Chapter 40

February 2006

PART 3

40.38 Mutual credit and set-off

For mutual credit and set-off to apply in a liquidation or bankruptcy there must, before the company goes into liquidation or before the commencement of bankruptcy, have been mutual credits, mutual debts or other mutual dealings between the company or the bankrupt and any creditor proving or claiming to prove in the liquidation or bankruptcy [note 1].

The object of insolvency set-off is to do substantial justice between the insolvent and any creditors. It would be unjust if the solvent party had to discharge his/her debt to the insolvent estate in full while being left only with the right to prove and thereby receive a dividend in respect of the debt due to him/her. Insolvency set-off is mandatory and cannot be excluded by agreement between the parties [note 2].

For set-off to arise it is only necessary that there be mutual debts arising from dealings between the same parties in the same capacity. For example, where a bankrupt builder is owed money for building work by a florist, any debt due to the florist by the builder for the supply of flowers can be set off against the debt for the building work done even though the transaction is one of a different nature.

In the same capacity means that a debt owed to a person in a personal capacity cannot be set off against a debt owed by that person in a non-personal capacity, i.e. as a representative for a third party or state. For example, a debt owed by the official receiver for the provision of telephone services to his/her office cannot be set-off against a debt due from that telephone company to an insolvent estate of which he/she is the trustee or liquidator.

An account shall be taken of what is due from each party to the other at the date of the insolvency order in respect of the mutual dealings and the sums due from one party shall be set-off against the sums due from the other [note 3].

Set-off is strictly limited [note 1] [note 3] to mutual claims existing at the relevant date; there can be no set-off in respect of claims by third parties, even with their consent, for to do so would be to allow parties by agreement to subvert the fundamental principle of pari passu distribution of an insolvent’s assets [note 4].

40.39 Mutual credit and set off for companies in liquidation

Rule 4.90 on mutual credits and set off in companies in liquidation was amended with effect from April 2005 to provide greater detail and clarity of meaning, to reflect applicable case law and to harmonise the rule for set off in liquidation with the rule in administration. The rules relating to bankruptcy have not been amended and different provisions are now applicable for mutual credits and set off in insolvent companies and bankruptcy (see paragraph 40.41).

Mutual credits, mutual debts or other mutual dealings does not include [note 5]- 

1. any debt arising out of an obligation incurred at a time when the creditor had notice that a meeting of creditors had been summoned under section 98 or a petition for the winding up of the company was pending;
2. any debt arising out of an obligation where the liquidation was immediately preceded by an administration and at the time the obligation was incurred the creditor had notice that an application for an administration order was pending or a person had given notice of intention to appoint an administrator.
3. any debt arising out of an obligation incurred during an administration which immediately preceded the liquidation.
4. any debt which has been acquired by a creditor by assignment or otherwise, pursuant to an agreement between the creditor and any other party where that agreement was entered into-

(i) after the company went into liquidation;

(ii) at a time when the creditor had notice that a meeting of creditors had been summoned under section 98;

(iii) at a time when the creditor had notice that a winding up petition was pending;

(iv) where the liquidation was immediately preceded by an administration, at a time when the creditor had notice that an application for an administration order was pending or a person had given notice of intention to appoint an administrator; or

(v) during an administration which immediately preceded the liquidation.

40.40 Contingent claims (companies)

Rule 4.90(4) provides for how a contingent debt is to be dealt with for the purposes of mutual credit and set off. Under this rule a sum shall be regarded as being due to or from the company for the purposes of mutual credit and set off whether-

(a) it is payable at present or in the future;

(b) the obligation by virtue of which it is payable is certain or contingent; or

(c) its amount is fixed or liquidated, or is capable of being ascertained by fixed rules or as a matter of opinion.

Where any obligation to or from the company does not bear a certain value as it is subject to a contingency or for any other reason, the official receiver as liquidator should estimate the value and inform the creditor of his/her estimate [note 6]. Only the balance (if any) of the account owed to the creditor is provable in the liquidation. The official receiver as liquidator should deal with every creditors proof [note 7]. Where, after the calculation of the set off account, an amount is owed to the company arising from a contingent debt or a sum payable at a future time, the amount only has to be paid to the liquidator if and when it becomes due and payable.

Where a creditor has proved for a debt of which payment is not due at the date of the declaration of dividend, he/she is entitled to dividend equally with other creditors [note 8], reduced by applying the formula set out in Rule 11.13(2).

40.41 Mutual credit and set off in bankruptcy

In calculating mutual credit and set off the official receiver as trustee should not include sums due from the bankrupt to any creditor for set off if that creditor had notice at the time the debt became due that a bankruptcy petition relating to the bankrupt was pending [note 9]. Only the balance (if any) of the account owed to the creditor is provable as a bankruptcy debt [note 10]

40.42 Contingent claims - bankruptcy

The trustee shall estimate the value of any obligation to or from the bankrupt which, by reason of its being subject to any contingency or for any other reason, does not bear a certain value [note 11]. The provable amount is used in the calculation of any set off [note 12]. Events occurring after the insolvency can be taken into account when assessing the amount that can be set-off. Part 7 provides further details of contingent debts.

40.43 Crown set-off

Pre-insolvency tax liabilities may be subject to the right of Crown set-off [note 13]. The Crown is regarded as a single entity in its dealings, even though various aspects of its affairs may be handled through different Government departments, e.g. prior to the creation of the department of HM Revenue and Customs it was held that debts owing by a company in liquidation to the Inland Revenue and the Department of Social Security could be set off against amounts due to the company from HM Customs and Excise in respect of VAT refunds, because they all represent debts due to and from the Crown [note 14]. Crown set-off also applies against amounts due to the company under contracts for the supply of goods or services, for example contracts with the Ministry of Defence. Where set-off is available to the Crown, amounts withheld from payment to the company in liquidation must be applied pro rata in the reduction of preferential and non-preferential liabilities. In cases where the petition was presented on or after 15 September 2003, however, it should be remembered that there will generally be no preferential status for Crown departments following implementation of EA2002.

Amounts due to the Secretary of State for the Department of Business, Innovation and Skills (BIS) in respect of payments made to employees out of the National Insurance Fund [note 15] can be subject to set-off notwithstanding that the debt was not due and payable on the insolvency date. The Secretary of State for BIS is part of the Crown with whom the insolvent has mutual dealings and the money due is a contingent claim which has become certain after the insolvency order [note12].

40.44 Personal guarantees

(August 2008)

Where a person has guaranteed a debt due from the insolvent they cannot claim set-off in respect of any debt they owe to the insolvent whilst the original creditor is still able to prove as this would be contrary to the rule against double proof (see paragraph 40.37) [note 16].

In the case of Glen Express Ltd [note 16] a company director claimed a right of set-off for his personal debt to the company of around £100,000, in relation to a personal guarantee he had provided regarding the company’s bank borrowing.

At the date of liquidation, the director had not paid the bank under the guarantee but the bank had commenced action against him. There were insufficient assets in the liquidation to discharge the liability owing to the bank and the director would be required to pay the entire bank debt of £170,000 under the guarantee. The director would then be subrogated as the bank guarantor and become a creditor of the company in the sum of £170,000. The director submitted that he should be considered as a contingent creditor for this sum and therefore exonerated as a creditor of the company in respect of the £100,000, a position he would have been entitled to claim had he paid the liability to the bank before the liquidation of the company.

Mr Justice Neuberger rejected the director’s claim, as it would be contrary to the rule of double proof to allow the director to prove for a debt he had not discharged and in respect of which the bank was still entitled to prove. It was also held that no reduction in the claim by the bank could be allowed, in respect of the charge it held over the director’s three properties to secure the guarantee, as this could lead to a burden upon the liquidator in gathering information as to the value of the security and was inconsistent with the intention of the legislation.

[Back to Part 2 - Creditors, petitions and proofs of debt] [Onto Part 4 - Secured creditors ]