The potential conflict between winding-up proceedings and arbitration is a resurging topic. In the recent case of Telnic Limited v Knipp Medien Und Kommunikation GmbH  EWHC 2075 (Ch), the Chancellor of the English High Court found that, in circumstances where a petition debt is alleged to arise under a contract which includes an arbitration agreement, the Court either will stay or dismiss the winding-up petition, in the absence of wholly exceptional circumstances. The rationale is to protect party autonomy and to discourage parties from bypassing an arbitration agreement by presenting a winding-up petition. As a consequence, before entering into a contract, a party should consider whether it would be in its interests to carve out from the arbitration agreement debt disputes which affect the counterparty’s solvency. If there is already a contract between the parties, consideration should be given to the scope of any arbitration clause which binds them before presenting a winding-up petition.
Facts and issues
Knipp had provided data hosting and software development services to Telnic since 2009. The services agreement included an arbitration clause providing that, “any dispute, controversy or claim arising out of or relating to this agreement… or the breach, termination or validity thereof shall be referred to arbitration upon the written request of either party”.
By March 2019, £263,777.28 for services provided by Knipp were outstanding and Knipp petitioned to wind up Telnic on 25 October 2019.
At first instance, it was held that the winding-up petition should not proceed for reasons including that: (a) the petition debt was based on the services agreement which contained an arbitration clause; (b) as the petition debt was disputed, such dispute should be referred to arbitration; and (c) there were no special or exceptional circumstances which would require the Court to enquire into the merits of the disputed debt.
On appeal and cross-appeal, the key substantive issues were:
The Court decided that Salford Estates was the relevant binding authority because the petition debt, which was disputed, arose under the services agreement which included an arbitration clause.
It also clarified that Salford Estates does not establish that the Court cannot enquire into whether or not the debt is disputed in good faith or on substantial grounds. Where there are wholly exceptional circumstances, the Court is able to enquire whether the debt is disputed in good faith on substantial grounds.
Knipp argued that there were wholly exceptional circumstances because the debt was admitted on a without prejudice basis, Telnic was balance sheet insolvent and Telnic did not participate in the arbitration in good faith. The Court considered these allegations and found that they were unclear and inconclusive and that there was nothing out of the ordinary to take it into the realm of wholly exceptional circumstances. Accordingly, it did not need to enquire into the merits of the dispute.
The Court also found that the judge below had properly exercised his discretion to stay the winding-up petition, which was to protect the petitioner should he be successful in the arbitration and to uphold the policy of the Arbitration Act.
This is another decision from the English Courts, this time from the Chancellor of the High Court, which demonstrates an approach that prioritises arbitration when it comes to disputed petition debts.
Contracting parties should be aware of the scope of the arbitration clause when entering into agreements and should be conscious of the potential impact that an agreement to arbitrate could have on the ability to wind up the counterparty, if debts arise under the contract. The winding-up option may not be available if there is an extant binding arbitration agreement in place and the parties may first have to go through the process of arbitration to determine the disputed debt.
The Hong Kong jurisprudence on this issue is divided. The early authorities decided the matter on a traditional approach by staying or dismissing the petition with regard to whether the alleged debt was disputed on genuine and substantial grounds. Lasmos Ltd v Southwest Pacific Bauxite (HK) Ltd  2 HKLRD 449 departed from the traditional approach by following the principle enunciated in Salford Estates but added a condition that the debtor had to have taken steps required under the arbitration clause to commence the arbitration process, before the Court would stay or dismiss the winding-up petition. However, more recently in Dayang (HK) Marine Shipping Co., Ltd v Asia Master Logistics  HKCFI 311, the traditional approach was preferred and a winding-up order was made despite an existing arbitration agreement between the parties. The Court found that there was no bona fide dispute on substantial grounds concerning the alleged debt and that even if the Lasmos approach was applicable, the debtor had failed to timely commence arbitration proceedings. As such, there is less certainty in how the Hong Kong Courts will handle this potential conflict and it continues to be an interesting developing area of law.