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

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 claims...so 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...