When you can set off one debt against another

If two parties have monetary claims against one another, they may be entitled to claim a right of set-off, as a result of which the liability of one to the other may be reduced or eliminated altogether.

Although this may seem obvious, straightforward and fair, the courts do not necessarily apply it automatically.

The law generally recognises four main rights of set-off:

• Contractual set-off where a right of set-off is contained in the agreement.
• Insolvency set-off, where the right arises under the Insolvency Rules 1986.
• Legal set-off where the respective claims are (a) due and payable and (b) fixed or at least ascertainable.
• Equitable set-off where the respective claims are so closely connected that it would be unjust to allow one of them to be enforced in precedence over the other.

Each of these rights is subject to its own limits:

With contractual set-off, the issue is most likely to be the wording of the contractual clause in question. Commonly a right of set-off (legal or equitable) is in fact excluded although insolvency set-off is not capable of exclusion.
In order for insolvency set-off to apply, there need to have been mutual credits, mutual debts or other mutual dealings between the insolvent company and the creditor, although the extent to which insolvency set-off can apply in relation to companies in administration is limited.

A recent reported decision of the High Court shows some of the limitations of legal and equitable set-off arguments.

• A father sued his son in order to recover repayment of a loan. The son defended the claim and brought a counterclaim, arguing that his father owed him money in respect of rental income from a property in Turkey. The son claimed both legal and equitable set-off rights.
• The court declined to permit set-off on either ground.
• In the case of legal set-off the son’s argument failed because the amount of his claim was uncertain.
• In the case of equitable set-off the son argued that the claims were closely connected because of the familial relationship. The court rejected that argument. The connection needed to relate to the claims not the parties making those claims.

Equitable set-off arguments are frequently successful where claims arise out of the same contract but where that is not the case, the close connection requirement presents a significant barrier to success.

In situations where the claim is not fixed or ascertained either, then in the absence of contractual set-off rights, a party seeking to argue for set-off may be in some difficulty.

This article is provided free of charge for information purposes only; it does not constitute legal advice and should not be relied on as such. No responsibility for the accuracy and/or correctness of the information and commentary set out in the article, or for any consequences of relying on it, is assumed or accepted by Field Seymour Parkes LLP.