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Industry Updates

Winding Up Petitions, Bona Fide Disputes and Exclusive Jurisdiction Clauses

21 Jan 2014

The Cayman Islands court may wind up a company upon the application of a creditor when it can be shown to be unable to pay its debts. However, it is well established that this jurisdiction may not be invoked in reliance of a debt which is disputed by the company on bona fide and substantial grounds. Creditors winding up petitions are not an appropriate mechanism for settling genuine disputes between parties. When dealing with such a petition, the Cayman Islands court will therefore generally look at the evidence before it and determine whether the grounds on which the debt is disputed are real and bona fide and not frivolous or without substance.

However, a layer of complexity can arise where the company and the creditor have contractually agreed that disputes between them relating to the debt should be determined exclusively by another tribunal – for example, through arbitration, or in a different court.  Clearly, the parties cannot seek to contract out of the court's winding up jurisdiction (and for a more detailed discussion on that topic, refer to our update titled Winding Up a Cayman ELP, Post Judgment Admission of Evidence and Costs).  However, when presented with a creditor's winding up petition based on an ostensibly disputed debt, should the Cayman Islands court itself consider the evidence as to whether there is a real and substantial dispute regarding that debt (including to weed out defendants frivolous and hopeless defences), or must even that threshold question be determined by the tribunal nominated by the parties? 

Judges have not always agreed on the answer to this question - and an article published in our Summer 2011 Litigation & Insolvency Update, which can be viewed here, illustrated two differing approaches.

In Re Times Property Holdings 1 , Foster J held that, the parties having agreed that any dispute would be referred to arbitration, "it is not appropriate for this court, even if minded to do so, to deprive the company of putting its case and pre-judging the issue by seeking to determine that the company's dispute with the alleged indebtedness has no real substance." However, at around the same time in Re Duet Real Estate Partners 1 LP 2 , notwithstanding the existence of an arbitration clause, Jones J considered the evidence before him and determined that the companys defences were "nothing more than a disingenuous delaying tactic" potentially clearing the way for the making of a winding up order.

A recent further decision of Foster J in Re SRT Capital SPC Ltd 3 has helped to bring some clarity to this area. In this decision Foster J has showed a willingness to look at the merits of the underlying alleged dispute.

The respondent company had borrowed from the petitioner by way of a swap transaction for the purpose of leveraging an investment in shares.  The borrowing was governed by an English law ISDA and associated confirmation, which contained an exclusive jurisdiction clause in favour of the English courts.  The shares performed poorly, the petitioner closed out the swap and then claimed an additional USD$6.8m from the company.  Having not been paid, the petitioner then sought to wind up the company on the grounds of insolvency. 

On the face of the contract, the company's position seemed hopeless. However, the company claimed it had been misled by the petitioner. In particular, it said that it had agreed with the petitioner that its liability under the swap would be limited in recourse to the shares, and this was clear from the term sheets which passed between them, including the day before the confirmation was signed. The petitioner had then provided the formal contractual documents, saying that it was "purely a legal reflection of the commercial terms" agreed in the term sheets. However, this was not true because, unlike the terms sheets, the confirmation contained no limited recourse language. The company argued it has believed and relied upon these representations and had "reasonably expected the Confirmation to be as [the petitioner] said it would be". It claimed that the petitioners representations and conduct were "intentional or at least reckless and consequently to be considered a fraudulent misrepresentation, which the Company had reasonably relied upon".

For its part, the petitioner argued that this essentially amounts to a plea of non est factum or mistake - a notoriously difficult argument for a company to make out, and which cannot be established simply through a failure to read a document carefully before signing it. The petitioner also relied heavily on the "entire agreement" and "no pre-contractual representations" clauses, which are common in contracts of this nature, and which in other instances have been held to give rise to a contractual or evidential estoppel. 

As a threshold point, relying on Re Times Property Holdings, the company argued that it was not appropriate or necessary for the Cayman Islands court to consider the merits of these arguments. The contract contained an exclusive jurisdiction clause in favour of the English courts and, it said, it was therefore a matter for the English courts to determine this dispute, which must happen before any winding up petition could be determined.

Foster J rejected that argument, and sought to clarify his dicta in Re Times Property Holdings .4 The Judge noted that, in that earlier case, he had in fact looked at the underlying merits (although, he appears to have done so in support of an express alternative finding that, in any event, there was a genuine dispute). Foster J held that he should "in accordance with the agreed established practice, determine whether the Company's dispute of the debt is genuine and on substantial grounds or whether it is frivolous and of no substance and so should be ignored." He added that if he did "conclude that there is a substantial dispute about the alleged debt, that dispute must be resolved by the English courts in accordance with English law". In other words, the court hearing the winding up petition should first determine whether there really is a dispute, and if there is, the Cayman Islands court should at that point defer to the choice of forum or arbitration clause.

Foster J went on to find that, on the (quite detailed) law and evidence he had reviewed, the company had demonstrated there was at least a bona fide dispute. This was, in part, on the basis that the operation of the "complete agreement" and "no reliance" clauses, and the associated potential estoppel arguments, were not always absolute defences and their application was fact sensitive; in particular, they were potentially capable of being overridden by conduct which was determined to be fraudulent, in the sense of having been made without caring whether or not they were true. Finally determining those factual and legal questions would, however, properly be matters for the English courts. Foster J therefore dismissed the petition.

This a welcome clarification to the law, and appears now to reflect a largely settled approach, both in the Cayman Islands and the British Virgin Islands. The approach also strikes a good balance between (on the one hand) preventing insolvent respondent with frivolous defences resisting winding up petitions through procedural game-playing, while (on the other hand) giving proper effect to choice of forum and arbitration clauses where there is a genuine dispute. As happened in this case, provided the defendant company can discharge the (relatively low) burden of showing that their arguments are real and not frivolous, the Cayman Islands courts can be expected to give proper effect to these clauses.

1 [2011] 1 CILR 223

2 Unreported, 7 June 2011

3 Unreported, 22 November 2013

4 It is also worth noting that the BVI decision on which Foster J placed significant reliance in Re Times Property Holdings, being the judgment of Bannister J in Pioneer Freight Futures Co Ltd v Worldlink Shipping (Unreported, BVIHC, 1 July 2009) has also been walked-back by its author. In De Wet v Vascon Trading  (Unreported, BVIHC, 6 December 2011), Bannister J held that his earlier analysis was "wrong" and that, even where there is an exclusive jurisdiction clause, "the Court [hearing the winding up petition] must first decide, on the evidence before it, whether there is a dispute at all."

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