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?