16 October 2015

Circumventing pari passu: Hong Kong’s generous enforcement of arbitral awards at the expense of equal ranking

This article was written by Edmund Wan (partner) and Nicole Parlee (solicitor).

Consider this situation: a dispute has arisen between two parties in relation to an agreement which is subject to an arbitration clause. Separately, a winding up application has been made against one of the parties to the arbitration in the jurisdiction in which it is incorporated. An arbitral award is obtained against the potentially insolvent company. That company has assets in Hong Kong, against which the creditor is now seeking to enforce their rights. Due to Hong Kong courts’ generous enforcement of arbitral awards, the lead up to a winding up order may prove to be a costly time for a foreign liquidator and other creditors of the foreign company.

This article discusses the situation where a creditor enforces its rights pursuant to an arbitral award against Hong Kong assets of a foreign company on the brink of being wound up, potentially defeating the interests of other creditors.

Background to Hong Kong’s foreign insolvency regime

Hong Kong has not enacted the UNCITRAL Model Law on Cross-Border Insolvency, nor has it implemented comprehensive legislation providing for the recognition of foreign insolvencies. As a result, there is often substantial confusion, indecision, and delay in deciding how to approach a foreign insolvency which involves assets located in Hong Kong.

Pursuant to section 327 of the Companies Ordinance (Cap 622) (Companies Ordinance), Hong Kong courts have jurisdiction to wind up “unregistered”[1] companies in certain circumstances. In addition to the grounds set out in the Companies Ordinance, Hong Kong courts have been very clear in demonstrating that a requisite jurisdictional connection between the company and Hong Kong is necessary before an order for winding up will be made against a foreign company.[2] Where a company is already being wound up in the jurisdiction of its incorporation, Hong Kong courts may order that the Hong Kong liquidation be treated as ancillary to the main liquidation and the liquidator’s powers and functions be framed accordingly: collect in the Hong Kong assets and finalise a list of Hong Kong creditors for provision to the main liquidator.[3]

Further, Hong Kong courts have found that, in accordance with the principles of private international law[4], the appointment of a liquidator whose authority is recognised by the laws of the place of incorporation should be automatically recognised in Hong Kong.[5] These decisions further establish that the liquidator’s powers should also be recognised. This recognition of power only applies to the extent that the foreign liquidator can request documents and information from Hong Kong entities: a foreign liquidator will still need a court order to obtain title to property of the foreign company in Hong Kong.[6]

This recognition, however, only applies once a winding up order has been made. Further, whether Hong Kong courts will recognise the appointment of a foreign liquidator appointed in a country other than the company’s place of incorporation is undecided.[7] While the winding up application in the foreign jurisdiction is on foot, there is a risk that a creditor can enforce their rights against the potentially insolvent company’s assets in Hong Kong pursuant to an arbitral award, often in preference to the other creditors. The speed and ease in which arbitral awards are enforced in Hong Kong, and the limited scope to oppose their enforcement, potentially results in the creditor taking away assets to the detriment of other creditors and in circumvention of the principle of pari passu.

Pari Passu

Distribution in insolvency regimes is based on the principle of pari passu: that there should be equal sharing between (unsecured and non-priority ranking) creditors.[8] That is, except as provided for in the relevant pieces of legislation,[9] all unsecured debts proved rank equally and if there are insufficient funds to cover the entire amount of the debts, they are paid proportionately. On this basis, it follows that a creditor who obtains an arbitral award for the payment of a debt against an insolvent foreign company should submit a proof of debt in the winding up with all other creditors after the winding up order has been made, and receive distributions in line with pari passu. However, as foreshadowed, Hong Kong’s liberal enforcement of arbitral awards allows creditors to circumvent this process by claiming their entitlement to Hong Kong assets regardless of any winding up application on foot. 

Enforcement of the arbitral award

Arbitral awards are recognised and enforced in Hong Kong with ease.

In anticipation of its resumption of sovereignty over Hong Kong on 1 July 1997,[10] the Government of the People’s Republic of China extended the territorial application of the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards 1958 (New York Convention) to Hong Kong.[11] The New York Convention provides for mutual recognition and enforcement of arbitral awards in countries which are parties to the convention. Hong Kong also has similar mutual recognition and enforcement arrangements with the People’s Republic of China and Macau. 

Further, Hong Kong has substantially implemented the provisions of the UNCITRAL Model Law (including the 2006 amendments) (Model Law)[12] in its domestic laws through the Hong Kong Arbitration Ordinance (Cap 609) (Arbitration Ordinance).[13]

The enforcement provisions of the Arbitration Ordinance distinguish between New York Convention and non-New York Convention awards.[14] Section 84 of the Arbitration Ordinance provides for the enforcement of arbitral awards of all foreign countries irrespective of whether they are a signatory to the New York Convention, making them summarily enforceable with leave of the court. Section 87 further provides that a New York Convention award is enforceable by action in the court.[15]

An application is made by commencing a proceeding for enforcement.[16] It is made ex-parte and an order for leave to enforce the award may be obtained within a few weeks. The order must then be served on the debtor who then has 14 days to apply to set it aside. The arbitral award may only be enforced after the expiry of this 14 day period. This is a much shorter amount of time than a standard application for winding up, particularly where the act of insolvency is not based on a failure to comply with a statutory demand.

Pursuant to the Companies Winding Up Ordinance, a creditor is unable to commence proceedings in Hong Kong against a company that is being wound up.[17] Further, proceedings that are already on foot against the company will be automatically stayed.[18] There have been a number of decisions in Hong Kong which recognise that these principles also apply where a foreign company is being wound up in the jurisdiction of its place of incorporation.[19] The basis of this is that where a court finds “that there is already pending a process of universal distribution of a bankrupt's effects it should not allow steps to be taken in its territory which would interfere with that process.”[20] In practice, however, the foreign liquidator will need to apply to the court in Hong Kong for a stay of execution for each proceeding occurring within its jurisdiction, informing the court of their appointment and the status of the company. 

As Hong Kong courts recognise the appointment of a foreign liquidator[21] (and accordingly recognise that the foreign company is being wound up), it is therefore unlikely that an arbitral award can be enforced after a winding up order has been made against the foreign company, as a proceeding for the enforcement of the arbitral award cannot be commenced against a company in liquidation. These decisions prevent Hong Kong creditors from gaining a recovery in preference to other creditors who are bound to observe the liquidation.[22] It is however possible that an enforcement proceeding could be commenced or even completed prior to the court becoming aware of the debtor’s winding up, or the newly appointed liquidator becoming aware of the proceeding.

Can the company oppose the application?

After a creditor has obtained an order for leave to enforce and served it on the debtor company, the debtor company may apply to set aside the order on the grounds set out in section 86 of the Arbitration Ordinance. These grounds, however, are limited. They essentially mirror the grounds set out in New York Convention and are focused on procedural breaches.[23] Sections 86(2)(b)[24] and 89(3)(b)[25] further provide that enforcement of arbitral awards may be refused if their enforcement would be contrary to public policy. The application of this section by Hong Kong courts has been extremely limited, and only considered applicable where the enforcement of an arbitral award would violate Hong Kong’s most basic notions of morality and justice.[26]

Rather, Hong Kong courts are very generous in their enforcement of arbitral awards and, tellingly, Hong Kong courts have found that the refusal of courts in other jurisdictions to enforce awards should not affect their decisions to enforce them.[27] On this basis, it is doubtful whether a debtor company would be successful in setting aside an order for enforcement of an award on the ground of insolvency. On the other hand, it may be possible to argue with some force that an order for enforcement should be set aside because it would circumvent the pari passu principle and lead to an unfair result on other creditors. However, there is as yet no authority either way as to whether an order for enforcement would be set aside on the ground that the debtor company is being wound up overseas.  

How does the creditor gain access to the Hong Kong assets?

As discussed, where a liquidator has been appointed to the foreign debtor company in the country of its incorporation, this appointment is generally recognised by Hong Kong courts. Once this occurs, it is unlikely that the creditor can proceed on their rogue mission to enforce their rights against assets of the insolvent company in Hong Kong.

However, where winding up proceedings have been commenced but not yet ordered, creditors with a Hong Kong court judgment recognising an arbitral award (or foreign judgment), are in a position to enforce their rights against local assets of the foreign company, and quickly.

The creditor can apply[28] for a garnishee order to obtain assets of the debtor held by a third party. Under a garnishee order, the obligation of the third party to pay money to the debtor converts into an obligation by that third party to pay the money owed to the creditor. Applications for a garnishee order are made ex parte, and are supported by an affidavit or affirmation.[29] Once an order is obtained by the creditor, the debtor company is served with the order at least 7 days before the day appointed for the further consideration of the matter.[30]

As a garnishee order is an equitable remedy, where the court has any reasonable ground as to why an absolute order should not be made, they have discretion to refuse to make an absolute order.[31] Hong Kong courts have declined to make an absolute order where the judgment debtor is insolvent or likely to become insolvent (where, for example, there is a winding up application on foot) in Hong Kong.[32] However, courts in Hong Kong have not yet been willing to extend this discretion whereby the debtor company is a foreign company to which a winding up application is pending offshore. In light of the recent court decisions favouring recognition of foreign insolvencies, courts may be inclined to consider this situation to be a reasonable ground in the future. Until this time, garnishee order applications can be made, heard, ordered, and enforced within a few weeks, allowing a creditor to gain access to the debtor company’s Hong Kong assets quickly and with ease.

After a winding up order is made, can the liquidator claw back the assets?

Where the type of order sought by the foreign liquidator is available under Hong Kong’s statutory insolvency regime, as well as under common law and equitable principles, Hong Kong courts have the power to assist the foreign liquidator with this process.[33] Therefore, if the Hong Kong court considers that a creditor’s obtainment of the Hong Kong assets is an unfair preference under section 266B of the Companies Winding Up Ordinance, the court may grant the liquidator the right to claw these assets back. However, in the situation described, a court is unlikely to make this finding.

Payments made to creditors within the six months[34] leading up to the commencement of winding up may be clawed back where the liquidator can establish that the payment was motivated by a “desire to prefer” that creditor over others.[35] On this basis, a creditor enforcing their rights against assets of a company pursuant to an arbitral award is unlikely to be considered a preferential payment, as it is not made pursuant to a decision by the company to prefer that creditor over others.

This leaves no recourse available to liquidators to claw back company assets whereby a creditor’s right to those assets has already been enforced pursuant to an arbitral award.

Conclusion

Despite Hong Kong not having implemented the UNCITRAL Model Law on Cross-Border Insolvency nor any legislation for the recognition of foreign insolvencies, it would seem that the common law position generally provides adequate protection for creditors of a company being wound up in its place of incorporation. However, there are a number of circumstances in which a creditor may be able to enforce their rights against Hong Kong assets in contravention of the principle of pari passu.

In the circumstances described in this article, where a winding up application has been made but a winding up has not yet been ordered, a creditor with a favourable arbitral award may be able to enforce against Hong Kong assets to the detriment of other creditors. In addition, where a liquidator does not actively seek a stay of the enforcement proceedings, it may be possible to enforce against HK assets even after grant of the foreign winding up order. Creditors may also be able to sidestep the liquidation where it is occurring in a jurisdiction other than that in which the company is incorporated, as common law principles do not recognise foreign liquidations in these circumstances.

These loopholes provide creditors with the ability to enforce their rights against Hong Kong assets potentially at the expense of other creditor’s rights, contradicting the principle of pari passu.


[1] Including foreign companies.

[2] Re Yung Kee Holdings Ltd [2012] 6 HKC 246.

[3] This approach has been affirmed as the most practical approach to concurrent windings up; however courts still have jurisdiction to award the Hong Kong liquidator full power to collect in all Hong Kong and foreign assets, and settle a list of all local and foreign creditors alike.

[4] The rules set out in Dicey, Morris and Collins, The Conflict of Laws, 15th edn (Sweet & Maxwell, 2012) provide a convenient guide to private international law. Relevantly, Rule 179 states that “the authority of the liquidator appointed under the law of the place of incorporation is recognised in England”. Harris J makes unequivocally clear at paragraph [7] of The Joint Official Liquidators of a Company v B and Another [2014] 4 HKLRD 374 that this rule applies in Hong Kong.

[5] The Joint Official Liquidators of a Company v B and Another [2014] 4 HKLRD 374; Joint Administrators of African Minerals Ltd v Madison Pacific Trust Ltd [2015] HKEC 641. These decisions demonstrate that Hong Kong courts are willing to make orders assisting foreign liquidators with their investigations of the affairs of the insolvent company without ordering an ancillary winding up in Hong Kong.

[6] Fletcher, I., Insolvency in Private International Law, 2nd edn (Oxford University Press, Oxford, 2005), 3.95 and 3.96 referred to at paragraph 6 of The Joint Official Liquidators of a Company v B and Another [2014] 4 HKLRD 374.

[7] Per Millet J in Re International Tin Council [1987] Ch 419, at pp 446-447; per Lord Collins in Rubin v Eurofinance [2013] 1 AC 236 at [13].

[8] Pari passu has been described as one of the “cardinal principles” of corporate insolvency laws (see Goode, Commercial Law, 3rd edn (London: Butterworths, 2004), pp 831-833), and is reflected in section 250 of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32) (Companies Winding Up Ordinance).

[9] Which differ between jurisdictions but often provide for, among other things, employee entitlements, specific judgments often relating to personal injury claims and debts of the administration.

[10] Prior to 1 July 1997, the New York Convention applied to Hong Kong as a result of the United Kingdom acceding to it on Hong Kong’s behalf on 21 April 1977.

[11] Subject to the reciprocity reservation and commercial reservation.

[12] The Model Law was developed as a result to the successful operation of the New York Convention, and in an attempt to create uniformity in arbitration regimes across New York Convention states.

[13] Division 2 of Part 10 of the Arbitration Ordinance gives effect to the New York Convention.

[14] The Arbitration Ordinance also distinguishes arbitral awards made by recognised mainland arbitral authorities.  For the purposes of this article, these arbitral awards are not discussed.

[15] Or in the same manner as for non-New York Convention arbitral awards under section 84.

[16] Under Order 73, rule 1 of Cap 4A The Rules of the High Court.

[17] Except with the leave of the court. See section 186 of the Companies Winding Up Ordinance.

[18] Ibid.

[19] CCIC Finance Ltd v Guangdong International Trust & Investment Corp & Guangdong International Trust and Investment Corp Hong Kong (Holdings) Ltd (Garnishee) [2005] HKEC 1180; Modern Terminals (Berth 5) Ltd v States Steamship Co [1979] HKLR 512.

[20] Galbraith v. Grimshaw (1910) A.C. 508 which was cited with approval in CCIC Finance Ltd v Guangdong International Trust & Investment Corp & Guangdong International Trust and Investment Corp Hong Kong (Holdings) Ltd (Garnishee) [2005] HKEC 1180.  For clarity, Deputy Judge Gill in CCIC Finance Ltd v Guangdong International Trust & Investment Corp & Guangdong International Trust and Investment Corp Hong Kong (Holdings) Ltd (Garnishee) [2005] HKEC 1180 confirms that “the principle of fairness amongst creditors of equal rank is the same” between bankruptcy and liquidation.

[21] The Joint Official Liquidators of a Company v B and Another [2014] 4 HKLRD 374; Joint Administrators of African Minerals Ltd v Madison Pacific Trust Ltd [2015] HKEC 641.

[22] Lord Hoffmann in Cambridge Gas Transportation Corp v Official Committee of Unsecured Creditors of Navigator Holdings plc (Cambridge Gas) [2007] 1 AC 508 confirmed that “[n]o one should have an advantage because he happens to live in a jurisdiction where more of the assets or fewer of the creditors are living”.

[23] Section 86 for non-New York Convention awards and section 89 for New York Convention awards.

[24] For non-New York Convention awards.

[25] For New York Convention awards.

[26] Hebei Import & Export Corp v Polytek Engineering Company Ltd (1999) 2 HKCFAR 111.

[27] Karaha Bodas Co LLC v Perusahaan Pertambangan Minyak dan Gas Bumi Negara (Pertamina) (No 2) [2003] 4 HKC 488.

[28] Pursuant to Order 49, rule 1 of the Rules of the High Court Garnishee Proceedings (Cap 4A).

[29] Order 49, rule 2 of the Rules of the High Court Garnishee Proceedings (Cap 4A).

[30] Order 49, rule 3 of the Rules of the High Court Garnishee Proceedings (Cap 4A). This order must also be served on the garnishee by hand, at least 14 days before the day appointed for the further consideration of the matter.

[31] Rooke v HV Construction Services Ltd [1998] 1 HKC 686.

[32] Chellic Industries v Datacom Wire and Cable Co Ltd [2000] 1 HKC 646.  Further, Godfrey JA stated in Rooke & Another v HV Construction Services Limited [1998] 1 HKC 686 that where the debtor was in financial difficulties but not in liquidation, “It is a matter within the discretion of the court whether or not to make absolute a garnishee order nisi. There are no general principles laid down upon which the discretion falls to be exercised”.

[33] Joint Administrators of African Minerals Ltd v Madison Pacific Trust Ltd [2015] HKEC 641.

[34] Where the creditor is an associate of the company, this time frame is two years (section 266B(1)(b)(ii) of the Companies Winding Up Ordinance).

[35] Re Sweetmart Garment Works Limited (in liquidation) [2008] HKCU 173. Further, payments made as a result of genuine pressure, both commercial and moral, are excused. See also Trustees of the Property of Hau Po Man Stanley (in bankruptcy) v Hau Po Fun Ivy [2005] 2 HKC 227).

Download Crossing Borders: International Arbitration Insights - Where will we be in 2028?

Crossing Borders is a periodic review of developments in international arbitration across the world. Included in this special 10th edition, we explore what arbitrations will be like going into 2028 - where, how and by whom disputes will be decided.

Belt and Road Hub

We explore the opportunities the Belt and Road Initiative brings for your business, and provide our comprehensive, professional services to help.


Belt and Road

A Guide to Doing Business in China

We explore the key issues being considered by clients looking to unlock investment opportunities in the People’s Republic of China.

Doing Business in China
Share on LinkedIn Share on Facebook Share on Twitter
    You might also be interested in

    This article was written by Edwina Kwan (关凯丽) and Jay Tseng (曾誌輝). In the midst of the COVID-19 pandemic, the NSW Supreme Court (Court) vacated the hearing dates for an 8-day trial due to...

    30 June 2020

    This article was written by Patric McGonigal and Ramon Garcia-Gallardo. At a virtual ceremony on 11 June 2020, Singapore's Minister for Home Affairs and Law, K Shanmugam SC and the President of the...

    22 June 2020

    As of May 1, 2020, parties making a voluntary notice filing with CFIUS will have to pay a filing fee. There is no fee for declarations under the mandatory filing regime. The Treasury Department’s...

    26 May 2020

    As of May 1, 2020, parties making a voluntary notice filing with CFIUS will have to pay a filing fee. There is no fee for declarations under the mandatory filing regime. The Treasury Department’s...

    19 May 2020

    This site uses cookies to enhance your experience and to help us improve the site. Please see our Privacy Policy for further information. If you continue without changing your settings, we will assume that you are happy to receive these cookies. You can change your cookie settings at any time.

    For more information on which cookies we use then please refer to our Cookie Policy.