THE REFERENCE

1.1 On 26 September 1997 the New South Wales Law Reform Commission received a reference from the Attorney General, the Honourable J W Shaw, QC, MLC, as follows:

1. To review the current law relating to set-off with a view to determining whether any change is needed.

2. In undertaking the review the Commission should have regard to the law relating to set-off that existed prior to the Imperial Acts Application Act 1969 and to judicial comment on the operation of the provisions in this Act relating to set-off.

1.2 This reference was made following a request from Justice K R Handley that consideration be given to rectifying the situation caused by the repeal of the Statutes of Set-off¹ by the Imperial Acts Application Act 1969 (NSW). Justice Handley’s view was that the repeal had been a mistake.²

DEFINITION OF SET-OFF

1.3 Set-off, at its most basic, is a mechanism whereby one party can apply a debt owed to him or her by another party to discharge all or part of a debt that he or she owes to that other party.³ The result is either that the debt is completely discharged, or a sum remains which represents the balance of the debt owed by one of the parties to the other.⁴ Although sometimes invoked as a self help remedy, it is usually applied as a countervailing claim in answer to a plaintiff’s claim in proceedings before a court. In the context of such proceedings set-off is quite different from counterclaim.

Comparison with counterclaim

1.4 While set-off as a plea in bar is a defence in whole or in part to a claim, counterclaim is merely a procedural device (involving cross-claim) whereby actions by one party against the another and vice versa are heard as part of the one proceeding. Such actions are treated essentially as distinct actions, including for the purposes of striking out, summary judgment⁵ and costs in the proceeding.⁶ Although the economic result of counterclaim will often be the same as the one which would be achieved by set-off, the result of a hearing involving claim and counterclaim is separate judgments for each party against the other,⁷ whereas a single judgment only is issued when set-off is pleaded.

TYPES OF SET-OFF

1.5 Traditionally there have been three basic types of set-off:⁸

• contractual set-off;
• set-off provided for by statute; and
• equitable set-off.

There are also some related remedies and procedures which cannot necessarily be said to be a type of set-off, but are analogous in certain respects.

Contractual set-off

1.6 Contractual set-off, or set-off by agreement, arises in the same manner as any other contractual term would, for example, expressly, by implications, from course of conduct, or by custom. The availability of this form of set-off is useful in circumstances where other forms of set-off are not available. Set-off by agreement has been recognised in New South Wales as not depending on any statutory foundation, but as being “in law equivalent to actual payment on each side”.⁹

1.7 A related issue is that of netting in financial market transactions, which has been the subject of a report of the Netting Sub-Committee of the Companies and Securities Advisory Committee.¹⁰ The report deals with two specific types of netting, namely bilateral close-out netting and market netting. Bilateral close-out netting, which is used in financial markets transactions, is described as:

a process which permits a party to a financial contract to terminate the contract if the counterparty becomes insolvent, to calculate the termination values of the obligations of the parties, and to set off the termination values so calculated to arrive at a net amount payable by one party to the other.¹¹

1.8 Market netting, which typically arises under the rules of a stock exchange, futures exchange or clearing house, commonly involves:

the novation to a clearing entity of contracts entered into by exchange members and the setting off of obligations under those contracts in the event of default by the member and for the purposes of settlement.¹²

1.9 Notwithstanding the advice of some experienced lawyers that there was no basis for doubting the effectiveness of such netting arrangements, the prime concern of the report was to ensure their effectiveness in the event of the insolvency of one of the parties.¹³ Draft legislation has been framed to achieve this so that the operation of close-out and market netting provisions would be confirmed notwithstanding the insolvency of one of the parties “on the basis that recovery of the net sum calculated under the netting provisions would be subject to the normal insolvency rules”.¹⁴

1.10 The operation of the proposed financial markets legislation is clearly within the Commonwealth’s field of legislative competence and is principally concerned with ensuring that other Commonwealth Acts do not hinder the operation of netting agreements. It will not apply to areas in which New South Wales is competent to legislate, such as non-bank financial institutions and non-corporate lending.

Set-off provided for by statute

Set-off under insolvency legislation

1.11 Set-off provided for under insolvency legislation is the oldest form of statutory set-off.¹⁵ It dates from 1705 when 4 & 5 Anne c 17 (1705)¹⁶ s 11 was enacted:

And be it further enacted by the authority aforesaid, That where there shall appear to the commissioners, or the major part of them, that there hath been mutual credit given between such person or persons, against whom such commission shall issue forth, and any person or persons who shall be debtor or debtors to such person or persons, and due proof thereof made, and that the accounts are open and unballanced, That then it shall be lawful for the commissioners in the said commission named, or the major part of them, or the assignee or assignees of such commission, to adjust the said account, and to take the ballance due in full discharge thereof, and the person debtor to such bankrupt, shall not be compelled or obliged to pay more than shall appear to be due on such balance.

1.12 In Australia the modern statement of this provision is s 86 of the Bankruptcy Act 1966 (Cth):¹⁷

(1) Subject to this section, where there have been mutual credits, mutual debts or other mutual dealings between a person who has become a bankrupt and a person claiming to prove a debt in the bankruptcy:

(a) an account shall be taken of what is due from the one party to the other in respect of those mutual dealings;

(b) the sum due from the one party shall be set off against any sum due from the other party; and

(c) only the balance of the account may be claimed in the bankruptcy, or is payable to the trustee in the bankruptcy, as the case may be.


(2) A person is not entitled under this section to claim the benefit of a set-off if, at the time of giving credit to the person who has become a bankrupt or at the time of receiving credit from that person, he had notice of an available act of bankruptcy committed by that person.

1.13 The phrase “mutual credits, mutual debts or other mutual dealings” has been described as more comprehensive than the provisions in the Statutes of Set-off.¹⁸ Indeed, given its broad coverage, s 86 of the Bankruptcy Act 1966 (Cth) has been held to be a code¹⁹ so that, in circumstances involving the insolvency of one of the parties, the set-off provided for by insolvency legislation is exclusive of all other forms of set-off, including in equity or under the Statutes of Set-off.²⁰

Set-off under the Statutes of Set-off

1.14 Set-off was provided for more generally in England by s 13 of 2 Geo II c 22 (1729) and s 4 and 5 of 8 Geo II c 24 (1735).²¹ This kind of set-off is limited to mutual claims that are liquidated or ascertainable with certainty and which are due and payable at the time the plaintiff commenced his or her action at law. As a result of the Imperial Acts Application Act 1969 (NSW) it is no longer applicable in New South Wales. Set-off under the Statutes of Set-off is discussed more fully in Chapter 2.

Set-off under the Supreme Court Act and Rules

1.15 Set-off was also found to have been available in New South Wales under s 78 of the Supreme Court Act 1970 (NSW) and the now omitted Part 15 r 25 of the Supreme Court Rules 1970 (NSW) which provided:

Where a claim by a defendant to a sum of money (whether of an ascertained amount or not) is relied on as a defence to the whole or part of a claim made by a plaintiff, it may be included in the defence and set off against the plaintiff’s claim, whether or not the defendant also cross-claims for that sum of money.²²

1.16 The Supreme Court Rules reproduce, virtually verbatim, the text of Order 18 r 17 of the Rules of the Supreme Court 1965 (Eng).²³ The English Supreme Court Practice²⁴ makes it clear that the provision merely states that set-off may be pleaded as a defence and does not in any way define the term, citing Lord Justice Morris in Hanak v Green:²⁵

The question as to what is a set-off is to be determined as a matter of law and is not in any way governed by the language used by the parties in their pleadings.

1.17 The New South Wales Court of Appeal had given a different interpretation to that provided in the English case of Hanak v Green. In Stehar Knitting Mills Pty Ltd v Southern Textile Converters Pty Ltd²⁶ the Court of Appeal overturned the conclusion of Justice Sheppard at first instance²⁷ that, because the Statutes of Set-off had been repealed, legal set-off was no longer available in New South Wales. Justice Hutley held that set-off established by the Statutes of Set-off operated procedurally for the most part, notwithstanding the fact that a plea of set-off can amount to a plea in bar. Since this type of set-off was mostly procedural in operation, Justice Hutley saw no reason why its existence could not be covered by Part 15 r 25 of the Supreme Court Rules which he saw as a partial restoration of set-off at law, though purely procedural in form.²⁸ Justice Glass also agreed that the contention that set-off under the Statutes of Set-off was substantive in nature was unsound and concluded that Part 15 r 25 allowed a defendant to raise set-off at law.²⁹ Derham noted that the effect of this judgment would have been that:

any monetary cross-demand which was due and payable, whether it was liquidated or unliquidated and whether or not it was connected with the plaintiff’s claim, could be the subject of a set-off in an action at law. It was not necessary to show mutual debts, or, if one of the demands was unliquidated, that the cross-demands were sufficiently closely connected so as to give rise to an equitable set-off.³⁰

1.18 Part 15 r 25 was omitted from the Supreme Court Rules 1970 (NSW) in 1984.³¹ Some commentators have suggested that this omission from the Rules was made, in light of the finding that the Statutes of Set-off had been repealed in New South Wales, “in order to avoid outmoded habits of thought”, the effect being “completely [to] eliminate the term ‘set-off’ from procedural law in the Supreme Court”.³² The consequence of this omission is that in New South Wales there is now no statutory set-off available except that provided for by the Bankruptcy Act 1966 (Cth).

Equitable set-off

1.19 Meagher, Gummow and Lehane have identified four distinct kinds of equitable set-off:³³

• Where equity recognises a right of set-off which exists at law. This type of equitable set-off is part of the general principle that all legal rights, titles and interests are recognised in equity. Equity in such instances will work in close analogy to the equivalent common law action,³⁴ and cannot operate when an action ceases to exist at law. A right to set-off which exists at law is not recognised in such cases only where reliance on it would be inequitable.
• Where an equitable set-off exists by analogy with a legal set-off. This type of equitable set-off arises from a situation where “equity follows the law by imitating a legal statute”. This allowed equity to extend its previously restricted doctrine of set-off following the enactment of the Statutes of Set-off,³⁵ so that, for example, equity could find set-off where one of two mutual liquidated cross-demands is itself “a matter of equitable jurisdiction” or because “a common law debt is held on trust or has been the subject of an equitable assignment so that the requirement of mutuality is satisfied only by reference to the equitable titles.”³⁶
• Where an equitable set-off exists by agreement. In equity very slight evidence of an agreement to set off will be invoked in order to establish a right to set off between the parties to an action.³⁷
• Where true equitable set-off can be said to exist. This is where “the party seeking the benefit of [set-off] can shew some equitable ground for being protected against his adversary’s demand”.³⁸

1.20 The early cases on “true” equitable set-off have been interpreted as requiring:

(i) clear cross-claims for debts or damages, which

(ii) were so closely related as to subject-matter that the claim sought to be set-off impeached the other in the sense that it made it positively unjust that there should be recovery without deduction.³⁹

1.21 There has been some movement in New South Wales from the traditional formulation of equitable set-off. Justice Giles, in AWA Ltd v Exicom Australia Pty Ltd,⁴⁰ concluded that the “ultimate question” was, remembering that the existence of the defendant’s cross-claim was not enough, whether it would be “unjust or inequitable” that the plaintiff be allowed to proceed with its claim.⁴¹ A more traditional approach has, however, been reasserted by the Court of Appeal which has held that the equity required to establish equitable set-off must be such as to impeach the plaintiff’s title to demand payment.⁴²

1.22 Another aspect of the “equitable jurisdiction” of the court is that it can order that the costs of the parties to a proceeding be set off. This right was once supposed to originate under the Statutes of Set-off, but since 1791 it has been recognised as part of the equitable jurisdiction of the court.⁴³ Justice Young in a recent case quoted Montagu on Set-off as stating:

Opposite demands arising upon judgments may upon motion be set-off against each other, whenever such set-off is equitable though the judgments are in different courts, and though the parties to the different records are not the same. Costs may be set-off against costs only, or against debt and costs.⁴⁴

Justice Young has noted that this basis for the setting off of costs is important in light of the repeal of the Statutes of Set-off in New South Wales.⁴⁵

Rights analogous to set-off

1.23 There are several rights which, while they cannot strictly be classified as forms of set-off, are closely analogous and have even, on occasions, been taken to be forms of set-off. They may be of particular interest to jurisdictions, such as New South Wales, where set-off is no longer generally available by statute, for example, in situations where the assignee of a debt takes subject only to any equitable set-off or such analogous rights as may be available.⁴⁶

Liability arising from a running account

1.24 Liability arising from a running account, despite some similarities to set-off, is often treated as quite distinct from set-off and counterclaim in that a running account simply does not involve a question of competing claims. The sum owed by either party is only determined once a balance has been struck between the parties’ transactions,⁴⁷ that is usually when a bank exercises it as a self-help remedy. Wood, however, has identified it as a form of set-off called “current account set-off”.⁴⁸

Abatement

1.25 The common law right of abatement is a defence which is generally limited to contracts for sale of goods or for work or labour⁴⁹ and can be invoked by a defendant to reduce the value of goods and services supplied by the plaintiff where, for some reason, the goods and services in fact supplied did not justify the payment of the full agreed price by the defendant.⁵⁰ Abatement with respect to contracts for sale of goods is now provided for by s 54(1)(a) of the Sale of Goods Act 1923 (NSW).

1.26 More recently abatement has been identified by some as a form of set-off.⁵¹ Wood has suggested that it is similar, in most essential respects, to a form of equitable set-off, noting in particular that it arises from the same transaction, or a closely connected series of transactions and can be seen as an attempt on the part of the common law to avoid the rigours of the Statutes of Set-off.⁵²

The rule in Cherry v Boultbee

1.27 Application of the rule in Cherry v Boultbee⁵³ arises where there is a person who is liable to contribute to a fund such as a deceased estate, trust fund, or insolvent estate⁵⁴ and that person seeks to take a part of the net assets of that fund without first contributing to it. The rule prevents the person from receiving anything from the fund without first making the required contribution.⁵⁵ It is applied in situations where set-off is not available.

1.28 While classing it as one of seven different types of set-off, Justice Young has noted that strictly speaking the application of the rule in Cherry v Boultbee is not a set-off, although it is “closely analogous to it”.⁵⁶ Wood, in his work on set-off, has identified the rule in Cherry v Boultbee as “retainer” or “fund set-off”.⁵⁷

1. 2 Geo II c 22 (1729) s 13 and 8 Geo II c 24 (1735) s 4 and 5.

2. K R Handley, Letter to the Chairman of the NSW Law Reform Commission (28 February 1994). Justice Handley’s views of the deficiencies arising from the repeal of the Statutes of Set-off are set out in Chapter 3. See especially paras 3.14 and 3.19.

3. Where a joint debt is owed to a creditor, however, one of the joint debtors cannot set off a debt owed separately to him or her by the creditor: Vale of Clwydd Coal Co v Garsed (1885) 2 WN 14.

4. See M B Hapgood, “Rights of Set-off as Security” in F W Neate (ed), Using Set-off as Security (Graham & Trotman, London, 1990) at 22.

5. See P R Wood, English and International Set-off (Sweet & Maxwell, London, 1989) at para 6-46.

6. See P R Wood, English and International Set-off (Sweet & Maxwell, London, 1989) at para 6-42.

7. See R P Meagher, W M C Gummow and J R F Lehane, Equity: Doctrines and Remedies (3rd edition, Butterworths, Sydney, 1992) at para 3701.

8. See S McCracken, The Banker’s Remedy of Set-Off (Butterworths, London, 1993) at 47.

9. Re application of Keith Bray Pty Ltd (1991) 23 NSWLR 430 at 431 per McLelland J. See also Pro-image Studios v Commonwealth Bank of Australia (1991) 4 ACSR 586 at 589-590 (Vic SC). This may be an aspect of the “common law” set-off referred to by Young J who noted that the line of authorities relied on may have depended upon there being an “express or implied agreement that there would only be an account for the balance due”: P Rowe Graphics Pty Ltd v Scanagraphix Pty Ltd (New South Wales, Supreme Court, ED 1429/1988, Young J, 6 September 1988, unreported) at 9.

10. Australia, Netting Sub-Committee of the Companies and Securities Advisory Committee, Netting in Financial Markets Transactions (Final Report, June 1997). The recommendations of the Netting Sub-Committee are also the subject of proposals put by the Corporate Law Economic Reform Program: Australia, Corporate Law Economic Reform Program, Electronic Commerce: Cutting Cybertape - Building Business (Proposals for Reform: Paper No 5, 1997) at 37-43.

11. Australia, Netting Sub-Committee of the Companies and Securities Advisory Committee, Netting in Financial Markets Transactions (Final Report, June 1997) at para 1.1.

12. Australia, Netting Sub-Committee of the Companies and Securities Advisory Committee, Netting in Financial Markets Transactions (Final Report, June 1997) at para 1.2.

13. See the legal concerns outlined in Australia, Netting Sub-committee of the Companies and Securities Advisory Committee, Netting in Financial Markets Transactions (Background Paper, December 1996) at 15-17. See also S R Derham, Set-off (2nd edition, Clarendon Press, Oxford, 1996) at 543-551.

14. Australia, Netting Sub-Committee of the Companies and Securities Advisory Committee, Netting in Financial Markets Transactions (Final Report, June 1997) at para 6.1.

15. Although there is a possibility that there may have been recognition of set-off in bankruptcy at common law: Anonymous (1676) 1 Mod 215; 86 ER 837; Chapman v Derby (1689) 2 Vern 117; 23 ER 684; Green v Farmer (1768) 4 Burr 2214 at 2221; 98 ER 154 at 158. See also the discussion on the origins of set-off in bankruptcy in Gye v Davies (1995) 37 NSWLR 421 at 424-425 per Powell JA; and W H Loyd, “The development of set-off” (1916) 64 University of Pennsylvania Law Review 541 at 547.

16. Often referred to mistakenly as 4 & 5 Anne c 4 which is, in fact, “An Act for the Naturalization of the most Excellent Princess Sophia, Electress and Duchess Dowager of Hanover, and the Issue of her Body”.

17. See also s 553C of the Corporations Law (Cth) which reproduces the substance of s 86 for the purposes of the winding up of companies. Set-off is not available if a company enters voluntary administration under Part 5.3A of the Corporations Law (Cth).

18. See Gye v McIntyre (1991) 171 CLR 609.

19. Day & Dent Constructions Pty Ltd v North Australian Properties Pty Ltd (1981) 34 ALR 595 at 601.

20. But see McIntyre v Perkes (1990) 22 FCR 260 at 271-272 per Gummow and Von Doussa JJ.

21. Statutes dealing with set-off can be traced in the American colonies to the enactment of a statute in Virginia in 1645: W H Loyd, “The development of set-off” (1916) 64 University of Pennsylvania Law Review 541 at 553-562.

22. Cf Rules of the Supreme Court 1965 (Eng) O 18 r 17. This ties in with s 91(2) of the Supreme Court Act 1970 (NSW) which provides:

“Where there is a claim by a plaintiff and a claim under section 78 by a defendant, the Court may:

(a) give judgment for the balance only of the sums of money awarded on the respective claims; or

(b) give judgment in respect of each claim

and the Court may give judgment similarly where several claims arise between plaintiffs, defendants and any other parties.”

24. The Supreme Court Practice 1967 (Sweet & Maxwell et al, London, 1966) Vol 1 at 268.

25. [1958] 2 QB 9 at 26. See also West Street Properties Pty Ltd v Jamison [1974] 2 NSWLR 435 at 438.

26. [1980] 2 NSWLR 514.

27. Southern Textile Converters Pty Ltd v Stehar Knitting Mills Pty Ltd [1979] 1 NSWLR 692.

28. Stehar Knitting Mills Pty Ltd v Southern Textile Converters Pty Ltd [1980] 2 NSWLR 514 at 519-520.

29. Stehar Knitting Mills Pty Ltd v Southern Textile Converters Pty Ltd [1980] 2 NSWLR 514 at 523-524.

30. S R Derham, Set-off (2nd edition, Clarendon Press, Oxford, 1996) at 133.

31. Supreme Court Rules (Amendment No 154) 1984 (NSW).

32. P W Young, K F O’Leary and A E Hogan, Supreme Court Civil Procedures: New South Wales (2nd edition, Butterworths, Sydney, 1987) at para 14.104.

33. R P Meagher, W M C Gummow and J R F Lehane, Equity: Doctrines and Remedies (3rd edition, Butterworths, Sydney, 1992) at para 3707.

34. R P Meagher, W M C Gummow and J R F Lehane, Equity: Doctrines and Remedies (3rd edition, Butterworths, Sydney, 1992) at para 308.

35. See Southern Textile Converters Pty Ltd v Stehar Knitting Mills Pty Ltd [1979] 1 NSWLR 692 at 698-699.

36. S R Derham, Set-off (2nd edition, Clarendon Press, Oxford, 1996) at 38-39.

37. Cf contractual set-off at paras 1.6-1.10. See also P R Wood, English and International Set-off (Sweet & Maxwell, London, 1989) at para 5-12.

38. Rawson v Samuel (1841) Cr & Ph 161 at 178; 41 ER 451 at 458. The best modern statement is that of Woodward J in D Galambos & Son Pty Ltd v McIntyre (1974) 5 ACTR 10.

39. D Galambos & Son Pty Ltd v McIntyre (1974) 5 ACTR 10 at 18.

40. (1990) 19 NSWLR 705.

41. AWA Ltd v Exicom Australia Pty Ltd (1990) 19 NSWLR 705 at 712. See also S McCracken, The Banker’s Remedy of Set-off (Butterworths, London, 1993) at 60.

42. Lord v Direct Acceptance Corporation Ltd (1993) 32 NSWLR 362 at 367. See also S R Derham, Set-off (2nd edition, Clarendon Press, Oxford, 1996) at 53-56.

43. Mitchell v Oldfield (1791) 4 TR 123; 100 ER 929.

44. Wentworth v Wentworth (New South Wales, Supreme Court, ED 3748/1989, Young J, 12 December 1994, unreported) at 3-4 quoting Montagu on Set-off (American Ed, 1825) at 6-8.

45. Wentworth v Wentworth (New South Wales, Supreme Court, ED 3748/1989, Young J, 12 December 1994, unreported) at 4.

46. See S R Derham, Set-off (2nd edition, Clarendon Press, Oxford, 1996) at 573 and paras 3.20-3.21 below.

47. R P Meagher, W M C Gummow and J R F Lehane, Equity: Doctrines and Remedies (3rd edition, Butterworths, Sydney, 1992) at para 3702.

48. See P R Wood, English and International Set-off (Sweet & Maxwell, London, 1989) at para 3-4.

49. See P R Wood, English and International Set-off (Sweet & Maxwell, London, 1989) at para 4-35.

50. See Mondel v Steel (1841) 8 M&W 858 at 871-872; 151 ER 1288 at 1293-1294; and Gilbert-Ash (Northern) Ltd v Modern Engineering (Bristol) Ltd [1974] AC 789 at 699 per Lord Morris, and at 717 per Lord Diplock. See also P R Wood, English and International Set-off (Sweet & Maxwell, London, 1989) at paras 4-32 - 4-37.

51. Young J has identified abatement as one of seven probable types of set-off: P Rowe Graphics Pty Ltd v Scanagraphix Pty Ltd (New South Wales, Supreme Court, ED 1429/1988, Young J, 6 September 1988, unreported) at 6. See also P R Wood, English and International Set-off (Sweet & Maxwell, London, 1989) at paras 1-20 - 1-25.

52. See P R Wood, English and International Set-off (Sweet & Maxwell, London, 1989) at paras 1-20 - 1-25.

53. (1839) 4 Myl & Cr 442; 41 ER 771.

54. See P R Wood, English and International Set-off (Sweet & Maxwell, London, 1989) at paras 8-30 - 8-78 for a full discussion of situations where the rule may be applied. See also S R Derham, Set-off (2nd ed, Clarendon Press, Oxford, 1996) at 436-451.

55. A recent application of the rule was Saltergate Insurance Co Ltd and the Companies Act (No 2) [1984] 3 NSWLR 389 at 393.

56. P Rowe Graphics Pty Ltd v Scanagraphix Pty Ltd (New South Wales, Supreme Court, ED 1429/1988, Young J, 6 September 1988, unreported) at 12. On the distinction between the right under Cherry v Boultbee and set-off see S R Derham, Set-off (2nd edition, Clarendon Press, Oxford, 1996) at 439-442.

57. P R Wood, English and International Set-off (Sweet & Maxwell, London, 1989) at para 8-6.