Demystifying set-
off in commercial
transactions
Dr William A.J. Higgs
Barrister at Law
Elizabeth St Chambers
Alex Chernishev
Senior Associate
Mills Oakley
Scope
What is set-off?
Core concepts
Complexities
Scope (2)
Principles
Practical applications – by Examples
What is Set-off? (1)
Some pedantry:
set-off = noun
set off = verb
“It is not worth spending too much time on definitions
of this sort. A definition wide enough to catch
everything becomes so woolly as to miss the pith. A
definition narrowed to the essence is incomplete”.
Wood, English and International Set-off
(1989)
What is Set-off? (2)
“In substance, however, where a creditor claims a debt
from his debtor and the debtor has a cross-claim on the
creditor, then, if the debtor can reduce or extinguish
the amount of the creditor’s claim by his cross-claim,
the debtor is said to set off. The set-off operates as a
double payment or discharge of the reciprocal claims.”
Ibid.
What is Set-off?(3)
B
(pays $80; receives $20 and pays $100)
A
(receives $80;receives $100 & pays $20)
Claim
$100
Cross-claim
$20
What is Set-off? (4)
Securitisation transaction
Originator
Bank
(assignor)
debtor Issuer
(assignee)
Deposit
$20
Loan
(P&I)
$100
Insolvency
official
$100
$80
How tricky is that, then?
Apples and pears: non-monetary obligations; different
currencies
Unmatured or contingent claims
Reciprocity
3rd parties and other interveners
Why does it matter?
Credit risk
Settlement risk
Regulatory capital
Accounting
A
B
GBP USD
A
B
Deposit Loan
A
B
Deposit Guarantee or
ISDA Master
A
B
Deposit Loan
C,D,ESharing payment
Some key distinctions (1)
security v. self-help
- i.e., right in rem v. personal right
“sword” v. “shield”
- i.e., substantive defence v. procedural defence
Some key distinctions (2)
solvent set-off v. insolvency set-off
mandatory set-off v. voluntary set-off
money claims v. other claims
- distinguish set-off from counterclaim
Types of set-off
contractual set-off
Statutory set-off
Insolvency set-off; and
Equitable set-off
Types of set-off
contractual set-off
Statutory set-off
Insolvency set-off; and
Equitable set-off
Types of set-off
contractual set-off
Statutory set-off
Insolvency set-off; and
Equitable set-off
Types of set-off
contractual set-off
Statutory set-off
Insolvency set-off; and
Equitable set-off
Sons, sisters, friends
security interests
charge-backs
payment (or settlement) netting
netting by novation
Core concepts
mutuality
“due” claims/cross-claims
executory contracts
choice (and conflicts) of law
Mutuality (1)
“one man’s money shall not be applied to pay another
man’s debt” Wigram V-C in Jones v. Mossop [1844]
“same name; same right”
each of the two parties must [solely?] beneficially own
the debt owed to it and be [solely?] personally liable for
the debt owed by it
Mutuality (2)
time for mutuality
trusts
joint creditors and debtors
creating mutuality through guarantees and co-primary
obligor arrangements
Bank
Corporate
Borrower
Loan
Personal
GuarantorDeposit
Guarantee
What is “due”?
matured debts
reciprocity: does it matter whether claim matures
before or after cross-claim?
liquidated damages
contingent, unascertained and unmatured claims
Executory contracts
executory on one or both sides
damages or equitable remedies?
repudiation and disclaimer
Ince Hall Rolling Mills Ltd. v. Douglas Forge Co. [1882]
Contracting out
payments free and clear and set-off waiver
different products, different practices
inconsistency and conflicts
British Eagle [1975] and SSL Realisations (Squires &
others v. AIG Europe) [2006]
is it reasonable? Stewart Gill v. Horatio Myer [1992]
Insolvency set-off
is set-off good or bad?
different countries, different entities
administration: a limbo state
Examples
Example 1
BANK
CUSTOMER
Assignment
Deposit DebtLoan Debtset-
off?
Example 2
ASSIGNOR
CUSTOMER
Deposit
Debtset-
off?
BANK
set-
off?
Loan
Debt
(Legal)Loan Debt
(Equitable)
Cross-claim
Equitable
Assignment or
Declaration of
Trust of Loan
Example 3
BANK
CUSTOMER
Assignment
ISDA SwapLoan Debtset-
off?
Example 4
BANK
CUSTOMER
PARENT
Collateral
Return
Loan
Debt
set-
off?
security?
CUSTOMER
G/EE
Example 5
BANK
CUSTOMER
Secured Loan
Debt + Mortgage 100
(Mortgage Value 110)
Unsecured
Unguaranteed
Loan Debt 100
Deposit Debt 100
Rateable or selective
set-off?