REUTERS | Kai Pfaffenbach

How will an arbitration agreement influence the court’s approach in relation to a winding up petition?

A recent judgment handed down by Sir Geoffrey Vos, Chancellor of the High Court, considered the approach the court should take when a winding up petition is presented with regard to a debt that is not admitted and where the debt is subject to an arbitration agreement.

Telnic Limited v Knipp Medien und Kommunikation GmbH (Telnic v Knipp) adds to the line of authorities that the court will usually exercise its discretionary power to wind up a company (under section 122(1) of the Insolvency Act 1986 (IA)) in a manner that does not allow parties to circumvent an arbitration agreement to resolve disputed debts, unless wholly exceptional circumstances are found to exist.

The facts

Knipp claimed that Telnic owed approximately £264,000 in unpaid invoices (petition debt) and that it was balance sheet insolvent.

Knipp and Telnic had entered into a services agreement (the agreement) in 2009 that contained an arbitration agreement. There was a dispute between the parties as to whether conditions precedent to a term sheet in November 2014 had been satisfied and whether Knipp agreed to waive the service fees that were allegedly due. In November 2015, a director of Telnic, allegedly wrote to Knipp agreeing that Telnic would pay the relevant service fees.

In April 2017, Telnic sold its business to Telnames Ltd and simultaneously, Telnic distributed all Telnames shares owned by Telnic to Telnic’s shareholders pro rata to their holding in Telnic. Knipp alleged this was an unlawful distribution. Telnic did not actively trade after that distribution.

On the basis of the petition debt, Knipp made a demand against Telnic in March 2019, and presented a winding up petition against Telnic in October 2019.

The court at first instance restrained the winding up petition from proceeding on the basis that the debt was not admitted and the agreement was subject to an arbitration clause. An appeal and cross-appeal followed. The appeal judgment was handed down on 29 July 2020.

Decision

The leading relevant authority is Salford Estates (No. 2) Limited v Altomart Limited (No. 2) (Salford Estates) (see below for a summary). On the three key issues for the court to consider relating to whether it was appropriate to stay or dismiss the winding up petition, Chancellor Vos held as follows:

  • Was the judge right to decide that he was bound, by Salford Estates, to consider whether there were wholly exceptional circumstances before asking whether the debt was disputed in good faith on substantial grounds? Once it was accepted that the petition debt was alleged to arise under the agreement, the agreement included a binding arbitration clause, and the debt was disputed, the judge was bound by Salford Estates to consider if wholly exceptional circumstances existed; only if such circumstances exist should the court go on to investigate if the debt is disputed in good faith on substantial grounds.
  • Was the judge right to decide that there were no such wholly exceptional circumstances in this case?

Chancellor Vos found the judge was right to conclude that no wholly exceptional circumstances existed in this case.

Chancellor Vos noted that the “wholly exceptional circumstances” test is an exacting one, as has been implied by the Court of Appeal of Singapore in AnAn Group (Singapore) Ptw Ltd v VTB Bank and Nugee J in Fieldfisher LLP v Pennyfeathers Ltd (Fieldfisher). The circumstances in which the court will enquire into whether or not the debt is disputed in good faith or on substantial grounds will be very rare, for the reasons given in Salford Estates.

Having examined the circumstances raised by Knipp, Chancellor Vos reached the clear conclusion that no “very rare and wholly exceptional circumstances” existed to justify the court from departing from the usual practice of dismissing or staying the winding up petition.

He briefly dealt with the various facts relied upon by Knipp to claim that there were “wholly exceptional circumstances”:

  • The alleged admissions of liability by Telnic in November 2015 were inconclusive. In addition, Chancellor Vos agreed with Nugee J in Fieldfisher that the fact that the alleged debtor has made admissions that money is due in the past does not fall within the description of wholly exceptional circumstances.
  • The alleged balance sheet insolvency of Telnic was unclear. In any event, even if Telnic had been balance sheet insolvent, that alone would not have given Knipp locus standi to pursue a petition unless it could show that it was a creditor.
  • The alleged unlawful distribution was disputed. It raised complex issues of law and fact that could not be resolved in the application that was before the court.
  • Telnic’s conduct in seeking to stay the arbitration could not be described as a wholly exceptional circumstance.

Since there were no wholly exceptional circumstances, there was no need for the court to consider whether the petition debt was disputed in good faith on substantial grounds.

Should the judge have:

  • Dismissed the petition?
  • Stayed the petition?
  • Allowed the petition to proceed?

The judge at first instance stayed the winding up petition, rather than dismissing it (as noted). While Chancellor Vos noted there is little authority as to whether a petition is to be stayed or dismissed to allow an arbitration to proceed, he concluded that the court plainly has jurisdiction to stay a winding up petition in these circumstances (save, perhaps, where the company is obviously solvent). The question here was whether the judge correctly exercised this discretion.

Chancellor Vos inferred from what the judge had said that he understood that the normal course would have been to dismiss the petition. Ultimately, Chancellor Vos found that the judge had considered the issue carefully and explained the reasons for granting a stay of the petition, as opposed to a dismissal. Accordingly, there was no basis on which to interfere with the judge’s discretion.

Key takeaways

When dealing with a winding up petition that concerns a debt that is disputed and where the debt is subject to an arbitration agreement, the starting point is that the court is bound by Salford Estates.

The court should exercise its discretion under section 122(1) of the IA to wind up a company consistently with the Arbitration Act 1996 (AA 1996). In practice, this means that in these circumstances the usual course is that the court will stay or dismiss the winding up petition, save where it finds the existence of wholly exceptional circumstances. Only if the court finds that wholly exceptional circumstances exist will the court then consider whether the debt is being disputed in good faith or on substantial grounds.

On the facts above, and from previous authorities on this issue, it will only be in very rare circumstances that wholly exceptional circumstances are found to exist. In this particular case, the court found that wholly exceptional circumstances did not exist even where Telnic was alleged to be balance sheet insolvent, to have admitted the debt in past correspondence and to have sought to delay the arbitration.

Where a party has an outstanding disputed debt that is subject to an arbitration agreement, careful consideration should be given to whether there exist “wholly exceptional circumstances” that would lead to the court embarking on a consideration of whether the debt is disputed in good faith or on substantial grounds if a winding up petition were to be presented. In the absence of such circumstances, the chances are that any such winding up petition will be stayed or dismissed by the court so that the parties can resolve the dispute through arbitration.

Legal background: Salford Estates

The leading authority on this issue is Salford Estates, which established that:

  • The mandatory stay provisions in section 9 of the AA 1996 do not apply to a winding up petition where the ground of the petition is that the company is unable to pay its debts and what is in dispute is that issue.
  • It is entirely appropriate that the court should, save in wholly exceptional circumstances, exercise its discretionary power to wind up a company (as conferred by section 122(1) of the IA) consistently with the legislative policy of the AA.
  • Exercise of the discretion in section 122(1) of the IA otherwise than consistently with the policy underlying the AA would encourage parties to an arbitration agreement, as a standard tactic, to bypass the arbitration agreement by presenting a winding up petition. That would be entirely contrary to the parties’ agreement as to the proper forum for the resolution of disputes and to the legislative policy of the AA. In Salford Estates, there was no doubt that the debt fell within the terms of the arbitration clause. The debt was not admitted. Therefore, it was right for the court either to dismiss or to stay the petition in order to compel the parties to resolve their dispute over the debt through arbitration.

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