Rights of set-off and their exclusion
CIS v IBM (High Court) [2021]
Rights of set-off can be incredibly important in the context of contractual disputes. For that reason, supplier drafted terms and conditions often try to exclude rights of set-off entirely whilst customer drafted contracts often try to extend rights of set-off that apply at common law and by virtue of equity. It is important to understand that there are two distinct rights of set-off each of which have their own rules and scope of application. The two rights are known respectively as ‘legal’ and ‘equitable’ set-off rights, the latter of which is much broader and arguably more valuable since it applies at an early stage before legal proceedings have commenced. The CIS case contained a very useful discussion of equitable set-off rights
Facts:
The Agreement that CIS entered into with IBM provided for various interim, milestone payments. Paragraph 11.7 of Schedule 5 stated that “Unless the Customer disputes an invoice in good faith in accordance with paragraphs 11.11 and 11.12 of this Schedule 5 (Charges), the Customer shall pay correctly prepared invoices properly submitted in relation to payments to be made under this Agreement within seven (7) Business Days of receipt.”
Paragraph 11.11 said “…The Customer shall within seven (7) Business Days of receipt of an invoice notify the Supplier in writing if it disputes any element of the invoice with details of the amounts (Disputed Amount) and reasons for disputing the relevant part of the invoice.” Paragraph 11.12 stated “Provided the Customer has given the notice in paragraph 11.11, the Customer may withhold payment of [the Disputed Amount] ...”
When IBM raised an invoice and CIS failed to pay it, IBM purported to terminate. CIS argued that it was not obliged to make payment because it had validly exercised its right to set-off its own unliquidated (i.e. unquantified) claim for damages arising out of the delay to the implementation of the IT system against the invoice.
Decision:
The court summarised the legal position on excluding rights of set-off by wording included in a contract. It said “clear words [are] required if rights of set-off are to be excluded” and the language must be unambiguous. However, the court said that a distinction should be drawn between a clause which completely excludes a right of set-off and a clause, such as the one in issue here, which simply makes exercising the right of set-off conditional upon giving notice. In the latter case it seems that slightly greater flexibility is allowed in the drafting. The starting point, however, in all cases is a presumption that the parties have retained all remedies for breach of contract, including any equitable rights of set-off.
In this particular case, the court was satisfied that the combined effect of the quoted paragraphs, read together, was clear and unambiguous and introduced a ‘pay now, argue later’ principle. They did not exclude any right of set-off entirely but restricted the exercise of such set-off rights to those invoices in respect of which a valid notice of dispute had been given within seven business days.
It was made clear that the effect of the clause was that if CIS had failed to validly dispute the invoice within the specified period it would have to pay over the money but would still have been perfectly entitled to dispute the payment obligation and to raise a counterclaim.
The court found that CIS had disputed the relevant invoice within the prescribed period sufficient to allow it to exercise the equitable right of set-off and validly withhold payment.
Points to Note:
- The court repeated the conditions necessary for a successful set-off in equity
- it must be "manifestly unjust" for the claim to be enforced without regard to the cross-claim;
- there must be a close relationship between the dealings and transactions which gave rise to the respective claims i.e. arising out of the same transaction or one very closely connected.
- An equitable set-off can be relied upon outside the context of court proceedings as an immediate answer to a liability to pay money otherwise due and to the exercise of [termination] rights which are contingent on such non-payment.
- An equitable set-off can also be exercised in respect of an unliquidated / unquantified claim provided the sum deducted is a reasonable assessment of the loss made in good faith.