Annex G Set-off

February 2012

Annex G Set-off

Note: Annex G contains the information previously included at Chapter 36 Part 8, paragraphs 36.108 to 36.120.  This information will be incorporated into Chapter 40 at a future date.

1. Credit and set-off (formerly paragraph 36.108)

The right of set-off applies where, before a company goes into liquidation or the commencement of the bankruptcy, there have been mutual credits, mutual debts or other mutual dealings between the company or bankrupt and any creditor proving, or claiming to prove, for a debt in the liquidation or a bankruptcy debt [Note 1] [Note 2]. If there is no mutuality between the parties, then the right of set-off does not apply Re Morris and Others v Rayners Enterprises Incorporated and Another, Same v Agrichemicals Ltd and Others: The Times 13 November 1997 [Note 3].  An account must be taken of what is due from each party to the other in respect of the mutual dealings and the sums due from one party must be set-off against sums due from the other [Note 4][Note 5].

The right of set-off takes priority before any distribution is made to any class of creditor.  Information as to when set-off cannot be applied is included at paragraphs 2 and 3.

2. Restrictions on set-off (notice received of pending insolvency) (formerly 36.109)

All provable claims, provided there is mutuality, may be the subject of set-off. However, for both company and bankruptcy cases, sums due from the company or bankrupt to another party shall not be included in the account if the other party had notice at the time the debt was incurred that a creditors’ meeting under section 98 IA86 had been called or a petition for the winding up of the company was pending or a bankruptcy petition relating to the bankrupt was pending [Note 6] [Note 7].

3. Other set-off exclusions (formerly 36.110)

In company cases other mutual credits, debts or dealings which are excluded from the right of set-off are as follows;

  • Debts arising out of an obligation where the liquidation was immediately preceded by an administration[Note 8], or the creditor had notice at the time the debt was incurred that an application for an administration order was pending or notice given of an individual’s intention to appoint an administrator[Note 9].
  • Any debt arising out of an obligation incurred during an administration which immediately preceded the liquidation [Note 10].
  • Any assigned or acquired debt where the agreement  to assign the debt was entered into either after the company went in to liquidation or at a time when the creditor had notice that a meeting of creditors under section 98 had been called. Also where the assignment occurred at a time when the creditor had notice that a winding-up petition was pending or during an administration which immediately preceded the liquidation [Note 11].

4. Future and contingent liabilities  

In addition to present debts, future liabilities can also be off-set where mutuality is established (see paragraph 1 for information on mutuality)[Note 12][Note 13]. Contingent obligations for liabilities,  and amounts capable of being fixed, liquidated or ascertained by fixed rules or as a matter of opinion are also eligible to be off-set where mutuality is established [Note 12].

5. Balance after set-off is provable in the proceedings (formerly 36.111)

Only the balance (if any) of the account, after set-off, is provable as a liquidation/ bankruptcy debt or, is claimable by the liquidator/trustee as part of the estate assets[Note 14][Note 15]. The right of set-off is intended to do substantial justice between parties and it is not limited to particular categories of claim but applies to all cross claims provided they are mutual and measurable in money terms.

6. Secured creditors not required to set-off (unless security is given up) (formerly 36.112)

The holder of a secured debt is not required by rule 4.90 IR86 to set-off money owed by the company to him/her against that debt, due to the fact that he/she is relying on their security, therefore will not prove in the insolvency proceedings Re Norman Holding Company Ltd [1991] 1 WLR 10 [1991] BCC 11 [Note 16]. If a secured creditor relinquishes the security over their debt deciding instead to prove in the proceedings,  where there is proven mutuality between the parties as detailed at paragraph 36.108,  the proved debt could then be off-set against any sums owed to the company by the (formerly secured) creditor. Set off will only apply where the creditor elects to prove for the secured debt in the proceedings, until that point set off will not apply.

7. Contributories (formerly 36.113)

A shareholder cannot set the liability to calls against any sums that may be due to him from the company Re Whitehouse & Co (1878) 9 Ch 595 [Note 17]   Where set-off is applied against sums due to a creditor whose claims are partly preferential and partly non-preferential, the preferential and non-preferential claims must be abated pro-rata Re Unit 2 Windows Ltd (1985) 1 WLR 1383, [1980-90] IJ 467 [Note 18].

An example of this would be where a company goes into liquidation owing an  employee(creditor) remuneration totalling £4,000 in respect of the 4 month period prior to the date of the winding-up order. This element of the remuneration owed to the employee is a preferential debt.  The employee(creditor) is also owed remuneration totalling £1,000 in respect of a 1 month period preceding the 4 month period prior to the date of the winding-up order.  This element of the remuneration owed to the employee is an ordinary unsecured debt and is not preferential.

At the same time the employee is a debtor owing money to the company, as at the date of liquidation he owes for an advance loan from the company of £5,000, used to purchase a travel season ticket. 

The company has sufficient assets to meet the claims of preferential creditors but has insufficient assets to pay ordinary unsecured creditors.

The employee can only off-set the debt he owes (£5,000) pro-rata against the preferential (£4,000) and non-preferential (£1,000) elements of the debt owed to him.   In this case, as the company can only meet the claims of preferential creditors, this means that the preferential element of the debt owed to him (£4,000) can be offset against his debt to the company, which will be to the benefit of the claims of the other preferential creditors.

8. Crown set-off and the case of SoS v Frid (formerly 36.115)

The position regarding the right of Crown set-off was considered by the House of Lords in the case of Secretary of State v Frid [2004], UKHL 24 [Note 19]. In that case, under Crown set-off, the Secretary of State took a share in a VAT credit due to the company at the date of voluntary liquidation for payments she had made to employees of the company under the Employment Rights Act 1986, and accordingly submitted a proof in the liquidation for a reduced amount. The liquidator rejected the proof, saying that was she not entitled to receive any part of the VAT credit under set-off as the debt did not exist at the date of voluntary liquidation, the company then still being liable to pay the employees. The House of Lords rejected the liquidator’s claim, stating that it was sufficient only that there should have been a statutory obligation on the Secretary of State by which a debt would become payable upon the occurrence of some future event. They also considered whether, in the circumstances of the case, there had been mutual debts or dealings as required under rule 4.90. It was stated that ‘mutual debts’ as required by rule 4.90 [Note 2] means only that there have to be cross obligations that are capable of being expressed in money between the same people in the same capacity. Further for ‘mutual dealings’, all that was required were dealings in an extended sense, including, for example, the imposition of a statutory obligation as here. As the Crown was in this case the beneficial owner of all central funds,  acting as both creditor and debtor via its different departments, the claims to the sums in question on either side were both claims due to and owed by the Crown and therefore there was no lack of mutuality and set off applied. 

9. HM Revenue and Customs statutory concession (formerly 36.116)

H M Revenue and Customs have published an extra statutory concession whereby their powers of set-off in the Finance Act 1988 will only be enforced in a limited way. Since 1998 HM Revenue and Customs have automatically offered any pre-insolvency credit of £500 or more to other Government Departments for the purposes of set-off.

Section 81(3) of the Value Added Tax Act 1994 states that any interest payable by HM Revenue and Customs due under that Act should be treated as a VAT credit and can be set-off against  any payment due to HM Revenue and Customs where the interest became due to the insolvent:

  • at a time when the estate was vested in the trustee in bankruptcy;
  • at a time when the estate was vested in an interim trustee or permanent trustee;
  • at a time, other than a time before the appointment of a liquidator, when that insolvent was being wound up, either voluntarily or by the court;
  • at a time when there was an administration order in force;
  • at a time when there was an administrative receiver of the insolvent;
  • at a time when a voluntary arrangement was in force; or
  • at a time when the estate was vested in a trustee under a trust deed; this right of set-off is not available and the interest should be paid to the estate.

10. Set-off where there has been an overpayment of tax credits (formerly 36.117)

Where a bankrupt has been in receipt of tax credits, an overpayment may be made and thereafter a recovery may be sought by HM Revenue and Customs. That recovery may be achieved by deductions made from ongoing awards of tax credits or by direct collection where there is no ongoing award of tax credits or where the ongoing award has ceased.   Where appropriate, HM Revenue and Customs will claim set-off in respect of monies it owes to a bankrupt to reduce or extinguish the indebtedness for overpaid tax credits [Note 1]. Reference should also be made to the following notice T19-07 - Bankruptcy; recovery of overpayments of state benefits; dealing with overpayments in bankruptcy

11. Liquidator/trustee applying set-off (formerly 36.118)

A liquidator or trustee who receives a sum of money from a Crown Department and also holds a claim from another Crown department would be expected to consider whether mandatory set-off under the Insolvency Act 1986 applies[Note 2][Note 1].

Unless the Crown specifically agrees that set-off should not be applied (e.g. as the amount to be set-off is beneath the agreed minimum amount), a liquidator or trustee who is aware that set-off has not been applied in this circumstance and has distributed funds to creditors,  has misapplied the funds, and could be compelled to repay, restore or account for the money or property with interest at such rate as the court thinks fit or to contribute compensation to the company [Note 20] or bankrupt [Note 21].

12. Banks (formerly 36.119)

The official receiver should request the bank to forward any credit balance held in an account to him/her immediately (subject to the release of funds to the bankrupt for day-to-day living expenses, as detailed at Chapter 31.5, paragraph 31.5.21). The bank may seek to apply set-off using the credit balance to discharge either liabilities owed to the bank; e.g. credit card debts, or debts due under a loan etc. If set-off is claimed,  the official receiver in his/her capacity as liquidator or trustee, should first verify whether the right of set-off exists prior to making any payment to return funds to the bank or seeking to recover funds from the bank. In this example, the credit card must have been signed and operated by the date concerned.

13. Partnerships (formerly 36.120)

A claim by a third party against a partnership cannot be the subject of set-off against a cross demand or cross demands of one or more partners Re Watts v Christie (1849) 11 Beav 546 [Note 22]. A joint debt owed by a partnership to a third party cannot be apportioned and applied by way of set-off against several debts owed to the partners in their individual capacities Re Ex p Christie (1804) 10 Ves 105 [Note 23].


End of Annex G