Law Report: Director's credit set off against bank debt: MS Fashions Ltd and others v Bank of Credit and Commerce International SA and another - Chancery Division (Lord Justice Hoffmann), 27 November 1992

A company director who guaranteed, as a principal debtor, the repayment to a bank of advances made to his company could, upon the bank's insolvency, rely on the right of set-off under rule 4.90 of the Insolvency Rules 1986 (SI 1925) to reduce or extinguish the debt owed to the bank by him and his company, by the amount standing to his credit in his own deposit account with the bank.

Lord Justice Hoffmann, sitting as an additional judge of the Chancery Division, granted declarations in three actions against the Bank of Credit and Commerce International SA, upon motions brought, under Order 14A of the Rules of the Supreme Court, by the respective plaintiffs, namely: (1) MS Fashions Ltd, MS Fashions (Wholesale) Ltd, and Mohammed Sarwar; (2) High Street Services Ltd, Portmaid Fashions Ltd, Cira Ltd, Raees Ahmed and Saeed Ahmed; and (3) Impexbond Ltd, Tucan Investments plc and Nasir Abdul Amir.

Alan Steinfeld QC and Francis Tregear (Zaiwalla & Co) for the plaintiffs in the first case; Jonathan Sumption QC and Helen Davies (Glanvilles; Slaughter & May) for the remaining plaintiffs; Neville Thomas QC and Robin Dicker (Lovell White Durrant) for BCCI.

LORD JUSTICE HOFFMANN said the three cases raised a common point of principle on the law of set-off in insolvency. A bank advanced money to a company. Repayment was guaranteed by a director who had a deposit account with the bank. As between himself and the bank, the director was expressed to be a principal debtor.

On the bank's insolvency, could the director set off his claim for return of his deposit against his liability to pay the company's debt, so that the debt was wholly or pro tanto extinguished? Or could the bank claim the whole debt from the company and leave the director to prove in the liquidation for his deposit?

Rule 4.90 provided: '(1) This rule applies where, before the company goes into liquidation there have been mutual credits, mutual debts or other mutual dealings between the company and any creditor proving or claiming to prove for a debt in the liquidation. (2) An account shall be taken of what is due from each party to the other in respect of the mutual dealings, and the sums due from one party shall be set off against the sums due from the other . . . (4) Only the balance (if any) of the account is provable in the liquidation. Alternatively (as the case may be) the amount shall be paid to the liquidator as part of the assets.'

Certain principles as to the application of these provisions had been established by the cases. First, the rule was mandatory: if there had been mutual dealings, before the winding up order, which had given rise to cross- claims, neither party could prove or sue for the balance.

Second, the account was taken as at the date of the winding up order ('the retroactivity principle'). This was only one manifestation of the wider principle of insolvency law, that the liquidation and distribution of the assets of an insolvent company were treated as notionally taking place simultaneously on the date of the winding up order.

Third, in taking the account, the court had regard to events which had occurred since the date of the winding up ('the hindsight principle').

His Lordship rejected BCCI's submission that there could be no set-off until such time as BCCI, which was compulsorily wound up on 14 January 1992, decided to sue the directors and they pleaded a set-off by way of defence. If there were existing cross-claims arising out of mutual dealings before the winding up, then rule 4.90 took effect.

The question then was whether such cross-claims existed. BCCI argued that the directors' liability was contingent upon the bank making a demand, and except in the first case none had been made. Since the directors' liability was merely contingent, it could not form the subject of a set-off.

If the relationship between BCCI and the directors had been governed only by the standard form guarantees, the directors' liability would have remained contingent.

In fact, the directors were also liable to BCCI under various additional or wider instruments, which deemed them to be principal debtors. This liability was not contingent at all. It was either a joint and several liability with the companies, or at any rate a several liability for the same debt.

In the MS Fashions and Impexbond cases, the letters of charge made no mention of the need for any demand. In the case of the mortgage deed in MS Fashions and the charge on the deposit in High Street Services, the obligation was to pay on demand in writing. However, in the case of primary obligations, as opposed to secondary ones like guarantees, a provision for demand in writing was not regarded as creating a contingency: see Re Brown's Estate (1893) 2 Ch 300. Here, the 'principal debtor' clauses had the effect of creating primary liability for the purposes of the rule that the debt was not contingent upon demand.

One therefore had, on one hand, the liability of BCCI to the individual director, against, on the other, a several liability of the director to pay the same debt as that for which the company was liable. Such liabilities could be set off against each other. Since that set- off was equivalent to payment by the director, it must also extinguish, to the same extent, the debt owed by the company.

His Lordship would therefore declare that the indebtedness of each of the companies to BCCI at the date of BCCI's winding up had been extinguished or reduced by the amount which on that date was standing to the credit of the directors on their respective deposit accounts with BCCI.

Paul Magrath, Barrister