Set off in its simplest form is generally understood by legal practitioners and laypersons alike - it refers to the reduction or extinguishment of a claim by a co-existing counter-claim. Thus, if Justinian owes £100 to Gaius and Gaius owes £80 to Justinian, set off can intervene to reduce the co-existing claims to a single claim for £20 owed by Justinian to Gaius.
That's the easy part, but it becomes more complex when set off is broken down into its various sub-categories under English law. Leaving aside "insolvency set off" (which is beyond the scope of this article), "pre-insolvency set off" is sub-categorised as either "legal set off" or "equitable set off". Before analysing the case law, it is worth providing some brief explanation as to the distinction in English law between these two sub-categories (since the distinction arises in the cases referred to)
Legal set off
- Legal set off is the set off of mutual debts which are due and payable in the same right. It has its origin in the Statutes of Set off of 1729 and 1735 (hence the term "legal"). Legal set off is confined solely to debts which are due and payable and which are therefore either liquidated or capable of ascertainment without valuation or estimation.
Equitable set off
- By contrast, equitable set off has its origins in the equitable jurisdiction of the English courts and allows for the set off of cross-claims which may not be due and payable and may not be liquidated or capable of ascertainment in circumstances where the cross-claims are so closely connected that it would not be equitable to allow one claim to survive in whole without its reduction or extinguishment against the counter-claim.
The Amethyst case involved two loan agreements concluded by AMC (as lender) with Amethyst (as borrower). The first loan agreement - referred to as the mezzanine facility agreement (the "MFA") - contained a "no set off or counterclaim" clause in substantively the same terms as the LMA wording set out above. The second loan agreement - referred to as the supplemental loan agreement (the "SLA") - contained a "no set off or counterclaim" clause which was in broadly similar terms to that contained in the MFA with some inconsequential differences.
The MFA and SLA were entered into in connection with the proposed expansion of the business of Amethyst, which was itself a "joint venture company" engaged in the operation of radiotherapy centres. AMC (which was part of the Accession Mezzanine Capital Group of companies) took an equity warrant in Amethyst in consideration of providing the mezzanine facilities documented under the MFA to Amethyst. Accordingly, the transaction documents also included a Shareholders Agreement which comprised obligations on AMC to appoint a CFO to Amethyst, to cooperate in the appointment of a CEO to Amethyst and generally to ensure that Amethyst was run in the best interests of the company. In addition, the parties concluded a business plan for Amethyst which involved the construction or acquisition of a further 13 additional radiotherapy centres. Thereafter, additional debt monies were advanced to Amethyst by AMC pursuant to the terms of the SLA alongside further equity injected into Amethyst by its original shareholders.
Following the conclusion of these arrangements, the relationship between Amethyst and AMC broke-down as a result of a number of disputes arising out of what were perceived as obstructive actions taken by AMC, including the fact that it had not appointed a CFO, had failed to support the appointment of a CEO and had vetoed expenditure on the construction or acquisition of new radiotherapy centres, apparently in breach of the terms of the Shareholders Agreement. Thereafter the parties entered into discussions regarding a possible exit for AMC which would involve the repayment of the loans advanced under the MFA and the SLA, and the sale of AMC's equity interests. These discussions did not reach a successful conclusion and the evidence shows that AMC took steps to block a proposed refinancing arranged by Amethyst which would have redeemed the MFA and SLA indebtedness. Amethyst and its shareholders therefore brought arbitration proceedings against AMC under the terms of the Shareholders Agreement.
It was common-ground between the parties that there were outstanding non-payment defaults under each of the MFA and the SLA as a result of the fact that Amethyst had failed to pay certain amounts on the applicable due dates. AMC therefore brought a claim in the High Court seeking a declaratory order that there were continuing Events of Default under each of the MFA and the SLA and seeking a court order for payment of the unpaid sums due under those documents. Amethyst sought to defend the action on the basis of a number of grounds (each of which was unsuccessful). One of those grounds was a defence that the relevant payments were not in fact due on the applicable payment dates specified because Amethyst was entitled to an equitable set off in respect of the various claims it had brought against AMC arising under the allegedly obstructive actions taken by AMC which were subject to the arbitration proceedings brought under the terms of the Shareholders Agreement. It will be seen that, if a set off existed, then it would be equitable only since the counter-claims which Amethyst sought to plead were contingent on an arbitral award in its favour and, accordingly, they were neither due nor ascertainable so as to constitute a legal set off.
The court had very little difficulty in rejecting this defence on the basis of the "no set off or counterclaim" clause appearing in both the MFA and the SLA, with Butcher J holding as follows:
"The short answer to this is that, even assuming that [Amethyst] has claims which it can bring of that sort against [AMC], it is not entitled to set them off against any payments falling due under the MFA and not entitled to make a deduction from those payments because of such cross-claims. That is the effect of clause 27.6 of the MFA."
In so holding, Butcher J disposed of the argument that the clause applied only to legal set offs and not equitable set offs by referring to each of the Ramot Plana and Caterpillar judgments and citing with approval the following passage from the judgment of Longmore LJ in the Caterpillar case:
"The average businessman who was told that a clause of this kind applied to legal set offs, but not equitable set offs would hardly be able to contain his disbelief."
Whilst the Caterpillar case arose out of a contract for the supply of electricity generators, the Ramot Plana case arose in a financing context and it is therefore worth having a quick look at the facts of that case before moving on to some conclusions and observations as regards the case law.
Ramot Plana involved a loan agreement concluded between Credit Suisse and Ramot Plana for the provision of €20 million refinancing and development finance facilities for a property development 30km from Sofia, Bulgaria. The initial refinancing tranche of €12 million was drawn-down by Ramot Plana, but thereafter it failed to satisfy conditions precedent to the availability of the development tranche by a contractual deadline set out in the loan agreement. This failure entitled Credit Suisse to refuse to allow the development tranche to be drawn-down and to demand immediate repayment of the refinancing tranche.
Credit Suisse brought its case in the High Court seeking an order for payment of the €12 million borrowed by Ramot Plana under the refinancing tranche plus accrued interest. Ramot Plana sought to defend the claim on the grounds that it was entitled to an equitable set off since it was counter-claiming for damages on the basis of the following alleged actions of Credit Suisse:
- That Credit Suisse had rejected a refinancing proposal put forward by Ramot Plana since it did not include an additional circa €12 million which Credit Suisse claimed it was due as a "make-whole amount" under certain profit share and prepayment fee documents signed in connection with the loan agreement.
- That "make-whole amount" was not in fact due and payable and Credit Suisse had accordingly wrongfully claimed for it. Had Credit Suisse not wrongfully claimed this "make whole amount" payment and insisted it was funded as part of the proposed refinancing, Credit Suisse would have been repaid in full in respect of the €12 million drawn facility and accrued interest and would have had no claim to bring in the court.
- Credit Suisse's wrongful insistence on payment of the "make-whole amount" therefore amounted to a breach of duty which had caused Ramot Plana a loss which exceeded the amount claimed by Credit Suisse and therefore extinguished it.
Ramot Plana's case was not assisted by the presence of a "no set off or counterclaim" clause in the loan agreement it concluded with Credit Suisse, which was in precisely the same terms as the equivalent clause in the MFA in the Amethyst case (and was therefore in LMA standard terms). Ramot Plana pled exceptional circumstances largely on the grounds that Credit Suisse should not be entitled to benefit from its alleged wrongful acts as set out above. It therefore sought a stay of execution of the payment claim pending resolution of the counter-claim by the court.
In rejecting this argument, Hamblen J pointed out that such a stay of execution would rarely if ever be granted by the courts and then only in exceptional circumstances. In so-doing he quoted extensively from the judgment of Parker LJ in a Court of Appeal case from 1986 on similar facts, including the following passage:
"The fact that a counterclaim which is likely to succeed existed would not by itself be enough….. It might be that the existence of such a counterclaim coupled with cogent evidence that the bank would, if paid, be unable to meet a judgment on the counterclaim would suffice, but nothing of that nature arises here. This is a simple case where no ground for granting a stay can be shown.”
The case pled by Ramot Plana did not meet the "exceptional circumstances" threshold and so the court declined to grant a stay based on the existence of an equitable set off.
Conclusions and Observations
Neither of the cases summarised above is enormously surprising in outcome as regards the set off questions which arose. However, some interesting conclusions and observations can be made:
- When drafting a "no set off or counterclaim" clause in a contract, it would be prudent to follow the LMA's language in this regard, which the courts have now upheld as being robust in at least two High Court cases. In particular, practitioners should be careful to avoid words such as "due and payable" which might suggest that only legal set offs are precluded by the clause. Equally, use of the phrase "any set off" will be helpful as the cases show that the word "any" will be given its usual meaning and will preclude an argument that an equitable set off is not struck at by the clause.
- The English courts again show themselves to be unwilling to intervene in contracts made between commercial persons where there is clear drafting in the contract which precludes a particular remedy. This principle of the sanctity of contractual terms survives even behaviours which might otherwise appear to be wilfully obstructive, such as those of AMC inferred by the evidence in the Amethyst case.
- The English courts again show themselves to be unwilling to go beyond the four corners of a particular contract to determine an issue even where there are existing closely connected contracts, commercial relationships or factual circumstances that might have a bearing on the issue at hand. Thus, in Amethyst, the court had regard to the terms of the loan agreements in question, including the "no set off or counterclaims" clauses therein, and did not allow itself to become distracted by the alleged defaults under the closely connected shareholders agreement.
- The existence of an equitable set off might be sufficient to defeat the ordinary effect of a "no set off or counterclaim" clause in exceptional circumstances where the court might be prepared to award a stay of execution pending resolution of the counter-claim issue. An example of such an exceptional circumstance might be if a lender under the relevant loan agreement was in fact close to bankruptcy (Lehman Brothers, Northern Rock, Bear Stearns, anyone?) and there was therefore material doubt as to whether the counter-claim was capable of being paid or satisfied by the lender in question absent the set off.
The Scottish Angle
As I have noted in previous epistles, we don't have the concept of "equity" in Scotland and so we don't draw a distinction between legal set off on the one hand and equitable set off on the other. In fact, the term "set off" is not one which has a strict legal meaning in Scots law, although it is generally understood as comprising the following legal rights and remedies:
- Compensation - This arises under the Compensation Act 1592 and allows for the "set off" of debts of the same kind which are each due and liquid and for which there is concursus debiti et crediti (in other words, each party must be debtor and creditor in the same capacity so that, for example, a claim as agent could not be set off against a debt due to the agent in its personal capacity). Compensation does not arise by operation of law, but must be pled as a defence to an action taken. Whilst compensation will ordinarily only apply if the mutual debits and credits are liquid, the Scottish courts have a discretion to allow a set off between a liquid debt and an illiquid debt if the illiquid debt may be made liquid without delay. Compensation is therefore the Scots law equivalent of legal set off and equitable set off in a pre-insolvency context under English law. However, it is probably correct to say that the concept of equitable set off in English law provides a broader range of protection to claimants than that available under the Scots law concept of compensation (since equitable set off is more flexible in terms of illiquid or unascertained claims).
- Retention - This isthe principle that a party to a contract may withhold performance of his or her obligations under the contract if his or her counterparty has not performed his or her obligations under that same contract; and this may be done in reduction or extinction of a debt due.
- Balancing of accounts in bankruptcy - These common law rules apply where one party is bankrupt or in liquidation, and they take precedence to compensation under the 1592 Act so that it is possible to set off an illiquid claim against a liquid claim. Accordingly, an unascertained or contingent debt due by the bankrupt person can be set off against a present debt due to the bankrupt person.
Notwithstanding these differences, it seems unlikely that a Scottish court would reach a different conclusion to those reached by the High Court in England in the Amethyst and Ramot Plana cases. Compensation is a very specific right which must be pled as a defence in a court action for a debt due. If there is a clause under a contract under which set off or counterclaim is prohibited then it is difficult to see a Scottish court allowing a claim for compensation to be brought in any event in clear contravention of the terms of the contract absent exceptional circumstances. Indeed the English cases are in line with a previous judgment of the Outer House of the Court of Session in Scotland which found that a right of set off (or compensation under the 1592 Act) pled in respect of a sum payable by an employer to a developer under a building contract so as to extinguish the developer's claim for the sum due was excluded by the clear terms of the contract.