Exclusion of set-off rights
KAUPTHING v MILL [2009]
The High Court confirmed that parties can exclude all rights of set-off. ‘Set-off’ arises where a debtor has a form of counterclaim against a creditor, which is used to reduce or extinguish the creditor's claim.
facts:
- The particular rules under which a Certificate of Deposit (Certificate) was issued by Newcastle Building Society (N) stated that any security had to be transferable “free from any equity, set-off or counterclaim” and further stated that “any provisions in any agreement relating to payment must be [compatible with such rules]”. The deed under which N had issued its Certificate stated that payment had to be made “without set-off, counterclaim, or other deduction save as required by law”.
- N had also purchased some deposit instruments from K and when K went into liquidation, N applied to set-off the amount due under the Certificate against the sums payable under the deposit instruments. N argued that the right to set-off at law could not be waived and that the wording in question should only be taken as applying to the right of set-off in equity.
decision:
The Judge held that the rights of set-off (both legal and equitable) could be excluded by agreement. The wording and the commercial context demonstrated that all types of set-off or counterclaim were excluded.
points to note:
Quite apart from re-affirming the fact that all forms of set-off may be excluded by contract, which is of itself very important, the judgment draws attention to the principal differences between rights of set-off in law and in equity:
- Firstly, the right of set-off at law potentially applies to debts which are unconnected i.e. the debts in question do not have to arise out of the same or closely connected transactions. Set-off at law is therefore a wider right than set-off at equity which only applies to debts which are connected. ‘Connected’ in this sense does not mean that they have to result from the same contract but, equally, just because they are part of a single trading relationship does not guarantee a sufficient degree of connection.
- Secondly, legal set-off only becomes operative at the point of judgement in proceedings being entered and not at an earlier stage. Consequently, this is not some form of ‘self help’ remedy.
- Thirdly, the right of set-off at law only applies to claims for liquidated i.e. certain, ascertained, sums whereas equitable set-off can apply where one or both of the claims is a demand for, as yet, unascertained damages. In such a case, the party concerned may deduct a reasonable assessment of its loss made in good faith.
PETROPLUS v SHELL [2009]
This is another case regarding set-off showing that wording in a payment clause which prohibits any set-off may oblige a buyer to pay an invoice in full notwithstanding that the buyer may have a valid claim against the seller arising from the seller's performance of the same contract.
facts:
- S contracted with P for it to supply S with some oil and the price payable was to be calculated with regard to the market price applicable as at the date of delivery i.e. the date of lading. P was late with delivery and hence the price calculated on this basis increased. S sought to argue that a term should be implied into the contract that P should not be entitled to benefit from its own breach so it could claim a higher price but this argument was dismissed.
- S had elected to exercise a right of set-off by only paying that amount which would have been paid had the oil been delivered on time. This was despite the fact that the contract expressly stated that “payment was to be effected in full without deduction, withholding, offset or counterclaim”.
decision:
The Court said the no set-off provision was effective to prevent S from making any unilateral deduction. S was not precluded from bringing a counterclaim in an action for damages for breach of contract, but the Judge decided that the express payment mechanism should be given effect.
points to note:
- Contractual provisions excluding the ability to exercise a right of set-off are important and should not be ignored since by doing so you may find yourselves in breach of contract if you attempt to withhold payment.
- A right of set-off may be extremely significant particularly in the current economic climate where the continued solvency of a party may be an issue. Possession, as they say, is nine tenths of the law. Having cash in the bank may be very important if the other contracting party then has to make the running to get that money whether through formal court proceedings or otherwise. Where the money is deposited may be the determining factor as to whether or not a dispute is resolved or simply goes away.
- The reality is that parties will often negotiate very strongly to retain an express right of set-off or to expressly exclude any such right. That begs the question - what is the position if the contract does not mention it? Do you need to expressly reserve a right of set-off or exclude such a right? If the contract says nothing, seemingly both legal and equitable rights of set-off will apply. So if you want to exclude or constrain such rights, it is imperative to make this clear in the contract as just omitting any express reference to a right of set-off is unlikely to be effective.
- Conversely, if you want to ensure you have a right of set-off and the contract you are presented with is silent on the point, it may be better to leave it that way. Including an express clause arguably may not improve your position and may simply raise the issue in the mind of the other party who might then seek to expressly exclude the right altogether. However, there may be circumstances where you want to make sure that the right of set-off in equity extends to claims which are entirely unconnected and in such circumstances express wording will be required.
- In any dispute where you are considering withholding payment, consider very carefully whether the right of set-off has been excluded and what constraints, if any, have been placed on the exercise of the right. There will often have to be an assessment as to whether or not the claims are sufficiently connected and in many cases a reasonable assessment of loss will have to be made. These are not easy questions to answer definitively and businesses would be wise to err on the side of caution since notwithstanding clear breaches by the other contracting party, you could find yourself in breach, facing a substantial claim for damages and provide an easy route for the other party to terminate a contract prematurely.