismiss or stay the proceeding after taking into account a non-exhaustive list of considerations, which includes the exclusive jurisdiction clause. Therefore, the lower court erred in formulating the test for the precondition of a genuine dispute, which Chow J. argued should be only one of many factors to be considered.
Key points to remember
As the law currently stands, the court is generally prepared to stay or dismiss a liquidation/bankruptcy petition in favor of a foreign court based on a broadly drafted exclusive jurisdiction clause and other factors of relevant consideration, unless there are serious reasons for refraining from doing so.
Creditors should consider this decision when developing effective enforcement strategies.