UK: Equitable set off: Court of Appeal Restates Legal Principles and The Appropriate Test

Last Updated: 21 June 2010
Article by Caroline Cummins

On 11 June 2010, the Court of Appeal gave its decision in Geldof Metaalconstructie NV v Simon Carves Limited [2010] EWCA Civ 667. In deciding this case, the Court took the opportunity to review and clarify the law on equitable set off – "because there appears to be some uncertainty on the subject" – and also to interpret an express clause in the contract between the parties which the Appellant argued extended the common law right of set off.

As is well known, the defence of set off allows a party receiving a claim to use a counterclaim to reduce or defeat the claim. The right to set off is often dealt with expressly in a contract, failing which, the common law fills the gap.

Special rules apply in the case of insolvency, which are not covered here.

Equitable set-off is more likely to be available where the counterclaim arises out of the same contract as the claim than where the claim and counterclaim arise out of different contracts.

Where there are contractual terms as regards set off, more often than not, the clause will seek to limit or exclude the common law right of set off. For example, construction contracts are subject to the statutory requirement that where parties intend to pay less than the sum notified as due (that is, where they intend to set off a counterclaim against that notified sum), they may not do so unless an effective notice has first been given.

Less frequently, clauses are found in contracts which allow a more liberal right to set off than is found in the common law.

Allowing equitable set off: the test

In the Geldof Metaalconstructie case, the Court reviewed a long string of cases ranging from Hanak v Green [1958] to Bim Kemi v Blackburn Chemicals [2001] where different judges have placed different emphasis in terms of the test for what is required before equitable set off may be allowed. The Court concluded that Lord Denning's clearly formulated test expressed in 1978 in The"Nanfri" was to be preferred, namely

"cross closely connected with [the plaintiff's] demands that it would be manifestly unjust to allow him to enforce payment without taking into account the cross claim".

The Court was at pains to emphasise that the test was based on legal principle rather than discretion. As Hobhouse J said in Leon Corporation v Atlantic Lines and Navigation Co Inc [1985]:

"This defence does not vary according to the length of the Lord Chancellor's foot. The defence has to be granted or refused by an application of legal principle".

The legal principle involves the application of a test which has two elements: firstly, the requirement for a "close connection" between the claim and the counterclaim (the "formal" element) and secondly, the requirement whereby it needs to be unjust to enforce the claim without taking into account the counterclaim (the "functional" element). The formal and the functional elements cannot be divorced from one another. Both are needed.

How may this re-statement of the test for equitable set off be applied in the everyday, commercial context? Each claim and counterclaim will have its own set of facts, all of which must be considered in order to assess whether the two elements of the test for equitable set off are satisfied. Where the claim and counterclaim both arise from the same contract, it is likely that both elements of the test will be satisfied, although this may not always be the case. Where the claim and counterclaim arise from different contracts, satisfying the test may prove more difficult. Nevertheless, as demonstrated in the Geldof Metaalconstructie case, where the claim and counterclaim arose separately from a supply contract and an installation contract which were concluded at separate times, separately tendered and independent of one another, it was possible to demonstrate links and behaviours which were sufficient to satisfy the "close connection" test and equitable set off was allowed.

The contractual right of set off

The supply contract in the Geldof Metaalconstructie case contained a clause which was headed "Right to Offset" which provided:

"Purchaser, without waiver or limitation of any rights or remedies of Purchaser or Owner, shall be entitled from time to time to set off against the Purchase Order Price any amounts lawfully due from the Supplier to the Purchaser whether under this Purchase Order or otherwise".[our emphasis]

The question which arose was, in reliance on this clause and as an alternative to the right to equitable set off, whether claims under the separate installation contract could be set off against claims under the supply contract. In particular, it was argued that the words "under this Purchase Order or otherwise" allowed the set off of claims arising under separate contracts and the words "any amounts lawfully due" went beyond the law of equitable set off by removing the need to satisfy the two elements of the common law test.

The Court decided that the claim under the installation contract could be set off against the claim under the supply contract in reliance on this clause without the need to satisfy the close connection and manifest injustice test required for equitable set off. This clause is thus an example of parties, by the terms of their contract, enlarging upon the equitable right of set off.

The Geldof Metaalconstructie case reminds us of how express contractual rights of set off can facilitate set off across contracts where circumstances make this convenient. However, take care with the drafting. The words "any amounts lawfully due" in the Geldof Metaalconstructie clause gave rise to considerable argument about whether the cross claim had to be ascertained, either by agreement or adjudication, prior to it being capable of set off. In this case, the court decided it was not necessary, but this was partly due to the claimant having already conceded that the cross claim fell within the set off clause. If the concession had not been made, the argument may have succeeded that the cross claim was not "an amount lawfully due". Consequently, consideration should be given to including different words in set off clauses, such as " claims which are reasonably assessed and made in good faith", or something similar.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to

Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.

The original publication date for this article was 18/06/2010.

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