UK: Setting Off For Iceland

Last Updated: 17 September 2009
Article by Edward Davis and Sue Millar

In a recent decision (In the matter of Kaupthing Singer & Friedlander Ltd (in administration) [2009] EWHC 740 (Ch)), the High Court found that a creditor of a bank in administration was not entitled to set-off a payment, otherwise due to the bank under an instrument of deposit, against the amounts owed to it by the bank.

On three dates in August and September 2008, the Newcastle Building Society ("NBS") acquired three instruments of deposit issued by Kaupthing Singer & Friedlander Ltd ("KSF"), a wholly owned subsidiary of the Icelandic bank Kaupthing Bank hf, in the aggregate sum of £11 million, repayable on three maturity dates in November and December 2008 ("the KSF Instruments"). Meanwhile, on 29 September 2008, KSF acquired a certificate of deposit issued by NBS in the principal sum of £10 million repayable on 6 January 2009 ("the NBS CD").

On 8 October 2008, KSF went into administration. The KSF Instruments were not repaid on maturity in November and December 2008. Since NBS was still to make a payment of £10 million to KSF under the NBS CD on 6 January 2009, on 15 December 2008 NBS applied to the High Court for a declaration that KSF was not entitled to payment or to enforce payment under the NBS CD as NBS had a legal right of set-off and a defence to any such claim arising out of the liability of KSF under the KSF Instruments. The parties agreed to an interim measure whereby NBS made payment into a joint account in the names of the parties' solicitors and the substantive application was heard in March 2009 by the Chancellor of the High Court.

The NBS CD was a dematerialised security issued and to be settled under the CREST system operated by Euroclear. The rules of CREST provide that any security transferable in accordance with its rules must be "transferable free from any equity, set-off or counterclaim between the issuer and the...holder of the security" (rule 7 para 3.2). Further, NBS had entered into a Deed in respect of its CREST obligations, clause 3.2 of which required payments by NBS to be made "without set-off, counterclaim or other deduction, save as required by law". In its application, NBS recognised that it would have to overcome the prima facie operation of these provisions in obtaining the relief sought. It was also accepted that insolvency set-off did not apply to this situation because KSF bought the NBS CD on behalf of a subsidiary, and because that subsidiary had an equitable interest in the NBS CD there was not the necessary mutuality of dealings between NBS and KSF for insolvency set-off to apply.

The Chancellor focussed his judgment on the issue of whether a right of legal set-off was available to NBS. He noted that legal set-off had originated in the provisions of two 18th century statutes, namely, the Insolvent Debtors Relief Act 1729 and 1735. These provided that where there were mutual debts, "one debt may be set off against the other" and that "judgment shall be entered for no more than shall appear to be truly and justly due to the plaintiff after one debt being set against the other as aforesaid". It was common ground that the rights of legal set-off originally conferred by those two statutes were now enshrined in section 49(2) of the Supreme Court Act 1981 and CPR Rule 16.6.

In particular, and by reference to leading case law, the Chancellor considered whether parties could exclude a right of set-off by express or implied agreement. In line with the authority of the decisions in the cases of Hong Kong and Shanghai Banking Corporation v Kloeckner & Co AG [1990] 2 QB 514 and Coca-Cola Financial Corporation v Finsat International Ltd [1998] QB 43, the Chancellor found that parties could exclude a right of set-off. He held that the provisions of the rules of CREST and the Deed which NBS had entered into were sufficient to prevent NBS from relying on a right of legal set-off. Accordingly, he dismissed NBS' application and NBS remained liable to make payment under the NBS CD without set off.

Practical implications

In assessing counterparty credit risk, agreements between parties should be checked to see whether they contain clauses excluding rights of set-off. If such clauses are present, they are likely to be sufficient to block any attempt by creditors to withhold payments otherwise due to insolvent debtors.

This article was originally written for Stephenson Harwood's quarterly publication, Finance Litigation Legal Eye. If you would like to receive this publication, please contact Stephenson Harwood (

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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