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When can one claim be set off against another? Does it “vary according to the length of the Lord Chancellor’s foot” or is there a better test?


The facts

The facts in Geldof Metaalconstructie NV v Simon Carves Limited [2010] EWCA Civ 667, decided by the Court of Appeal in June 2010, were an example of a very common commercial scenario, namely one party seeking to set off its claims against another’s.  The practical lessons are listed at the end of this blog.

Simon Carves Limited (“SCL”) was the main contractor for the building of a bio ethanol plant in Teesside.  SCL and Geldof agreed 2 separate contracts for the purchase of pressure vessels and the installation of storage tanks.  Other than that both the pressure vessels and the storage tanks were necessary ingredients of the bio ethanol plant, there was no connection between the supply and the installation.  SCL alleged that Geldof was in breach of the installation contract by failing to proceed regularly and diligently.

The question the Court of Appeal had to decide was whether SCL was entitled to set off its claims against Geldof’s claim for the money owed to it so that Geldof would have to wait to a full trial for a final decision on all of the claims which may be some time away and when each of the parties’ claims would probably be netted off against each other in whatever amount the claims succeeded.

One might think that circumstances similar to the Geldof / SCL dispute are so common that the law in this area (known as “equitable set off”) would be clear and well established.  However, that is not the case. Over the years the Courts had used different wordings for tests which were sometimes unhelpful, incorrect or used outdated language. In the words of one previous Judge “This defence does not vary according to the length of the Lord Chancellor’s foot”. In other words the test ought to be fair, known to all and predictable.

The test

The Court of Appeal said that the best restatement of the test and the one to follow was made by Lord Denning in Federal Commerce and Navigation Co Limited v Molena Alpha Inc [1978] 2 QB 927, known as the “Nanfri”.  This was that equitable set-off was permitted for “cross-claims … so closely connected with [the Plaintiff’s] demands that it would be manifestly unjust to allow him to enforce payment without taking into account the cross-claim”.

The decision

The application of the test in Geldof may be some measure of whether the Court of Appeal has achieved its objective of justice in individual cases coupled with predictability.  The Court found that Geldof, by insisting on the payment of the supply contract invoices as a pre-condition of returning to work on the installation contract, was itself connecting the 2 contracts.  Thus it fell within the test for equitable set off.

The Court also relied on the practical links between the 2 contracts, even if they were formally separate contracts.  Firstly, both supply contract and installation contract were in their separate ways dedicated to the bio ethanol plant project.  Secondly, the vessels to be supplied under the supply contract were no use to SCL unless the installation was properly performed.  Thirdly, the warranty under the supply contract was linked to practical completion of the plant and that could not occur without proper performance of the installation contract.  Fourthly, it would not be fair for Geldof to be able to enforce payment under the supply contract, especially payment to be triggered by the arrival of the vessels at the plant site, if SCL’s responsibilities to the main plant contractor were prejudiced by Geldof’s repudiation of its performance obligations under the installation contract.

The case mostly concerned equitable set off but SCL also argued it was entitled to set off because of the terms of the contract. The supply contract contained the right for SCL to set off “any amounts lawfully due from the Supplier to the Purchaser whether under this Purchase Order or otherwise”.  There was an argument about the meaning and effect of that provision.  However, the Court of Appeal ruled “belt and braces” in favour of SCL by deciding that SCL was also entitled to set off because of this contractual term.

Practical lessons

 1. Set off is extremely important to business. The Court acknowledged that set off regulates the extent to which disputed claims can be used to protect the cash flow of a business faced by a demand which may otherwise have to be met immediately.

2. Even though the Court of Appeal eventually found that SCL’s set off fell within the contract terms, SCL had to go to the Court of Appeal to obtain that finding and the Court itself admitted that it was a finely balanced decision on this point.  Set off (and anti set off) provisions need to be carefully drafted to ensure that they are enforceable. The contract should not be drafted in isolation, but considering the whole of the current and likely future relationship between the parties.

3. Had the contract contained an effective anti-set off provision, SCL may not have been able to argue set off as it did.

4. The Court attributed a considerable amount of importance to the fact that Geldof had itself made a connection between the contracts in its behaviour when the dispute arose by refusing to continue work on one contract when its invoices on the other were unpaid.  In this case the “practical links” between the contracts may have caused the Court to find in SCL’s favour in any event, but it seems that Geldof’s own behaviour may have sealed its fate.  What may have seemed like a pragmatic response at the time can backfire. Legal advice on tactics at the very outset can often save costs and result in a better outcome in the long run. 

5. Notwithstanding the Court of Appeal’s lengthy review of the authorities and endorsement of the test stated by Lord Denning in 1978 and helpful clarification, it will still not always be certain in which circumstances “cross-claims [are] … so closely connected with [the Plaintiff’s] demands that it would be manifestly unjust to allow him to enforce payment without taking into account the cross-claim”.  That still involves a significant amount of judicial discretion, so we will still not always be completely sure how long the Lord Chancellor’s foot is.

If you have any questions about setting off claims (either achieving it or preventing it) or any other questions about commercial disputes, please contact John Mackle who is a Senior Associate in the litigation department at Clarion on 0113 336 3336 or john.mackle@clarionsolicitors.com or another member of the litigation department on 0113 246 0622 or via our website.

Disclaimer: Anything posted on this blog is for general information only and is not intended to provide legal advice on any general or specific matter. Please refer to our terms and conditions for further information. Please contact the author of the blog if you would like to discuss the issues raised.