28 March 2023
Litigate or arbitrate: The continuing debate
Insolvency proceedings become more complex when an arbitration clause is in place, but a recent case in the British Virgin Islands brings some clarity.
Carey Olsen’s Singapore team has considered the first reported British Virgin Islands (BVI) case on the court’s jurisdiction to determine a just and equitable winding-up application when faced with an arbitration agreement between parties.
The authors also examine the trend in the Cayman Islands and in Hong Kong on this issue. In the authors’ opinion, the BVI judgment provides welcome guidance for prospective litigants who are confronted with the choice between presenting a petition in the court or referring the dispute to arbitration.
THE KENWORTH CASE
In Kenworth Industrial v Xin Gang Power Investments, Kenworth filed an application for the appointment of liquidators over the respondent (the company) on the just and equitable ground under section 162(1)(b) of the Insolvency Act, 2003.
The basis for the winding-up application was a lack of probity on the part of the company’s management in the conduct of the company’s affairs, giving rising to a justifiable lack of trust and confidence in the running of the company. This arose in relation to several issues, including the company’s attempt to forfeit and cancel Kenworth’s shares in the company.
Subsequently, the company filed its application for a stay of the winding-up application before the BVI court and commenced an arbitration with the Hong Kong International Arbitration Centre (HKIAC), seeking the substantive relief of a declaration that the company was entitled to forfeit Kenworth’s shares due to Kenworth’s failure to satisfy the call on the shares.
The issue that the BVI Commercial Court had to determine was whether a stay of the application to appoint liquidators should be granted on the just and equitable ground pending the arbitration, which had been commenced before the HKIAC, in circumstances where there was an arbitration clause between the parties contained in the company’s articles of association.
Prior to the Kenworth case, the arbitrability of just and equitable winding-up proceedings under section 162(1)(b) of the Insolvency Act, 2003, had not been tested before the BVI court, although the court had previously considered the issue of the stay of an application to appoint liquidators on the ground of an undisputed debt under section 162(1)(a) of the act in favour of arbitration.
The BVI court re-affirmed the position that first, an order appointing liquidators can only be made by the court, and second, the automatic stay provision under section 18 of the Arbitration Act does not apply to applications for the appointment of liquidators.
The court has a discretion of whether to stay the application to appoint liquidators pending determination of the arbitration – the party resisting a stay does not have to prove exceptional circumstances.
One of the factors that the court will consider is the existence of an arbitration agreement, which will generally favour the dismissal or stay of an application to appoint liquidators. In exercising its discretion, the court will have regard to the interests of justice, while at the same time giving effect to arbitration agreements that have been validly entered into.
The court held that:
- It was not possible to hive off the issue of whether the shares are paid up and liable to forfeiture from the other issues in the case, as the issues all stand or fall together; and
- The risk that the arbitrators may find that the shares were not paid up and liable to be forfeited would potentially undermine Kenworth’s standing to bring its winding-up application. Conversely, if Kenworth were to make good its overall case, it would potentially have a good claim for the appointment of liquidators on just and equitable grounds.
The court further held, as a separate ground militating against the grant of a stay, that a determination by the arbitrators as to the veracity of witnesses would not bind the court. Hence, in a case involving allegations of want of probity (as with many winding-up applications presented on a just and equitable basis) it is highly undesirable that issues as to the veracity of witnesses be heard by different tribunals of fact.
Therefore, the BVI High Court refused a stay of the just and equitable winding-up application in favour of the HKIAC arbitration. The Kenworth decision reinforces the finding in the earlier BVI case of Hydro Energy Holdings v Zhaoheng (BVI), that the issue of whether to wind up a company on just and equitable grounds was not arbitrable.
The Kenworth case also affirms that, unlike the position in Salford Estates (No 2) v Altomart in England, where a winding-up application based on a debt that is covered by an arbitration agreement will be stayed unless there are exceptional circumstances, the applicant for the appointment of liquidators in the BVI does not need to prove exceptional circumstances before the court will assume jurisdiction over the application to appoint liquidators on the basis of a debt that is not disputed on genuine and substantial grounds.
CAYMAN, HONG KONG DECISIONS
The approach taken by the BVI court in Kenworth is in line with the international trend of judicial reluctance to find that courts do not have exclusive jurisdiction over just and equitable winding-up applications, as evinced by the Cayman Islands decision in the matter of China CVS (Cayman Islands) Holding Corporation and the Hong Kong Court of First Instance case of Champ Prestige International v China City Construction (International), both of which were considered by the BVI Court in Kenworth.
In the China CVS case, the Cayman Islands Court of Appeal held that the winding-up petition was founded on allegations of misconduct and loss of confidence by reason of breaches by the directors of their fiduciary obligations, and an irretrievable breakdown of the relationship between the majority and minority shareholders.
These issues were inextricably connected to the determination of the statutory question of whether the company should be wound up on just and equitable grounds, and could not be distilled into discrete issues to be hived off to arbitration.
The court was required to evaluate all the circumstances of the case to determine whether there were sufficient grounds to justify a winding up on a just and equitable basis. The court contrasted the nature of the issues in the China CVS case with the English case of Salford Estates (No 2) v Altomart, where the disputed historic debt in the winding-up petition on the grounds of insolvency was a discrete issue that could be submitted to arbitration.
The decision in China CVS has cemented the Cayman Islands court’s exclusive jurisdiction to assess whether there are just and equitable grounds to wind up a company, and it is only in cases where discrete issues can be identified and hived off to arbitration that the court may stay a winding-up petition.
In Champ, the Hong Kong Court of First Instance reached a similar conclusion in refusing to stay a just and equitable winding-up petition in favour of arbitration, albeit the judgment did not refer to China CVS. Justice Jonathan Harris held that as the complaints in the petition all formed part of one continuing narrative, the court would not exercise its discretion to stay the petition unless it were clear and obvious that the dispute forming the subject of the arbitration clause would be central and probably determinative of the factual issues raised by the petition.
The approach taken by the BVI court in Kenworth mirrors the approach in China CVS and Champ. All three decisions placed an emphasis on whether the issue covered by the arbitration agreement could be hived off from the other issues affecting the determination of the just and equitable winding up application.
The Kenworth ruling is currently on appeal to the Eastern Caribbean Supreme Court of Appeal, and China CVS has been heard on appeal by the Privy Council, with a decision pending soon.
It will be of interest to see the approach taken by the higher courts. Therefore, to litigate or arbitrate remains to be seen.
An original version of this article first appeared in Asia Business Law Journal, March 2023.