Canada: How to Limit Rights of Set-Off

A recent Ontario Superior Court of Justice case has highlighted the issues surrounding the right of set-off. This is a relevant topic to any lender who takes an absolute assignment of receivables as part of its financing package, and in particular to lenders who are in the business of factoring receivables.

Facts of Case

In Commercial Factors of Seattle LP v. CIBC1, the facts were as follows. Canadian Imperial Bank of Commerce ("CIBC") retained IT Group Inc. ("IT") to hire consultants ("Consultants") to provide technology services to CIBC pursuant to a staffing agreement dated May 1, 2006, as amended (the "Agreement").IT was to pay the Consultants' wages and benefits, and CIBC then paid that amount plus a mark-up to IT. IT sold the accounts receivable from CIBC to Commercial Factors of Seattle LP doing business as First Vancouver Finance ("First Vancouver").IT gave notice of the assignment to CIBC, and First Vancouver registered the assignment of receivables pursuant to the Personal Property Security Act (Ontario) (the "PPSA")2.CIBC subsequently discovered that IT had failed to pay certain Consultants. Although not legally required to do so, CIBC paid the Consultants and then deducted those amounts from invoices issued to CIBC by IT on the basis that IT was liable to pay those Consultants. CIBC then took an assignment from the Consultants of the sum IT had owed them. As a result, First Vancouver was not paid the full invoice amount which it had purchased and so brought an action against CIBC for the full invoice amount.


The application raised the following issues:

  1. Was CIBC relieved of its obligation to make payments under the Agreement as a result of IT's failure to pay the Consultants?

  2. If not, was CIBC entitled to rely on the remedy of equitable set-off to set off the amounts owing by IT to the Consultants and assigned to CIBC against amounts owing by CIBC to IT under the Agreement?

    1. Can CIBC assert equitable set-off despite having notice of assignment of the invoices? (Does section 40(1.1)(b) of the Personal Property Security Act, R.S.O. 1990, c.P.10 (the "PPSA"), apply to equitable set-off as well as legal set-off?)

    2. Are the amounts that CIBC has purported to set off sufficiently closely connected to give rise to equitable set-off pursuant to Holt v. Telford, [1987] 2 S.C.R. 193 (S.C.C.)?3

Law of Assignment

Before reviewing the issues set out by the court, it is useful to review briefly the law which enables First Vancouver to make a claim directly against CIBC. The Conveyancing and Law of Property Act4 provides:

53.(1) Any absolute assignment made on or after the 31st day of December, 1897, by writing under the hand of the assignor, not purporting to be by way of charge only, of any debt or other legal chose in action of which express notice in writing has been given to the debtor, trustee or other person from whom the assignor would have been entitled to receive or claim such debt or chose in action is effectual in law, subject to all equities that would have been entitled to priority over the right of the assignee if this section had not been enacted, to pass and transfer the legal right to such debt or chose in action from the date of such notice, and all legal and other remedies for the same, and the power to give a good discharge for the same without the concurrence of the assignor.

In this case, the sale of receivables was an absolute assignment and notice of the assignment was given by IT to CIBC in writing. It is therefore clear that First Vancouver had the right to sue CIBC in its own name, "subject to the equities" that existed at the date of the notice given to CIBC by First Vancouver of the assignment.

Issue One – Was Agreement Terminated?

On the first issue set out above, the court found that CIBC was not relieved of its obligation to make payments under the Agreement as a result of IT's failure to pay the Consultants. In short, CIBC continued to treat the Agreement as being in full force and effect and continued to accept the benefit of the services of the Consultants under the Agreement. CIBC did not terminate the Agreement until written notice of default was given by CIBC to IT which occurred after the date of the invoices in question.

Issue Two – Equitable Set-off versus Statutory Set-off

In order to determine the second question, whether CIBC was entitled to rely on the remedy of equitable set-off, the court first looked at the differences between legal and equitable set-off. The court reviewed the case of Holt v. Telford5, where the Supreme Court considered and adopted the principles governing equitable set-off as set out in Coba Industries Ltd. v. Millie's Holdings (Canada) Ltd6.

In Holt v. Telford, the Telfords sold land (the "Telford Sale") to Canadian Stanley Development Ltd. ("Canadian Stanley") for $265,000. At the same time, Canadian Stanley sold land to the Telfords (the "Canadian Stanley Sale") for the same purchase price. In each case, a partial payment was made and a mortgage for the balance was taken back. Canadian Stanley assigned the Telford mortgage to the Holts, without notice to the Telfords. Following the assignment, the Telfords paid $50,000 under the mortgage held by Canadian Stanley, conditional on receipt of a discharge. The Telfords argued that the balance owing on such mortgage, while not yet due, was offset by the amount owing on the mortgage in their favour. Because the mortgage had been assigned, the Holts refused to discharge the mortgage and claimed against the Telfords for the whole amount owing under the assigned mortgage. The court found that there was no agreement to set off, and so in order to win the case, the Telfords had to demonstrate that they had a right of set-off at law or in equity.

The court in Holt v. Telford summarized statutory set-off, which required the fulfillment of two conditions. The first was that both obligations must be debts. The second was that both debts must be mutual cross obligations.7 Under this definition, any assignment would destroy mutuality and therefore destroy the possibility of set-off at law.

The court then went on to decide whether a set-off was available in equity. The court first reviewed the case law surrounding equitable set-off. The court relied on five principles which were set out in Coba Industries Ltd. v. Millie's Holdings (Canada) Ltd as follows:

  1. The party relying on a set-off must show some equitable ground for being protected against his adversary's demands.
  2. The equitable ground must go to the very root of the plaintiff's claim before a set-off will be allowed.
  3. A cross-claim must be so clearly connected with the demand of the plaintiff that it would be manifestly unjust to allow the plaintiff to enforce payment without taking into consideration the cross-claim.
  4. The plaintiff's claim and the cross-claim need not arise out of the same contract.
  5. Unliquidated claims are on the same footing as liquidated claims.8

Overall, the court in Coba Industries Ltd. v. Millie's Holdings (Canada) Ltd concluded that in the case of equitable set-off, an assignee takes subject to cross-claims, including claims for damages, arising after the date of the notice of assignment.

In the case of Holt v. Telford, the court found that the Telfords were able to demonstrate that the debts arose out of the same contract or closely interrelated contracts and, as a result, allowed the debts to be set off. Because the Telford mortgage and the Canadian Stanley mortgage were part of the land exchange deal, being part of the consideration for the reciprocal transfers, the court considered that they were closely connected and met the requirements for an equitable set-off.

Issue Two A – Can CIBC Assert Equitable Set-off Despite Having Notice of Assignment?

In Commercial Factors of Seattle LP v. CIBC, it was clear that CIBC could not assert legal set-off because it had received notice of assignment. The court then looked at the issue of whether CIBC could assert equitable set-off despite having had notice of the assignment of the invoices. Specifically, it considered the question of whether Section 40(1.1)(b) of the PPSA applied to equitable set-off as well as legal set-off.

Section 40(1.1) of the PPSA provides as follows:

(1.1) An account debtor who has not made an enforceable agreement not to assert defences arising out of the contract between the account debtor and the assignor may set up by way of defence against the assignee,

  1. all defences available to the account debtor against the assignor arising out of the terms of the contract or a related contract, including equitable set-off and misrepresentation; and

  2. the right to set off any amount owing to the account debtor that was payable to the account debtor before the account debtor received notice of the assignment.

CIBC argued that the specific reference to equitable set-off in Section 40(1.1)(a) made it clear that subsection (b) only applied to legal set-off. The court agreed that set-off in Section 40(1.1)(b) of the PPSA refers only to legal or statutory set-off, and not to equitable set-off. The court reviewed the legislative commentary surrounding Bill 1529 which was passed in 2006 and stated that Section 40(1.1) was not considered a substantive change. Rather, it was "intended to restate the current law about the defences available by an account debtor as against an assignee, and was not intended to make any substantive changes to the common law or the rule currently in Section 40(1)."10 The court quoted a consultation paper released prior to the 2006 amendments by the Ministry of Government Services which illustrated the mechanics of the current Section 40(1) with the following scenario:

"A person (the account debtor) purchases a new vehicle from a car dealership (the assignor) pursuant to a conditional sales contract, and the dealership then assigns this contract to a financing institution (the assignee/secured party). Once the assignee notifies the account debtor of the assignment, the account debtor must make future installment payments under the sales contract directly to the assignee.

However, Section 40(1)(a) permits the account debtor to raise any defence or claim with the assignee that it could have served against the assignor with regard to the sales contract (this concept is known as equitable set-off).Therefore, if the car was defective, the account debtor would be able to set off any damages resulting from this defect against the demand by the assignee to pay the balance of the sales contract. Furthermore, Section 40(1)(b), which incorporates the concept of statutory set-off, allows the account debtor to set off against the assignee any other defence or claim that the account debtor has against the assignor, including a defence or claim arising from an unconnected transaction, that existed before the account debtor received notice of the assignment."11

As a result, the court confirmed that the right to set off referred to in Section 40(1.1)(b) of the PPSA refers to the right to legal set-off, and so did not limit CIBC's right to assert equitable set-off to the time before CIBC received notice of the assignment of the accounts receivable from First Vancouver. The court concluded that equitable set-off was available where there had been an assignment.

Issue Two B – Are Amounts CIBC Wanted to Set Off Sufficiently Closely Connected to Meet the Test for Equitable Set-off?

The final question that the court considered was whether the amounts that CIBC purported to set off were sufficiently closely connected to meet the test for equitable set-off in Holt v. Telford. The court found that CIBC's cross-claim was sufficiently connected for equitable set-off to apply. The Agreement required IT to pay the Consultants. When IT did not pay this amount, CIBC paid the amount that IT was contracted to pay, as it was of the view that if the Consultants were not paid for their work, there was a serious risk that they would not complete the project for CIBC and CIBC would as a result suffer damages.

How Can Lenders Protect Themselves Against Set-off?

The case of Commercial Factors of Seattle LP v. CIBC highlights the importance of drafting assignment documents with a view to protecting lenders from an account debtor's extensive right of set-off. An experienced lender should ensure that the underlying contract that is being assigned contains a waiver of defences. The following phrase is an example of appropriate language, also sometimes known as a "hell or high water clause":

"Obligor agrees not to assert against the assignee any claim by way of abatement, defence, set-off, compensation, counter-claim or the like which obligor may have against the assignor. Upon notice of an assignment obligor shall unconditionally pay to such assignee all payments and other amounts due hereunder and shall not assert any defence against such assignee in any action for payments or other amount due and payable hereunder."

If the underlying contract being assigned does not contain language similar to this, then the lender should ensure that the assignment documentation itself includes such language and is acknowledged by the account debtor. Financing a contract that does not contain this clause means that the financer may be subject to any defences which the obligor had against the assignor.

In general, case law has held these clauses to be enforceable. For example, in Key Equipment Finance Canada Ltd. v. Jacques Whitford Limited ("Key Equipment"), Jacques Whitford Limited ("Whitford") entered contracts with Oracle Corporation Canada Inc. ("Oracle") to provide computer applications and services. The contracts were assigned by Oracle to Key Equipment Finance Canada Ltd. ("Key"). Whitford subsequently sued Oracle alleging that Oracle fundamentally breached its contract. Whitford stopped making payments to Key and Key sought summary judgment.

The agreement which was assigned in Key Equipment contained an exclusion clause which stated, among other things, that "Customer shall not assert against Assignee any claim, defense, counterclaim or setoff that Customer may have against Supplier. Customer waives all rights to make any claim against Assignee for any loss or damage of the System...."

The court gave summary judgment for Key, holding that the defendant was bound to pay, notwithstanding claims by the defendant that Oracle had not done what it had undertaken to do. The court concluded that the wording of the exclusion clause was specific, unambiguous and comprehensive. In her reasons for judgment, Hood J. quoted:

"In Hunter and the cases which have subsequently followed it, the prima facie assumption is that the contract will be enforced. The exception arises only if the contract is unconscionable, such as might arise between parties of unequal bargaining power...."13

The court did consider the argument that Key is subject to the equities inherent in its relationship with Oracle, since Key is Oracle's assignee, but concluded that this rule was excluded since the exclusion clause applied, as well as for other reasons relating to the conduct of Whitford.14


Overall, when entering into any agreement where contracts or receivables are assigned to a lender, in order for the lender to make a successful claim against the underlying account debtor, it is vital for the lender to ensure three things. First of all, that the contract contains a waiver of defences. As discussed above, if this is not in the underlying contract with the account debtor or otherwise acknowledged by the account debtor, the lender may be subject to any defences that the account debtor has against the assignor. Secondly, as per section 53(1) of the Conveyancing and Law of Property Act, the assignment must be absolute. Finally, notice of the assignment must be given to the account debtor.


1.2010 ONSC 3516, [2010] O.J. No. 2663 (ONT S.C.J.)

2.R.S.O. 1990, c.P.10.

3.Ibid. at para.3

4.R.S.O. 1990, c. C.34

5. [1987] 2 S.C.R. 193 (S.C.C.)

6. [1985] B.C.J. No. 1994 (B.C.C.A.)

7Supra note 4 at para.25

8Ibid. at para.34

9Bill 152, Ministry of Government Services Consumer Protection and Service Modernization Act, 2006, S.O. 2006, c.34

10.Supra note 1 at para.36

11., p.7.

12.2006 N.S.S.C. 68

13.Ibid. at para. 7

14.Ibid. at para. 121

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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