Insolvency and Arbitration: Will a winding up petition be stayed in favour of arbitration?

I am just setting out my thoughts and where I will be planning to write a more extensive article on this area. I have always been fascinated on the interaction of the statutory process of winding up and the contractual bargain of arbitration. Will one process always necessarily trump the other?

There are now several cases which try to deal with whether there can be a form of a stay of the Court winding up proceedings in favour of arbitration. The winding up itself can arise from either a creditor petitioning on the grounds of insolvency or a shareholder petitioning on the just and equitable grounds. In the former scenario, the petition may be grounded on a debt arising from a contract containing an arbitration clause. In the latter, the shareholder’s complaints may be arising from a shareholders’ agreement with the other shareholders. I now just record down some cases in the scenario of a petition being presented by a creditor on the grounds of insolvency.

There is a recent English Court of Appeal decision in Salford Estates (No. 2) Limited v Altomart Limited [2014] EWCA 1575 Civ  which held that the mandatory stay provisions in the English Arbitration Act would not apply to stay winding up proceedings. Instead, the Companies Court would exercise its usual discretion in whether to stay or dismiss a winding up petition, for example, if there was a bona fide dispute of the debt on substantial grounds.

This is a similar approach taken in Hong Kong, where its Arbitration Ordinance closely follows the Model Law (and therefore, may be more persuasive in Malaysia). The case of Jade Union Investment Limited [2004] HKCFI 21 also similarly held that the mere existence of an arbitration clause does not mean that the mandatory stay provisions under the Arbitration Ordinance would apply. The Court would still apply the test as to whether there was a bona fide dispute of debt when hearing the petition. Another case of Re Sinom (Hong Kong) Ltd [2009] HKCFI 2201 similarly followed Jade Union when deciding whether to grant an injunction to restrain the presentation of a petition.

It will be interesting to see how such a situation would play out in Malaysia. I am not aware of any such case involving a stay of a winding up petition or an injunction to restrain presentation based on the Arbitration Act 2005 (“AA”). I know of one or two cases under the old Arbitration Act 1952 where a stay of winding up proceedings was sometimes granted and sometimes not.

If there is an arbitration clause in a contract and a statutory demand is made for payment under the contract, would the other contracting party be able to apply under section 11 of the AA for an injunction to restrain the presentation of the petition? What would the test for such an injunction be? Would it still be the Tan Kok Tong Court of Appeal test of a bona fide dispute of debt on substantial grounds? Or would the mere existence of an arbitration clause be sufficient? Or would an application for an injunction have to be grounded outside of the AA and the Court would exercise its inherent jurisdiction to grant a Fortuna injunction to restrain the presentation?

If the Petition was filed, would a stay of those Court proceedings be allowed under section 10 of the AA? The test for a stay under section 10 of the AA will not require the Court to decide on whether there is a bona fide dispute (that original provision has been taken out) and it is almost mandatory for a stay unless the arbitration clause can be questioned (e.g. the clause is null and void or inoperative).

I will try to deal with these questions in my more extensive article and after I have done more research.

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What is a ‘court’ for a stay of court proceedings pending arbitration?

The Supreme Court of Victoria in Subway Systems v Ireland [2014] VSCA 142 interpreted the meaning of the term ‘court’ under the Australian Commercial Arbitration Act 2013 for the purposes of a stay of court proceedings pending arbitration. In line with the Model Law, the term ‘court’ was extended to cover an administrative tribunal. Therefore, those tribunal proceedings were stayed pending arbitration. This is also of significance to Malaysia on how the Arbitration Act 2005 may be interpreted for a stay of court proceedings pending arbitration.

Subway Decision

A dispute arose between the parties to a franchise agreement involving a Subway sandwich business. The agreement contained an arbitration clause. The franchisees sought to have the dispute heard in the Victorian Civil and Administrative Tribunal (VCAT) while Subway argued that VCAT was precluded from hearing the proceeding and must instead refer the parties to arbitration.

There is a useful summary of the principles from this decision in this Allens commentary. I quote a section from this commentary.

In interpreting the Act and the definition of the word ‘court’, the majority recognised the aims of the Model Law, of uniformity and harmonisation, given the Act’s genesis from the Model Law. The policy behind the Model Law was central to the majority’s analysis of whether VACT fell within the definition of a ‘court’ for the purposes of s8 of the Act. If VCAT was found to be a court in this instance, disputes to be heard in VCAT, where an arbitration agreement existed, would be referred to arbitration under the Act. Conversely, if VCAT was found not to be a court, parties would have a choice of forum in which to have their disputes heard: either at VCAT or under arbitration. The majority judges recognised the wholly unsatisfactory position of the latter option.

In analysing whether VCAT was a ‘court’, the Acting Appeal Justice Kyrou (in the minority) noted instances in legislation where the definition of court intentionally omitted VCAT, and observed that VCAT lacks the typical indicia of courts at common law, as it:

  • is not bound by the rules of evidence;
  • cannot enforce its own decisions;
  • is constituted by some members who are not legally trained;
  • can apply government policy; and
  • can provide advisory opinions.

Acting Appeal Justice Kyrou’s analysis focused on the text of the Act and other statutes where the word ‘court’ is applied and noted the intentional omission of VCAT in various definitions of court in legislation. This led his Honour to find that VCAT was not a ‘court’ for the purposes of s8 of the Act.

Conversely, Appeal Justice Beach (in the majority) held that VCAT possesses the six features typical of courts at common law and noted instances where the definition of courts in statutes has been held to include VCAT. President Maxwell focused on the international development, and aims, of the Model Law that were picked up in the Act and the effect of these on interpreting the definition of ‘court’ under the Act.

As a matter of statutory construction, the majority considered the text, context and purpose of the Act, and held that both the Model Law and the Act had application to ‘a body or organ of the judicial system,’ which extended to VCAT.

Malaysian Context

Section 10 of the Arbitration Act 2005 (“AA 2005”) provides that: “A court before which proceedings are brought in respect of a matter which is the subject of an arbitration agreement shall … stay those proceedings and refer the parties to arbitration … (emphasis added)”

In the AA 2005, similar to the Subway decision, there is no definition of the term ‘court’. This is in contrast with the definition in Article 2(c) of the Model Law where ‘court’ means a body or organ of the judicial system of a State. The term ‘court’ in the AA 2005 does not appear to mean only a High Court (i.e. the High Court in Malaya and the High Court in Sabah and Sarawak) since other sections in the AA 2005 refer specifically to the term ‘High Court’ and ‘High Court’ is defined in section 2 of the AA 2005 (for example, section 11 of the AA 2005 states that “a party may … apply to a High Court for any interim measure and the High Court may make the following order …”).

Further, I would also argue that there is a difference between ‘court’ (with the small ‘c’) and ‘Court’ (with the capital ‘C’). ‘Court’ is defined in the Courts of Judicature Act 1964 as the Federal Court, the Court of Appeal or the High Court. So if there is a deliberate use of ‘court’ (with the small ‘c’) in the AA 2005, could it be argued that Malaysia can also draw on the Model Law definition of ‘court’ as being a body or organ of the judicial system?

In line with this wider definition, the term ‘court’ should encompass this broader definition in order to allow the Subordinate Courts (i.e. the Magistrate and Sessions Court) to also grant a stay of proceedings to refer parties to arbitration. The Subordinate Courts do not fall within the definition of ‘Court’ under the Courts of Judicature Act 1964, but  it has been largely assumed that the Subordinate Courts would have the power to grant a stay of proceedings under section 10 of the AA 2005 (for example, see Sundra Rajoo & WSW Davidson (2007) ‘The Arbitration Act 2005: UNCITRAL Model Law as applied in Malaysia’, para 10.3).

If we accept this broader definition of ‘court’ under the Model Law, could this then be extended to other forms of statutory tribunals, the Industrial Court or other regulatory bodies for the purposes of a ‘court’ ordering a stay of proceedings? It will be interesting to see how this will develop and be argued in the Malaysian courts.

The Uncertainty on the Law Governing the Arbitration Clause

The law governing the arbitration agreement (i.e. the arbitration clause in a contract) potentially covers matters such as the existence, legality, interpretation, termination, and the identities of the parties to the arbitration clause. It is very common to not see any express provision on the law governing the arbitration clause. Contracting parties commonly make the assumption that the governing law of the contract will be the same law governing the arbitration clause.

(1) Governing law of the contract could be a strong indication of the governing law of the arbitration clause

The English Court of Appeal decision in Sulamérica CIA Nacional de Suguros SA and others v Enesa Engenharia SA and others [2012] 1 Lloyd’s Rep 671. In essence, the English Court of Appeal set out a three-stage enquiry in determining the law governing an arbitration agreement. (1) The express choice; (2) The implied choice in the absence of such an express choice; and (3) Where the parties had not made any choice, the proper law would be the law which the arbitration agreement has its closest and most real connection with. In particular for stage (2), the English Court of Appeal held that an express choice of law governing the substantive contract is a “strong indication of the parties’ intention in relation to the agreement to arbitrate.” On the specific facts of SulAmerica, the Court of Appeal agreed that the arbitration clause should be governed by the law of the seat (English law) and not the governing law of the contract (Brazil law). Nonetheless, the SulAmerica approach creates a rebuttable presumption that an express choice of law to govern the substantive contract would also apply to the arbitration clause. There have been English decisions that have since followed the SulAmerica approach.

(2) Or should the law of the seat of the arbitration be the governing law of the arbitration clause?

FirstLink Investments Corp Ltd v GT Payment Pte Ltd and others [2014] SGHCR 12 departs from the SulAmerica approach in treating substantive law in the main contract being a strong indication of the parties’ intention to have that same substantive law be the law governing the arbitration clause. The case of Firstlink instead argues that, the natural inference ought to be that the law of the seat of arbitration should be the law governing the arbitration clause. This is because when commercial relationships break down and there is dispute resolution, the parties’ desire for neutrality comes to the fore. The law governing the performance of contractual obligations prior to the breakdown takes a backseat and primacy should be accorded to the neutral law selected by parties to govern the proceedings of dispute resolution.

In Malaysia, the High Court in Government of the Lao People’s Democratic Republic v Thai-Lao Lignite Co Ltd [2013] 3 MLJ 409, it was held that the law governing the arbitration clause should be the law of the seat of the arbitration (see [98] to [100]). On appeal, the Court of Appeal upheld the High Court decision but the Grounds of Judgment did not delve into the issue on the law governing the arbitration clause. This case is now pending an application for leave to appeal to the Federal Court.

The case of Thai-Lao Lignite demonstrates the significance of the law applicable to the arbitration clause. One of the contentions in the High Court for the setting aside of the award (as seen in the reported decision) was that Malaysian law should apply to the arbitration clause (as that is where the seat of arbitration is stipulated). From that, it would follow that the ‘party’ to the arbitration clause must be a signatory to the main agreement itself in order to be a party to the arbitration agreement. However, if the governing law of the main agreement (New York law) were to apply to the arbitration clause, under New York law, the concept of an “intended third party beneficiary” would be deemed to be a party to the arbitration agreement. Hence, a non-signatory to the main agreement but one which is an intended third party beneficiary, could rely on the arbitration clause and could be one of the claimants to initiate arbitral proceedings (just like in the facts of Thai-Lao Lignite. However, by applying Malaysian law to the arbitration clause, the High Court held that this was one of the grounds for setting aside the award. The Judicial Commissioner held that the arbitral tribunal had exceeded its jurisdiction by allowing a non-signatory and essentially, a non-party to claim in the arbitral proceedings.

(3) Takeaway Point: Expressly Provide for the Law Governing the Arbitration Clause

It is therefore best to expressly provide for the law governing the arbitration clause to negate any uncertainty. It will just require the simple provision such as “The law of this arbitration clause shall be [state the law e.g. the law of Malaysia]”

 

Delivering a Talk on Enforcing Arbitral Awards and Foreign Judgments

I have been invited by the Singapore Management University School of Law to deliver a lunchtime seminar on Enforcing Arbitral Awards and Foreign Judgments in Malaysia. This will be held on Tuesday 12 August 2014.

As part of my talk, I will set out some of the statistics for the successful (or unsuccessful) applications for the enforcement of arbitral awards under the Arbitration Act 2005.

 

SMU

 

Indemnity Costs for Initiating Court Proceedings in Breach of Arbitration Clause

I had earlier written about the case for indemnity costs in opposing arbitral awards. This was in the context of costs being awarded on an indemnity basis where there was an unsuccessful attempt at setting aside an award or resisting an enforcement of an award.

In my earlier article, I had pointed out that the English courts may award indemnity costs where proceedings are brought in breach of a binding arbitration agreement. In the High Court decision of A v B (No 2) [2007] EWHC 54 (Comm), court proceedings were stayed as the proceedings were brought in breach of an arbitration agreement. It was held that as the breach had caused the innocent party to incur legal costs, those costs should normally be recoverable on an indemnity basis.

The approach in A v B has now been adopted in Australia in the Supreme Court of Western Australia decision of Pipelines Services WA Pty Ltd v ATCO Gas Australia Pty Ltd [2014] WASC 10. The Court had ordered Pipeline to pay costs on an indemnity basis to ATCO when ATCO had successfully applied for a stay of proceedings under section 8 of the Commercial Arbitration Act 2012.

In making this order, the Court confirmed the application of the principle in the English case of A v B [2007] EWHC 54 that indemnity costs will generally be awarded where a party commences legal proceedings in breach of a contractual obligation to refer a dispute to arbitration.

I am not aware of the Malaysian Courts having determined whether costs on an indemnity basis should be allowed if there is a successful stay of Court proceedings under section 10 of the Arbitration Act 2005. Hopefully this case for indemnity costs can be canvassed before the Courts.

Shareholder Oppression Action Not Arbitrable

The Singapore High Court in the Silica Investors case (Silica Investors Ltd v Tomolugen Holdings Limited and others [2014] SGHC 101) refused a stay of an oppression action initiated by a shareholder pending a reference to arbitration. The Court found that based on the facts of the case, the minority oppression claim was non-arbitrable. There were relevant parties, including other shareholders, who were not parties to the arbitration. Further, the Plaintiff in the oppression action was seeking for remedies that the arbitral tribunal could not grant, including winding up.

Briefly, there was an arbitration clause in an agreement between only two of the shareholders. The Plaintiff filed an oppression action against both the party to the arbitration agreement as well as against non-parties (being the directors and some of the other shareholders of the Company). The Plaintiff sought a share buy-out order, an alternative prayer for winding up, and for several declaratory orders.

The Judge took great lengths in looking at the developments in Australia, Canada and the UK, and the academic commentary arising from those cases. In particular, the Judge distinguished the English Court of Appeal decision in Fulham Football Club (1987) Ltd v Richards and another [2012] Ch 333 (where an unfair prejudice action was stayed pending arbitration) as the unfair prejudice relief in that case was for a specific injunction Order. There was no possibility of a share buy-out or winding up in that case.

This is a fascinating area of the law where there is still no clear answer on the right balance to be struck. On the one hand, there is the policy of interpreting an arbitration clause as wide as possible in order for contracting parties to be bound by their bargain to go to the exclusive forum of arbitration. On the other hand, parties e.g. shareholders, may still want to rely on their statutory remedies and the Court will have to consider whether a dispute is arbitrable or not.

CJ Menon’s Cautionary Notes for an Age of Opportunity

The Chief Justice of Singapore cautions on the issues arising from dramatic growth of new entrants, third-party funding and rising costs in international arbitration.

At the Chartered Institute of Arbitrators International Arbitration Conference held in Penang on 22 August 2013, which I had the pleasure of attending, The Honourable The Chief Justice Sundaresh Menon delivered his keynote address entitled “Some Cautionary Notes for an Age of Opportunity.”

Chief Justice Menon highlighted the essential role that arbitration plays in the global infrastructure and in the development of an international rule of law. However, he cautioned that how successfully this Titanic continues to sail ahead would depend on the diligence of its stewards in spotting and reacting to the approaching icebergs.

He identified three distinct issues which he believed the international arbitration community needed to take cognizance of.

1. Dramatic growth in number of new entrants

The first was the “explosive growth in the number of new entrants to the global arbitration community, many from diverse legal traditions“. The result, he feared, was that: “[i]mplied understandings or shared values no longer provide any meaningful means of shaping or influencing conduct in this context. Arbitrators can no longer consider themselves bound by peer standards, because there are no peers in the true sense, amidst all this diversity.”

Chief Justice Menon posed the question as to what yardstick should be applied in the present setting of a largely unregulated industry with little, if any, barriers to entry. Drawing an analogy from sports, “[i]f football were played without rules but with massive stakes and rewards, how would we condemn those playing the man instead of playing the ball?’

2. Third-Party Funding

The second issue was “the growing incidence of third party funding and the participation of funds in international arbitration” and the “virtual absence of any form of regulation” in contrast to third party funding for litigation.

Chief Justice Menon gave examples of a European gas company announcing that a Luxembourg fund would finance its €1 billion ICSID claim and of a Canadian mining company having made an agreement with a third-party funder to cover the costs of a multi-billion arbitration claim brought by its subsidiary against Bolivia.

In particular, he touched on how the prevalent use of third-party funding in international arbitration has seen the emergence of a market for the sale of the payment obligation that will be owed by the claimant in the event of success, as a chose in action to third-party speculators. Such practices are reminiscent of and have the potential to replicate the vulture funds that were prevalent in the 1990s.

Would funders create a portfolio of high risk claims, consisting of frivolous or unmeritorious claims, hedged by low risk claims, consisting of claims with a good chance of success, and sell them as a diversified basket of claims to third-party speculators? This would make it possible to profit from frivolous and unmeritorious claims that would not otherwise have a market with speculators if they were sold individually.

3. Rising Cost

Finally, Chief Justice Menon raised the issue of the rising costs of international commercial arbitration and warned that there was a “growing recognition amongst users that the level of costs in international arbitration is rising at an unsustainable rate“.

While he acknowledged the various reasons for such rising costs, he stated that it was “unsatisfactory that the international arbitral community has not acted with dispatch to address this issue. On the contrary, the trend might even point somewhat the other way“.

4. Possible Responses to these Challenges

Chief Justice Menon suggested two ways to combat these three issues.

The first is to develop and implement codes of ethics to set uniform standards for both arbitrator and counsel conduct. He then proceeded to distinguish the common arguments in opposing the implementation of such a uniform code.

The second is for arbitral institutions to play a larger role in developing and implementing a regulatory framework to apply and enforce such standards.

This speech completed a trilogy of views expressed by Chief Justice Menon on the topic of international arbitration. The first were the views expressed in his keynote address at the 21st International Council for Commercial Arbitration Conference on 11 June 2012 which were then expanded on at the seminar at Queen Mary, University of London on 27 September 2012.