Insolvency vs Arbitration: Landmark Federal Court decision affirms higher threshold for restraining winding-up petition even if debt is subject to arbitration agreement
This article discusses the Federal Court decision in V Medical Services M Sdn Bhd v Swissray Asia Healthcare Co Ltd (Civil Appeal No. 02(f)-1-02/2024(W)) where the court affirmed that a debt must be “genuinely disputed on substantial grounds” when it is governed by an arbitration agreement in winding-up proceedings.
The Court of Appeal decision in this matter was the first appellate court decision in Malaysia that addressed the interplay between insolvency and arbitration. Read more in our article “Court of Appeal finds insolvency trumps arbitration where there is no bona fide dispute of debt”.
This article continues our reporting of this important matter with an overview of the Federal Court’s decision.
Snapshot
The dispute arose from a Distributorship Agreement (“DA”) entered into on 1 April 2016 for the distribution of medical machines. On 24 May 2016, the respondent received two medical machines (“devices”) under the DA.
The appellant claimed that the respondent had not made payment for the devices, while the respondent contended that the devices were only for demonstration and promotional purposes, and no confirmed order had been placed. The DA was terminated by the appellant on 30 August 2017.
High Court
Following failed settlement discussions and the issuance of a statutory demand notice by the appellant, the respondent sought an injunction from the High Court to restrain the appellant from presenting a winding-up petition. The respondent argued that the debt was disputed and subject to arbitration pursuant to the arbitration clause in the DA. The High Court granted the injunction, and the appellant appealed.
Court of Appeal
The Court of Appeal set aside the injunction and allowed the appeal, finding that a debtor must meet a higher threshold to restrain the presentation of a winding-up petition if the alleged debt is subject to arbitration.
While acknowledging the lower threshold set out in the English Court of Appeal case of Salford Estates (No. 2) Ltd v Altomart Ltd (No. 2) [2014] EWCA Civ 1575 (“Salford”) and the Singapore case of BDG v BDH [2016] 5 SLR 997, the Court of Appeal observed that judges should not “abdicate their responsibility and refrain altogether from inquiring into the genuineness of the dispute”. The thresholds the court considered are as follows:
- A lower threshold, where the court halts the winding-up process so the matter can go to arbitration as long as the debt is disputed and falls under an arbitration agreement (“lower threshold”); or
- A “higher” threshold from the traditional winding-up rules where the debt must be “genuinely disputed on substantial grounds” before a winding-up petition is stayed, dismissed, or restrained (“higher threshold”). This approach has been recently reaffirmed by the UK Privy Council in Sian Participation Corp (In Liquidation) v Halimeda International Ltd [2024] UKPC 16 (“Sian Participation”).
The Court of Appeal concluded that that the higher dispute threshold was the appropriate standard. As it is within the court’s inherent jurisdiction to prevent abuse of the court process, a balanced approach is required to prevent frivolous disputes from being alleged just to stave off the presentation of a winding up petition when, in fact, there is no genuine dispute of debt.
Judgment
Permission to appeal to the Federal Court was granted, with the fundamental issue before the Federal Court being the standard or threshold that a debtor must meet to restrain a presentation of a winding-up petition if the alleged debt is subject to an arbitration clause.
The Federal Court rejected the Salford approach and endorsed the higher threshold, the bona fide threshold, set out in Sian Participation.
The court held that a court’s role when hearing a winding-up petition is to determine whether the debtor is insolvent in order to decide if a collective process should be started for the orderly distribution of the debtor’s assets on a proportionate (pari passu) basis; the court is not adjudicating on a dispute which is a subject matter of the arbitration agreement. It is therefore not justifiable to import the statutory provisions of the Arbitration Act 2005 into the statutory provisions for winding-up under the Companies Act 2016.
The Federal Court decision was also driven by the need to balance the policy of party autonomy that underpins arbitration with the policy considerations for winding-up, including the need to preserve the assets of an insolvent company for distribution to its creditors. Giving undue weight to the arbitration process would defeat these policy considerations and undermine the policy objectives of the law relating to a company’s winding-up. A balance is achieved by adopting the higher threshold of assessing whether a debt is genuinely disputed on substantial grounds when deciding whether to allow, restrain, or dismiss a winding-up petition involving a disputed debt that is subject to an arbitration agreement.
In the present matter, the Federal Court found that even under the bona fide dispute threshold, the existence and quantum of the alleged debt were indeed genuinely disputed on substantial grounds.
However, as the debt was not clearly established on the facts, an injunction to restrain a winding-up petition was justified. The court found that the parties should resolve the merits of their dispute in arbitration as originally agreed and reversed the Court of Appeal’s decision.
Comment
This decision is a landmark apex court decision that resolves longstanding tension between arbitration and insolvency law in Malaysia, by providing much-needed guidance on how Malaysian courts should approach winding-up proceedings where the alleged debt is subject to an arbitration agreement. Departing from the Salford decision that has been adopted in some other jurisdictions, the Federal Court affirmed that the appropriate standard is the higher threshold of whether the debt is genuinely disputed on substantial grounds.
The mere existence of an arbitration agreement does not, by itself, preclude the court from entertaining a creditor’s petition. If the debt is not genuinely disputed, creditors ought not to be deprived of their statutory right to initiate winding-up proceedings.
Accordingly, parties involved in such disputes must be prepared to substantiate their claims or defences with a sufficient factual basis. Bare assertions and reliance on the existence of an arbitration agreement will not suffice. The debtor must show a real, bona fide dispute grounded in substantial facts.
From a policy perspective, the decision strikes an important balance. On one hand, it upholds the principle of party autonomy that underpins arbitration - courts will honour the parties’ agreement to resolve disputes privately, where appropriate. On the other, it ensures that arbitration agreements are not used as a shield against insolvency law, which serves a broader public function by preserving an insolvent company’s assets for fair distribution among all creditors.
