November 2020

BG: (Mis)Using Arbitration Clauses in Winding-up: Till Death Do Us Apart?

Non-payment defaults, whether arising from Covid-19 or otherwise have skyrocketed prompting governments across the world to put in place temporary relief legislation to prevent an unprecedented spiral of insolvencies. These measures will eventually come to an end, as it has in Singapore where on 20 October 2020, certain protective measures against commencing insolvency or winding-up proceedings against companies in Singapore were lifted. With insolvency proceedings at their door, debtors will desperately try to hold on to their companies with their fingernails, raising all manner of disputes which can only be adjudicated by the arbitration clause contained in their contracts – a clause they say, binds them and their creditor, till death do them apart. Can a winding-up petition be derailed by raising disputes, even trivial or manufactured ones, that are nonetheless subject to arbitration?

The starting point is that parties are bound to resolve their disputes by the arbitration clause contained in their contracts. But a dispute and a debt are not the same – the latter is more often associated with liquidity issues rather than an actual quarrel over performance. The most common form of debt claim arises from a loan or financing arrangement where repayment liability is unconditional. When a debtor is unable to pay for an extended period, debt enforcement may require winding-up the debtor on the basis that it is insolvent. If there is no arbitration clause in the contracts, a debtor facing a winding-up petition has to demonstrate there is a triable issue, a process by which untenable or frivolous defences are sieved out by the judge when investigating the underlying facts. Where there is an arbitration clause, the presumption swings in favour of arbitration and a court examining a winding-up petition cannot engage in the same sieving out process because the investigation of the merits of the defence falls within the remit of arbitration and not the court.  In the case of a winding-up petition brought as a result of non-payment under a contract that has an arbitration clause, the debtor has a lower threshold to demonstrate on a prima facie basis that a dispute exists and is covered by a valid arbitration clause . This could produce an outcome where a debtor seeks to invoke arbitration to stave off winding-up where it may not in fact have a substantial or good faith basis to dispute the debt.

Earlier this year, the Singapore Court of Appeal had to balance these competing considerations in two cases, which were heard together: AnAn Group (Singapore) Pte Ltd v VTB Bank (Public Joint Stock Co) [2020] 1 SLR 1158 (“VTB Bank”), and BWG v BWF [2020] 1 SLR 1296 (“BWG v BWF”). In these landmark rulings, the Court alive to these practical realities, acknowledged the threshold of setting up a prima facie challenge but put in place two safeguards to prevent debtors from derailing winding-up proceedings.

First safeguard: winding-up to proceed if the debtor is abusing the court’s process

Notwithstanding an arbitration clause, a petitioning creditor can still proceed with winding-up, if it can demonstrate that the debtor is raising a dispute in abuse of the court’s process. The court has given the following non-exhaustive examples of such abusive conduct:

  • Where the debt is admitted as regards both liability and quantum. One way of ensuring this would be to record this in a repayment or settlement agreement post default.

  • Where the debtor has waived or may be prevented from asserting arbitration, g. where parties have subsequently agreed that the dispute may be resolved by litigation. Likewise, the best time to record this would be in settlement talks post default.

  • Where there exist substantiated concerns justifying the invocation of the insolvency regime, g. where the debtor company’s assets have gone missing or where there is a proper basis to conclude that fraudulent, unfair or undue preferences have been made.

  • Where all of the debtor company’s defences to the debt are inconsistent with its position in another set of proceedings (g. proceedings with another party in a string of contracts). Even then however, it should be noted that the court may conclude that a debtor adopting inconsistent positions is not in abuse of the court’s process if there is a greater risk of injustice in barring his defences (e.g. where the petitioning creditor is seeking to enforce an illegal contract).

It is also important to note the court’s guidance on what will not constitute abuse of process for the purposes of staying a winding-up application. The court emphasised that the standard for establishing abuse is high, and the following instances do not qualify as abuse of process:

  • Where the debtor’s defence is “obviously lacking in merit”. This factor is irrelevant, as the court will not assess the factual or legal strength of the disputed debt (which is for the arbitrator to do).

  • Where the debtor delays particularising its case or adducing information to support it.

Second safeguard: staying instead of dismissing the winding-up application

If the dispute is prima facie covered by a valid arbitration agreement, and is not being raised in abuse of the court’s process, ordinarily, the court would dismiss the winding-up application. However, the court considered that a dismissal may be unfair to creditors, and it may be more appropriate to stay (i.e. defer) the winding up applications in certain circumstances. As examples, the court suggested the following:

  • A company which does not appear to be immediately insolvent (by reference, for example, to its balance sheet), but is faced with a substantial claim which could push the company into insolvency – and in relation to this debt, it can only raise a prima facie dispute, but not a triable dispute. In such a case, if the court dismisses a winding up application, the potentially insolvent company would be given unrestrained freedom to continue trading, incurring liabilities and depleting its assets.

  • A company may face many claims, with the large claims being subject to arbitration while the smaller claims are not subject to arbitration. The larger creditor’s winding up application may be dismissed, while the company chooses to pay its smaller debts which are not subject to arbitration. The result would be that a debt-ridden company may prefer, in a bid to avoid liquidation, to pay off smaller creditors.

In such situations, the court considered that it may be more appropriate to grant a stay instead of dismissing the winding up application. The creditor will then be given the liberty to apply to the court to proceed with the winding up if, for example, it can be shown that the debtor has no genuine desire to arbitrate the dispute and that it is taking steps to stifle the arbitration. This approach helps to balance the competing interests of the debtor’s rights to have a dispute decided by its pre-agreed choice of arbitration while limiting the possibility of the debtor misusing the arbitration clause to avoid or delay a ruling when winding-up proceedings are commenced against it.

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