Bankruptcy – setting aside a statutory demand – misrepresentation – dispute covered by an arbitration clause – whether a statutory demand should be set aside because of an arbitration agreement – the Lasmos approach
Applicant B entered into a customer agreement (the “Agreement”) with respondent R pursuant to which B opened an online portfolio margin account with R’s online broker-dealer platform (the “Account”). In January 2015, due to a change in national bank policy, the net liquidation value of the Account plummeted to a negative value. R subsequently served a statutory demand on B for the Account deficit and interest thereon. B applied to set aside the statutory demand on two broad grounds. First, B argued that the alleged debt was disputed on substantial grounds and that he had a cross-claim because R had misrepresented its risk management policies or obligations on its website and had not put those policies into practice. Second, B argued that – consistent with the approach in Re Southwest Pacific Bauxite (HK) Ltd  2 HKLRD 449 (“Lasmos”) (which followed the English Court of Appeal approach in Salford Estates (No 2) Ltd v Altomart Ltd (No 2)  Ch 589) – the statutory demand should be set aside without any need to show a bona fide dispute on substantial grounds because the Agreement contained an arbitration clause.
The judge dismissed B’s application. The judge held that B had failed to show that he had a bona fide defence of misrepresentation, and his cross-claim based on misrepresentation was “illusory”. After noting that Lasmos departed substantially from previous Hong Kong authorities, the judge followed the traditional approach. The judge held that there was no genuine dispute to be arbitrated and, in any event, B had failed to fulfill the third Lasmos requirement of taking steps to commence arbitration. B appealed to the Court of Appeal (the “CA”).
Held, dismissing B’s appeal that:
1) The CA rejected B’s argument that R had an obligation to liquidate positions. It held that the alleged representations must be read together with the Agreement which expressly provided that R had the right in its sole discretion not to carry out the liquidation of positions in a customer’s account.
2) The CA held that the judge was right that the third Lasmos requirement had not been complied with. The CA agreed that B had not taken any steps to commence arbitration for over four years and had no genuine intention of doing so.
While it was unnecessary for the CA to determine the appropriateness of the Lasmos approach, the Honourable Madam Justice Kwan V-P, delivering the CA judgment, made some observations on an obiter basis given its importance to insolvency proceedings:
1) Because an insolvency petition is not covered by section 20 of the Arbitration Ordinance, there is no automatic, mandatory or non-discretionary stay in favour of arbitration. Prior to Lasmos, the courts considered there to be a discretionary power under the insolvency legislation to dismiss or stay a petition where the alleged debt arose out of a transaction containing an arbitration agreement.
2) Lasmos directs that this discretion should only be exercised one way: in favour of arbitration. Any petition for winding up should “generally be dismissed” save in “exceptional” or “wholly exceptional” circumstances” if: (a) the debt is not admitted, (b) the dispute is covered by an arbitration agreement, and (c) the alleged debtor has taken steps to commence contractually-mandated dispute resolution process. However, the insolvency legislation confers on creditors a statutory right to petition winding up based on insolvency. It is contrary to public policy to preclude or fetter the exercise of this statutory right, and the Lasmos approach substantially curtails the statutory right.
3) A BVI court has already declined to adopt the Salford approach (which underlay Lasmos), noting that the statutory jurisdiction to wind up a company unless there is a bona fide dispute on substantial grounds is “too firmly a part of BVI law”. Her Ladyship stated that the position is the same in Hong Kong and expressed reservations about the Lasmos approach restricting the exercise of the discretion only in favour of arbitration, which substantially curtails statutory right.
4) Her Ladyship acknowledged that exercise of the discretion in a manner inconsistent with Hong Kong’s pro-arbitration policy might encourage the use of winding up petitions as a standard tactic to pressure alleged debtors, bypassing any arbitration agreement. That said, the courts have powers to deal with such tactics.
This is an appeal against the decision of Deputy High Court Judge Yee dismissing B’s application to set aside the statutory demand. The facts are set out in the CA judgment.