Set-Off Right Applied In Separate Financial Transactions

This case addressed, amongst other things, the question of whether a right of set-off in respect of sums owed under an ISDA agreement could be exercised against sums due under an unrelated letter of credit.

The defendant, Calyon1 issued an English law governed letter of credit (L/C) in connection with a derivatives trading contract in favour of LBCS which, when drawn upon, was for the sum of €50 million. One year prior to issue of the L/C, LBCS and Calyon entered into a wholly separate contractual relationship governed by a distinct ISDA Master Agreement (IMA) which was subject to New York law.

Section 6(f) of the IMA provided that in the event of a default, there would be a right to set-off "any obligation" of Calyon owed to [LBCS] against "any obligation" of [LBCS] owed to Calyon whether or not arising under the IMA.

An event of default under the IMA arose upon the filing by an LBCS group holding company under Chapter 11 of the US Bankruptcy Code. This in turn gave rise to a debt on the part of LBCS of US$15,030,239 under the IMA. Consequently, once LBCS sought to draw down on the L/C, Calyon set-off an equivalent sum to that owed under the IMA and paid a balance to LBCS of only €38,377,190.69 under the L/C.

Issue

A number of preliminary issues were ordered to be tried most of which turned upon questions of US law and the impact, if any, of the applicable bankruptcy law in New York. These were readily disposed of leaving, as the key issue, the question of whether on a proper construction of the IMA, Calyon was entitled to set-off sums owed to it under the IMA against the amount payable to LBCS under the L/C.

Discussion

There is little authority on this area, primarily because in most cases it is relatively unusual for there to be a pre-existing contractual relationship between the paying bank and a beneficiary under a letter of credit such as to enable the bank to raise a claim for set-off. Of the authorities where there has been an underlying commercial relationship, set-off has usually been possible because the letter of credit arose from the same underlying transactions in respect of which there was a liquidated debt2. In a leading judgment on this point, which arose out of a summary judgment application, the Court of Appeal took the view that it would be unjust for a bank to have to pay under a letter of credit where it had a real prospect of succeeding on a claim on the underlying transaction, particularly in the case of a liquidated...