RIGHT OF SET-OFF
40.160 Right of set-off – general
Where, before a company goes into liquidation [note 1] or a bankruptcy order is made, there have been mutual credits, mutual debts or other mutual dealings (see paragraph 40.164) between the insolvent and any creditor of the insolvent proving or claiming to prove for a debt, an account must be taken by the official receiver, as liquidator or trustee, of what is due from each party to the other in respect of the mutual dealings and the sums due from one party to the other must be set-off [note 2] [note 3].
The balance, if any, once the account has been taken, is provable as a debt in the bankruptcy [note 4] [note 5].
By way of summary example, therefore, if a creditor owes an insolvent £1,000 and the insolvent owes that same creditor £1,500, the two amounts will be set-off and the provable debt would be £500, being the difference between £1,500 and £1,000.
Guidance on set-off in relation to PPI claims is provided in Chapter 31.9, Part 5.
40.161 Right of set-off – balance due to the estate
It is possible for the provisions relating to the right of set-off (see paragraph 40.160) to operate to reduce a book debtor’s liability to an insolvent estate (see Chapter 31.1, paragraph 31.1.3).
See also Chapter 31.9, Part 5 regarding the right of set-off and claims for the mis-selling of Payment Protection Insurance (PPI).
40.162 Right of set-off – purpose of the provisions
The purpose of the provisions relating to insolvency set-off are to do substantial justice between the insolvent and his/her creditors [note 6]. It would be unjust if the creditor had to discharge his/her debt to the insolvent in full while being left only with the right to prove and perhaps eventually 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 7].
40.164 Mutual credits, mutual debts or other mutual dealings
The legislation requires that, for set-off to take effect there have to have been mutual credits, mutual debts or other mutual dealings between the parties.
Mutual credits arise where one or both parties to a transaction allow the other party to pay the sum due at a later date or on the occurrence of an agreed event [note 8].
Mutual debts arise where the insolvent and the other party owe each other a sum due payable now or in the future [note 9].
40.165 Mutual credits, mutual debts or other mutual dealings – exceptions in companies
The legislation provides that in a liquidation mutual credits, mutual debts and mutual dealings (see paragraph 40.164) shall not include [note 10]:
40.166 Mutual credits, mutual debts or other mutual dealings – exceptions in bankruptcies
The legislation provides that in a bankruptcy mutual credits, mutual debts and mutual dealings (see paragraph 40.164) shall not include sums where the sum became due in knowledge that a bankruptcy petition had been presented [note 12].
40.167 No set-off where debt assigned with prior notice of ‘insolvency’ – company only
There can be no right of set-off, in liquidation, in respect of 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 [note 13]:
40.168 No mutuality where a debt has been assigned
In addition to the company restrictions in paragraph 40.167, where a debt owing by or to the insolvent has been assigned to a third party, and that third party has no other dealings with the insolvent, there can be no mutuality and, therefore, no right of set-off [note 15] [note 16] [note 17].
40.169 Requirement for mutual dealings in the same capacity
In order for the provisions relating to insolvency set-off to apply, the dealings between the insolvent and the creditor must have been in the same capacity [note 18]. For example, where a bankrupt that is a builder did work for a florist, any sum due to the builder by the florist for that work would be off-set against monies owed by the builder to the florist for the provision of flowers, as they were both acting in a personal capacity.
If, however, the florist were acting as an executor of a will in relation to which the builder was a beneficiary and the builder did work on the florist’s property, the debt for the work carried out would not be off-set against the monies due under the will as the florist does not owe those monies personally, but in his/her capacity as executor [note 19].
40.170 Right of set-off cannot apply to third parties
The debts of third parties cannot be set-off, even with their consent, as to do so would be to allow the parties, by agreement, to subvert the fundamental principle of pari passu distribution of an insolvent’s assets [note 20].
For example, where a bankrupt had work carried out by a builder, any sum due to the builder by the bankrupt for that work could not be off-set against monies owed to the bankrupt by the builder’s wife, even with the builder’s agreement.
40.171 Mutual rights must exist at date of order
For insolvency set-off to apply there must have been mutuality of obligation (see paragraph 40.164) at the date of the insolvency order [note 21] [note 22].
A debt owed to the bankrupt by a bankruptcy creditor arising after bankruptcy cannot therefore be off-set against a bankruptcy debt owed by the bankrupt to that creditor [note 23].
40.172 Contingent claims and unliquidated claims
Contingent claims and unliquidated claims (see paragraph 40.9) can be included in a right of set-off [note 24]. The official receiver, as liquidator or trustee will be required to put a value to such claims in order that an account can be taken of them for the purposes of set-off [note 25] [note 26] [note 27].
Where, after calculation of the set-off account, an amount is owed to the insolvent arising from a contingent debt or sum payable at a future time, the amount due only has to be paid if and when it becomes due and payable.
For the purposes of the insolvency set-off provisions, the Crown is considered a single entity, even though various aspects of its affairs may be handled through different departments of the Government [note 28] [note 29] [note 30].
Crown set-off would apply to all provable debts due to or from the Crown, whether they arise through legislation (tax liabilities, for example), or contract (through a Government procurement, for example).
Amounts due to the Secretary of State in respect of payments made to employees out of the National Insurance Fund (see Chapter 76, Part 2) can be subject to set-off notwithstanding that the debt was not due and payable to the Secretary of State at the date of the insolvency. This is because the debt is considered to be contingent (see paragraph 40.9) [note 31].
40.174 Set-off where preferential and non-preferential debts
Where set-off applies in respect of a creditor that has both a preferential claim (see Part 4) and a non-preferential claim, the amount due to the creditor must be applied pro-rata to the different categories of debt to arrive at the provable amount [note 32].
40.175 Set-off and rule regarding double proofs
The rule regarding double proof (see paragraph 40.18) would apply in respect of insolvency set-off. A guarantee creditor cannot therefore apply set-off unless he/she has discharged the principal creditor’s liability [note 33].
Where, for example a director of a company in liquidation owed the company £100,000, he/she could not claim right of set-off in respect of a guarantee for £100,000 given to the bank for the company’s indebtedness unless he/she had discharged the debt due under the guarantee.
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