“Abuse of process” is the touchstone of an injunction restricting a petition for liquidation | Dentons

In Hung Yip (HK) Engineering Company Limited v. Kinli Civil Engineering Limited [2021] HKCFI 153, the Honorable Mr. Justice Harris reiterated the test for when the court will limit the bringing of a winding-up motion. It is a timely reminder amid the COVID-19 crisis, which has sparked disputes between companies and their creditors.

A common method of debt collection is by filing a petition for liquidation. The starting point is that a creditor can serve a legal demand on a debtor for the repayment of a debt. If the debtor does not repay the entire debt or does not raise an exception within the specified time (usually 21 days), the creditor can bring a liquidation petition against the company, thereby initiating liquidation proceedings. If the company wishes to restrict the presentation of a petition, it can apply to the court for an injunction. The requirement is to demonstrate that the request will constitute an abuse of process; for example, if the company can produce evidence that the creditor knows, when making a claim, that the company has a authentic defense of the claim based on substantial grounds.

Harris J stressed that this test does not amount to proving a authentic defense based on substantial grounds, which the company would be required to prove in order to resist a claim. The key is “abuse of process”. When the creditor knows or should have known that a claim is really disputed, he should not have made a request, which would constitute an abuse of process. Winding-up proceedings are not the appropriate process for resolving substantive disputes. To assess whether there is abuse, the learned judge highlighted the following factors: (1) the debt and how it is supposed to arise; (2) when and how the debt was disputed; (3) what is said authentic defense on substantial grounds; (4) the solvency of the company; (5) any prejudice that will be caused by the presentation of a petition; and (6) if the obligee knowingly uses the threat to inappropriately make a claim.

A liquidation request can create commercial pressure, due to its disastrous consequences for the company. He formally initiates the judicial liquidation procedure, which is a standard case of default in the context of loan contracts, guarantee instruments and financial documents. This will trigger cross defaults, which can lead to accelerated loan repayments, the execution of guarantees and termination of financing agreements. Regarding listed companies, there will be a public announcement or other reporting obligations. Additionally, since liquidation hearings are held in open court, they may attract negative publicity and attract the attention of other creditors. Other creditors may support the claim by participating in the proceedings and may even “step in” as the claimant creditor after the original claimant has withdrawn. This means that, even if the business settles with the original claimant, other creditors can jump on the bandwagon and seek settlement agreements.

Given these potential ramifications, creditors should develop an appropriate strategy and plan carefully. From a legal point of view, there are two points that a potential petitioner should keep in mind. First, if the creditor knows or should have known that a claim is in fact disputed on substantial grounds, he should refrain from bringing a claim. If the court finds that the creditor is abusing the insolvency process, it can order him to pay the costs of the company on an indemnity basis. Second, the company may even have a claim against the creditor for damages for malicious presentation of the petition, as Deputy High Court Judge William Wong SC pointed out in Dayang (HK) Marine Shipping Co., Limited v. Asia Master Logistics Limited [2020] HKCFI 311. Therefore, before making a claim, the creditor should make sure that the business has no real dispute and is insolvent.

From the point of view of the company, when served with a legal demand, it must respond correctly to the creditor and his legal representatives. The grounds for opposing and defending the debt as a whole must be sufficiently explained. The objective is to affix the creditor in knowledge of his authentic defense on substantial grounds. On this basis, the company can ask the creditor to confirm that it will not apply for liquidation, failing which the company can apply for an injunction.

As COVID-19 continues to ravage the global economy, we expect business and insolvency litigation to continue to increase. A wind up petition is a powerful tool, but it is not a cure for all ills. Hung yip demonstrates that each particular complaint requires a tailor-made solution, which the parties must review regularly as circumstances change. Recourse to legal proceedings will be submitted to the court for review. Creditors and well-advised businesses should handle legal proceedings appropriately, in order to resolve their disputes quickly and efficiently.

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About Natalee Broderick

Natalee Broderick

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