5.01  This chapter considers various aspects of set-off between solvent parties.

5.02  Questions of set-off in the context of charterparties have been the subject of particular attention in recent years.¹ In that regard the courts have drawn a distinction between, on the one hand, freight payable under a voyage charter or bill of lading, and on the other hire payable under a time charter or a charter by demise.² In the former case, equitable set-off generally is not available, whereas it may apply in the latter.

5.03  There is a general common law principle whereby the defendant in an action for payment of the price of goods sold with a warranty, or of work to be performed according to a con-tract, can deduct the amount of any damage sustained by the defendant by reason of a breach of warranty or contract. This is not by way of set-off, but rather it is a means by which the defendant can defend him-or herself by showing how much less the subject-matter of the contract is worth as a result of the claimant's breach. This principle, known as abatement, or the rule in Mondel v Steel,³ was considered earlier.⁴ However, the right to abate does not apply to every contract for work and labour. It was established early in the nineteenth century⁵ that, in the case of a contract for the carriage of goods by sea, a bill of (p. 165) lading holder or a voyage charterer cannot make a deduction from the freight payable⁶ except to the extent specifically allowed by the contract.⁷ As a consequence of this exception,⁸ a defence of abatement has failed in cases involving damage done to the goods being shipped,⁹ short delivery¹⁰ and delay.¹¹

5.04  It is unclear whether the rule against deductions from freight was originally thought to extend to the equitable defence of set-off as well as the common law defence. In Stimson v Hall¹² a lighterman brought an action against the owner of goods for freight owing for the conveyance of the goods. The goods owner alleged that other goods had been lost as a result of the negligence of the lighterman,¹³ and said that his cross-claim for damages for the loss of those goods gave rise to an equitable defence to the claim. While the Court of Exchequer rejected this contention on the ground that the facts failed to disclose a natural equity sufficient to ground a set-off, there is nothing in the judgments or in the arguments of counsel to suggest that an equitable set-off was considered to be unavailable in any event against a claim for freight. However, the courts have since accepted that equitable set-off is subject to the same restriction as for common law abatement with respect to the payment of freight.¹⁴ The restriction is not confined to cases of loss of or damage to goods (p. 166) or delay,¹⁵ but applies to any damages claim available to the charterer or bill of lading holder.¹⁶ In Bank of Boston Connecticut v European Grain and Shipping Ltd,¹⁷ the House of Lords confirmed that the restriction extends to the situation in which the voyage was never completed as a result of the shipowner's wrongful repudiation of the charterparty, in circumstances where the right to freight had accrued under the charterparty before it was terminated by acceptance of the repudiation.¹⁸ Moreover, it applies equally to advance freight and to freight payable on delivery of the goods at the port of discharge.¹⁹ It has also been held to extend to a claim for additional freight, in circumstances where additional freight became payable because of the owner's own breach of contract.²⁰

5.05  The principle precluding deductions is not limited to the situation in which a shipowner is suing a voyage charterer or a bill of lading holder for freight. An agent who collects freight on behalf of the shipowner or charterer must account for the freight without deduction or set-off.²¹ Similarly, a freight forwarder who arranges carriage as agent for a goods owner, and who pays the cost of carriage on behalf of the owner, is entitled to be reimbursed with-out a set-off in respect of an allegation of breach of duty as agent.²² The principle is also relevant when the right to freight has been assigned. The assignee is entitled to the freight undiminished by an equitable set-off.²³

(p. 167) 5.06  Nor is the principle confined to shipping. Contracts for the carriage of goods by road pursuant to the Convention on the Contract for the International Carriage of Goods by Road (CMR) are subject to the rule,²⁴ even though Articles 32 and 36 of the Schedule to the Convention seem to contemplate that set-offs are possible. Further, it has been held, albeit with reluctance, that the principle is equally applicable to a domestic contract for carriage by land.²⁵ It would probably also apply to a contract for carriage of goods by air.²⁶

5.07  In the Bank of Boston case,²⁷ the House of Lords warned that the rules of procedure should not be used to bring about a result contrary to the principle. Lord Brandon of Oakbrook, who delivered their Lordships’ judgment, rejected an argument that the court could try both the claim and the counterclaim and then make an order pursuant to the former Ord. 15, r. 2(4) RSC. The rule provided that: ‘Where a defendant establishes a counterclaim against the claim of a plaintiff and there is a balance in favour of one of the parties, the court may give judgment for the balance …’ He said that to utilize the rule for that purpose would constitute a wrong exercise of the court's discretion. Similarly, a cross-claim available to a charterer ordinarily does not constitute a ground for staying execution on a judgment obtained against the charterer for payment of freight.²⁸

5.08  While freight must be paid without deduction in respect of a damages cross-claim, Judge Diamond QC in the Commercial Court suggested that, in the case of an arbitration, when an arbitrator is called upon to exercise his or her discretion to make an interim award in respect of freight, he or she may make it a condition of the issue of the interim award that the owner provide reasonable security for the charterer's cross-claim. He also suggested that there ‘may perhaps’ be exceptional cases where an arbitrator in the exercise of his or her discretion may find a valid reason for refusing to issue an interim award in respect of a claim for freight, but he conceded that those cases would be rare.²⁹

5.09  On the other hand, the freight rule does not apply when a shipowner has presented a petition to wind up a company for non-payment of freight and the company has a genuine and serious cross-claim against the petitioner. If the amount of the cross-claim exceeds the debt to the shipowner, the court may dismiss or stay the petition unless there are (p. 168) ³⁰ special circumstances which make it inappropriate for the petition to be dismissed or stayed.

5.10  Different considerations apply to hire payable under a time charter.³¹ Admittedly, it was assumed in Russell v Pellegrini,³² after a concession by counsel to that effect, that a cross-claim for damages for breach of an implied warranty of seaworthiness could not be set off against a claim for hire,³³ while more recently Donaldson J applied the freight rule in that context in two unreported decisions on interlocutory applications,³⁴ and later in Seven Seas Transportation Ltd v Atlantic Shipping Co SA.³⁵ Subsequently, however, Parker J in The Teno³⁶ followed an unreported decision of Ackner J to the contrary,³⁷ and held that the rule by which freight must be paid without deduction does not extend to hire. Parker J's judgment received the approval of the Court of Appeal in Federal Commerce & Navigation Co Ltd v Molena Alpha Inc,³⁸ and the principle has since become accepted.³⁹ It applies in the case of a charter by demise (sometimes called a bareboat charter),⁴⁰ as well as when a time charter is expressed to be for the period of a particular voyage,⁴¹ so that in substance it resembles a voyage charter.⁴²

(p. 169) 5.11  This right to an equitable set-off against a claim for hire is not confined to cases in which there has been a total withdrawal of the vessel for a specified time.⁴³ A set-off against hire may take place when the master has wrongfully refused to load a full cargo,⁴⁴ and when a speed warranty has been breached.⁴⁵ An equitable set-off may also be available when the shipowner has failed to perform its hold-cleaning obligations resulting in a delay to the vessel at port,⁴⁶ and when the vessel had to proceed to another port to discharge the cargo because of contamination which was caused by the owners’ breach of the charterparty.⁴⁷ A time charterparty may contain a stipulation to the effect that the owner must provide and pay for all provisions and wages, insurance, and deck and engine-room stores. If the owner fails to make those payments and the charterer, in order to ensure the vessel's availability and use, instead expends the money, the charterer's damages claim against the owner for breach of the clause may be employed in a set-off against hire.⁴⁸

5.12  It is not every cross-claim that can be set off. In Federal Commerce v Molena,⁴⁹ Lord Denning suggested that the right of deduction should be limited to cases where the owner through its neglect or default has either deprived the charterer of the use of the vessel or has hindered or prejudiced the charterer's use.⁵⁰ For example, both he and Lord Goff in that case said that a deduction would not be available when the cross-claim arises merely from damage to cargo. Similarly, a charterer may not set off the estimated value of bunkers remaining on re-delivery of the vessel, unless the charterparty specifically sanctions a deduction.⁵¹ The principle is illustrated by The Leon.⁵² Charterers alleged three breaches by the owners: (1) that the master had failed to keep full and accurate logs of the fuel consumption; (2) that the master had procured that invoices which did not represent the fuel actually taken on board should be sent to and paid for by the charterers; and (3) that the owners had breached their duty as bailees of the bunkers to use them during the charterparty in (p. 170) accordance with the charterer's orders. It was held that none of the breaches affected the use of the vessel, and that consequently they did not give rise to a set-off against hire. Hobhouse J emphasized, however, that there was nothing to show ‘overriding fraud’ on the part of the owners. If there had been, he suggested that the result may have been different.⁵³

5.13  Lord Denning's later judgment in The Aliakmon Progress⁵⁴ suggested a narrower scope to the set-off than that described in Federal Commerce v Molena. A vessel the subject of a time charter sustained damage while attempting to berth at a port in Iceland. Temporary repairs were effected there, and the vessel then sailed to Antwerp where permanent repairs were undertaken. Owing to the resulting delay the vessel lost an anticipated cargo at Antwerp and had to wait some thirty-nine days for a new cargo. Lord Denning, with whom Geoffrey Lane LJ agreed, doubted that the loss sustained by the charterers constituted a ground for equitable set-off. He cited Federal Commerce v Molena as authority for the proposition that equitable set-off is only available against a claim for hire ‘where the charterers have been deprived of the use of the ship by the fault of the owner’.⁵⁵ He said that, in the case before him, the charterers did in fact have the use of the ship but could not get a cargo. There was no mention of whether a set-off may arise when the shipowner merely prejudiced the charterer in the use of the vessel, and there was no discussion of whether in the instant case there had been any such prejudice. Subsequently, however, the courts have reiterated that prejudice in the use of the vessel not amounting to total deprivation may ground a set-off.⁵⁶

5.14  Counsel in The Leon⁵⁷ attacked the proposition that equitable set-off in the context of time charters should be limited to cases in which the charterer has been deprived of or prejudiced in the use of the vessel. Rather, it was suggested that the allowance or otherwise of a set-off should be determined by reference to whether it would be unfair in the particular case to allow the owner to sue for hire without giving credit for the cross-demand. However, Hobhouse J declined to depart from the statements of the ambit of the set-off by Lord Denning and Goff LJ in Federal Commerce v Molena, and emphasized that the relevant principle is set out in Lord Cottenham's judgment in Rawson v Samuel,⁵⁸ that the equity of the bill must impeach the title to the legal demand.⁵⁹ In the case of a time charter, hire is paid for the right to use the vessel for a specified period of time, irrespective of whether the charterer chooses to use it for carrying cargo or instead lays it up out of use. The hire is required to be paid in advance, and failure to make punctual payment gives the owner the right to withdraw the vessel. In those circumstances, Hobhouse J said that it is not a coincidence that, in cases where the right to an equitable set-off was upheld, the cross-claim (p. 171) involved something which could be identified as depriving the charterer of the use of the vessel or which prejudiced or hindered that use, because, in the context of a time charter contract and a claim for time charter hire, it is that type of cross-claim which has the requisite effect of impeaching the plaintiff's demand.⁶⁰

5.15  In a case where hire is payable periodically under a time charter, the charterer may have been prejudiced in the use of the vessel only in certain defined periods. In other periods the vessel may in fact have been made available in accordance with the contract. If the charterer's damages claim in such a case exceeds the amount of hire owing for the periods during which the use of the vessel was prejudiced, the charterer may wish to set off the excess against payments of hire relating to other periods. The question whether this is permissible was considered earlier.⁶¹

5.16  Given that there is this distinction between freight and hire as regards equitable set-off, the question arises whether there is any justification for it. It has been suggested that the original justification for the freight rule may have been based upon cash flow considerations, in that the master would require the freight to be paid in full at the end of the voyage in order to pay off the crew, and to refit and victual the ship. Communications in those days were slow, and the master could not wait a long time for funds to be remitted.⁶² Yet, in the context of building contracts, the courts have said that cash flow considerations are not a sufficient reason for denying a set-off.⁶³ Lord Wilberforce, on the other hand, doubted whether the freight rule indeed is anything other than an arbitrary rule, ‘in the sense that no very clear justification for it has ever been stated and perhaps also in the sense that the law might just, or almost, as well have settled for a rule to the opposite effect’.⁶⁴ Despite this, he concluded that the rule is too well established to be departed from now.⁶⁵ There are, nevertheless, dicta to the effect that it should not be extended,⁶⁶ and the attitude of the (p. 172) courts has been that voyage and time charters are sufficiently dissimilar in their operation to justify the application in the case of hire of the general rule permitting deductions, rather than having resort to the exception precluding deductions found in the freight rule. Thus, Lord Denning, in justifying the distinction, noted that freight is the sum payable for the carriage of goods from one place to another, while hire is paid for the right to use the vessel for a specified period of time irrespective of whether or not the charterer chooses to use it for carrying cargo.⁶⁷ But even this as a basis for treating them differently becomes blurred when a time charter is for the period of a particular trip.⁶⁸

5.17  A question in respect of which conflicting opinions have been expressed is whether the principle which precludes a defence of equitable set-off against a claim for freight also extends to the defence provided by the Statutes of Set-off in the case of mutual debts.⁶⁹

5.18  The cases favour the view that the freight rule does not apply in this context.⁷⁰ In Wilson v Gabriel,⁷¹ the defendant in an action for payment of freight pleaded set-off as a defence, based upon an unconnected debt owing by the plaintiff. The plaintiff replied, on equitable grounds,⁷² that when the freight was in the course of being earned he had assigned it for value to a third party, and that the plaintiff brought this action as trustee for the third party. The Court of Queen's Bench held that this did not to constitute an answer to the plea, the defendant not having had notice of the assignment before the mutual debts arose.⁷³ Cockburn CJ⁷⁴ and Blackburn J each accepted that the defendant was entitled to a set-off at law against the liability for freight, and that it was not affected by the assignment. Since this was after the courts had adopted the principle that the common law defence of abatement does not extend to freight,⁷⁵ it is evident that the statutory defence was thought to be subject to different considerations. The contrary view, however, was accepted in The Khian (p. 173) Captain (No. 2).⁷⁶ Hirst J held in that case that set-off under the Statutes is subject to the freight rule, and suggested that Wilson v Gabriel was impliedly overruled by the House of Lords in Aries Tanker Corporation v Total Transport Ltd.⁷⁷ The issue in the Aries Tanker case, however, was whether a damages claim in respect of cargo could be applied in reduction of a liability for freight either on the basis of equitable set-off or common law abatement. The House of Lords held that those defences did not apply. The statutory defence of set-off was not in issue, and nor was it considered. Subsequently, Hobhouse J at first instance in the Bank of Boston case⁷⁸ disagreed with Hirst J. He accepted that a freight debt and another debt can be set off under the Statutes, and that Wilson v Gabriel was not overruled by Aries Tanker.

5.19  Apart from The Khian Captain, it is difficult to find authority for the proposition that the Statutes do not apply in this context.⁷⁹ Two cases which have been said to support that view⁸⁰ are explicable on other grounds.

5.20  In Weguellin v Cellier,⁸¹ consignees of cargo had accepted six-month bills of exchange at the request of the shipowner. The shipowner assigned the freight payable by way of security to the respondents, who then brought the present action seeking a declaration that they were entitled to be paid the freight. However, the consignees, having honoured the bills, had a claim against the shipowner, and argued that this gave rise to a set-off against the liability for freight and that the respondents as assignees took subject to the set-off. It is apparent that any right of set-off would have arisen under the Statutes, based upon mutual debts, given that the demands would not have been sufficiently closely connected to give rise to an equitable set-off. While Lord Chelmsford held that there was no such set-off which would defeat the respondent's right to the freight, this was not because of a general principle that a claim for freight is not susceptible to a defence of set-off under the Statutes. In the first place, as counsel for the respondents argued, the bills did not mature until after the consignees received notice of the assignment, so that at the date of notice there was no accrued debt owing by the shipowner. An assignee does not take subject to a cross-debt which arises after notice, albeit as a result of a prior contract.⁸² But even apart from that, the Statutes of Set-off only provided a procedural defence to an action for payment of a debt; until a judgment for a set-off is obtained, separate and distinct debts (p. 174) remain in existence.⁸³ In Weguellin v Cellier, when the goods arrived at the port of discharge the respondents put a stop on them. They had a lien and, as Lord Chelmsford pointed out, the consignees could not have obtained the cargo without payment of the freight, and the master of the ship would have been bound to insist upon payment before delivery.⁸⁴ Because of the procedural nature of the defence of set-off, the consignees could not have acted unilaterally to bring about a set-off so as to obtain the release of goods the subject of the lien. The circumstances in Weguellin v Cellier were different, in that the consignees after some correspondence had paid the amount of the freight to the dock company holding the goods so as to obtain their release, and the respondents then filed a bill seeking a declaration that the freight in the hands of the dock company should be applied towards payment of what was due to them by the shipowner.⁸⁵ But it was still not a case of set-off under the Statutes, because it was not an action against the consignees for payment.

5.21  The second case, Tanner v Phillips,⁸⁶ similarly may be explained on other grounds. The plaintiff was mortgagee of a ship, and as further security held a mortgage of freight. The ship was chartered to the defendant. The charterparty provided that the defendant could make advances not exceeding £150 to the master as agent for the mortgagor/owner on account of freight, though other advances in excess of that amount were made. Before the cargo was unloaded and freight became due, the mortgagee took possession of the ship. When the freight later became payable the mortgagee sued the defendant for payment, and it was held that the defendant could not set off the excess advances. This was so notwithstanding that the advances were made before the defendant had notice of the mortgage, whereas ordinarily, if there are mutual debts in existence before notice of an assignment, the assignee takes subject to a right of set-off under the Statutes.⁸⁷ However, the mortgagee's entitlement to freight in Tanner v Phillips was not based upon an assignment of a debt. Rather, the mortgagee claimed payment of freight as mortgagee in possession. The mortgagee became entitled in his own right to freight which the ship was in the course of earning. As Lord Cairns pointed out in Keith v Burrows,⁸⁸ the right of a mortgagee in pos-session to freight in the course of being earned does not arise by virtue of any contract or antecedent right, but rather it is payable to the mortgagee once he or she goes into possession because the mortgagee is then regarded as the master or owner of the ship.⁸⁹ The (p. 175) mortgagee's right depends on property, not on contract.⁹⁰ Tanner v Phillips was not, there-fore, a case in which there were mutual debts between the mortgagor and the charterer which would have given rise to a set-off available against the mortgagee, were it not for a supposed principle that there may not be a set-off under the Statutes against a claim for freight. Rather, mutuality for the purpose of the Statutes was lacking in that, on the one hand, the charterer had a claim against the mortgagor for the excess advances and, on the other, the mortgagee in his own right was entitled to the freight from the charterer.⁹¹

5.22  The better view is that the freight rule, which precludes an equitable set-off or a common law defence of abatement against a claim for freight, does not extend to the Statutes of Set-off. In the case of the Statutes, the defence is statutory in origin, and the Statutes specifically allowed a set-off in the case of mutual debts. While the Statutes themselves have been repealed, the repealing legislation preserved the right of set-off conferred by the Statutes.⁹² The proper approach in the case of a statutory-based defence is to interpret the legislation,⁹³ and there is nothing in the language of the Statutes to suggest that there is an exception in the case of an action for freight.

5.23  When a ship has been chartered, and the master signs bills of lading with third party shippers for the carriage of goods, the question whether the shipowner or the charterer is entitled to the bill of lading freight depends upon whether the master signed as agent for the shipowner or the charterer. If the charter is by demise the contract will be with the charterer, but in other cases the question will depend upon the documents and circum-stances of the particular case.⁹⁴ When the contract is with the shipowner, the shipowner can sue the shipper for freight. If the charterer has nevertheless appointed an agent to collect the freight, and the shipowner gives notice to the agent before the freight has been received requiring the freight to be paid to it rather than the charterer, the shipowner can sue the agent for the freight as money had and received.⁹⁵ Any expenses incurred by the agent in carrying out the charterer's instructions cannot be set off by the agent,⁹⁶ since mutuality for the purpose of the Statutes of Set-off is lacking. If, on the other hand, the owner as the contracting party is paid the bill of lading freight, the owner is only entitled to retain an amount equal to the hire or freight then unpaid under the charterparty. The surplus must be paid to the charterer. Channell J decided this in Wehner v Dene Steam Shipping Co.⁹⁷ The reason is not that the owner is liable to the charterer for the bill of lading freight received (p. 176) and the charterer is liable for hire or freight under the charterparty, and that these obligations are set off.⁹⁸ It is not a case of cross-demands at all. Rather, the owner had contracted by the charterparty that it would be satisfied with the payment of the freight or hire specified in the charterparty for the use of the ship, and accordingly if the owner receives the bill of lading freight it is part of their contract that it will account for any surplus to the charterer.⁹⁹

5.24  When the contract is with the charterer rather than the shipowner, the shipowner may have reserved a lien on sub-freights, entitling the shipowner to require payment to it of the bill of lading freight that is otherwise due to the charterer.¹⁰⁰ The lien can be exercised only before the freight has been paid to the charterer or the charterer's agent.¹⁰¹ Moreover, it can be exercised only in respect of sums due to the shipowner at the time that the demand for payment is made pursuant to the lien.¹⁰² The lien does not confer a proprietary interest in the freight. It is merely a personal right to intercept freight before it is paid. It is analogous to a right of stoppage in transitu.¹⁰³ The lien therefore would be subject to a right of set-off available to the shipper against the charterer, including under the Statutes in the case of mutual debts, since the set-off would have the effect that nothing would be paid to the extent of the set-off which could be intercepted.

5.25  An unliquidated cross-demand generally cannot be employed as an equitable set-off in an action to enforce payment of a bill of exchange or other negotiable instrument.¹⁰⁴ The House of Lords affirmed the principle in Nova (Jersey) Knit Ltd v Kammgarn Spinnerei GmbH,¹⁰⁵ (p. 177) and it is also accepted in Australia¹⁰⁶ and New Zealand.¹⁰⁷ The principle applies whether the parties are immediate or remote,¹⁰⁸ and whether the cross-demand arose out of the transaction in respect of which the instrument was given or, a fortiori, in any other way.¹⁰⁹

5.26  The principle typically is invoked when a cheque is given as payment for the price of goods sold, and the vendor has breached a term in the contract which amounts to a partial failure of consideration¹¹⁰ so as to give rise to a claim against him or her for unliquidated damages. The breach does not provide the purchaser with a defence to an action by the vendor for payment of the cheque. This is sometimes explained on the ground that the cheque is a separate contract from the contract of sale, although it is not an essential requirement of an equitable set-off that the claim and the cross-claim should have originated in the same contract.¹¹¹ The cheque has also been described as constituting a separate transaction from the sale,¹¹² and indeed in the case of letters of credit in sale transactions this principle has been expressly incorporated in the Uniform Customs and Practice for Documentary (p. 178) Credits.¹¹³ But the most commonly accepted explanation is that the rule precluding a defence of equitable set-off is based upon a policy consideration, that a cheque or bill of exchange given as payment is considered to be equivalent to cash, albeit with payment deferred, and if an unliquidated cross-demand could provide a defence to an action on the instrument there would be a substantial inroad upon this commercial principle.¹¹⁴

5.27  Stays of execution are subject to a similar restriction. A defendant in an application for summary judgment who asserts a counterclaim not amounting to a set-off ordinarily would not be granted leave to defend. On the other hand, the court in its discretion may order a stay of execution¹¹⁵ on the claimant's judgment until the defendant's crossaction has been tried,¹¹⁶ so that if the defendant succeeds in the cross-action execution would only issue for the balance of the two claims. However, a different practice applies when the claimant's claim is on a cheque or bill of exchange. The fact that the defendant in an action to enforce payment of a cheque asserts a counterclaim for unliquidated damages is not usually regarded as a ground for staying execution.¹¹⁷ This is not an inflexible principle, however, because it is said that the court may grant a stay if there are exceptional circumstances.¹¹⁸ But while the existence of this exception is generally recognized, the courts have been reluctant to recognize ‘exceptional circumstances’ which may detract from the principle that cheques and bills of exchange should be treated as cash.¹¹⁹ Indeed, in (p. 179) Nova (Jersey) Knit Ltd v Kammgarn Spinnerei GmbH¹²⁰ Viscount Dilhorne said that it would ‘seldom, if ever’¹²¹ be right to allow a cross-claim to operate as a bar to execution, while Lord Russell of Killowen said that an unliquidated cross-demand is not available as a counterclaim in an action on a bill of exchange without referring to an exception of ‘exceptional circumstances’ in relation to a stay.¹²² Certainly it is not sufficient for a stay that there is a counterclaim which is likely to succeed,¹²³ or that the claim on the cheque and the cross-action for unliquidated damages are part of the same transaction.¹²⁴

5.28  A stay was ordered in Barclays Bank Ltd v Aschaffenburger Zellstoffwerke AG.¹²⁵ A German acceptor of bills of exchange had a cross-claim against the English drawer that was the subject of an arbitration to be held in Copenhagen. Judgment was given against the acceptor on the bills, but the Court of Appeal stayed execution until the result of the arbitration was known.¹²⁶ The reason for the stay is not altogether clear, although it appears from the judgment of Harman LJ¹²⁷ that the German acceptor had argued that there may have been some difficulty in obtaining payment if it succeeded. The case received a mixed reception when the Court of Appeal later considered it in Cebora SNC v SIP (Industrial Products) Ltd.¹²⁸ Buckley LJ said that it should be regarded as turning on its own particular facts. Stephenson LJ was more positive. He said that he was ‘not surprised’¹²⁹ that a stay was granted in the circumstances of the case. Sir Eric Sachs, on the other hand, was critical of the decision. He noted that the report of the case, ‘perhaps wisely’,¹³⁰ had not been included in the Law Reports or the All England Reports, and suggested that it was out of line with other authorities. Notwithstanding that criticism, a first instance judge ordered a stay in similar circumstances in Montecchi v Shimco (UK) Ltd.¹³¹ The plaintiff was an Italian businessman who had sold some goods to the defendant English company. The goods (p. 180) were paid for by bill of exchange drawn by the defendant. The defendant alleged that the goods were defective, and refused to honour the bill. The plaintiff then sought, and obtained, summary judgment for the amount of the bill, though execution was stayed until after the hearing of the counterclaim on condition that the defendant pay the amount of the judgment into a joint account or into court. In addition, the judge granted a Mareva injunction restraining the plaintiff from dealing in any way with or disposing of the proceeds of the judgment. Subsequently, however, the Court of Appeal upheld an appeal by the plaintiff against the order, principally on the ground that a Mareva injunction was inappropriate because there was no evidence that the plaintiff would attempt to avoid enforcement of a judgment obtained against him on the cross-action. In delivering the judgment of the court,¹³² Bridge LJ emphasized that it is not sufficient for a stay that the plaintiff suing on the bill, and against whom there is a cross-claim for damages, is foreign.¹³³ This would particularly be the case if the claimant has a substantial business in its own country.¹³⁴ On the other hand, Bridge LJ said that he should not be taken as saying that in no circumstances whatever could an injunction be granted to restrain a plaintiff from dealing with the fruits of a judgment in a case such as that before him.

5.29  The size of the paid up capital of a foreign company is regarded as of little significance,¹³⁵ while Sir Eric Sachs in Cebora SNC v SIP (Industrial Products) Ltd¹³⁶ rejected a submission that it is material to inquire into the virtues or defects of legal procedures in the country of a foreign plaintiff to which recourse may be necessary to enforce any judgment obtained on a cross-action. It has been suggested that a stay may be granted if there are ‘real grounds’ for supposing that the foreign plaintiff would not be likely to meet the counterclaim.¹³⁷ If Sir Eric Sachs was correct in the Cebora case in saying that it is not relevant to inquire into defects of the legal procedures of the plaintiff's country, it is difficult to see what could give rise to ‘real grounds’ for supposing that the counterclaim would not be met other than issues relating to the solvency of the claimant. But that circumstance should be just as relevant in the case of an English plaintiff. In Continental Illinois National Bank and Trust Co of Chicago v Papanicolaou (The Fedora),¹³⁸ Parker LJ suggested, in the context of a guarantee given in circumstances such that it was the equivalent of a letter of credit, to which principles similar to those applicable to bills of exchange apply,¹³⁹ that it ‘might be’ that a stay would be granted if there was a counterclaim which was likely to succeed, coupled with cogent evidence that the holder of the guarantee, if paid, would be unable to meet a judgment on the counterclaim. Even in those circumstances, however, it is (p. 181) suggested that the courts would be reluctant to grant a stay. Thus, it has been held that it is not sufficient for a stay that the claimant on the cheque is a company in administration.¹⁴⁰

5.30  The concept of exceptional circumstances is usually referred to in the context of a stay of execution, but there is authority suggesting that it might also be relevant in relation to the primary question, whether the holder of the instrument is entitled to judgment.¹⁴¹ In Barclays Bank v Aschaffenburger,¹⁴² Lord Denning said that, while the holder of a bill of exchange ordinarily is entitled to judgment notwithstanding a cross-claim for damages available against him or her, there may be exceptions to the rule,¹⁴³ and similarly Salmon LJ indicated that the rule is not invariable.¹⁴⁴ It is noticeable, however, that a stay of execution was granted to the defendant in that case, as opposed to a judgment recognizing that there was a defence to the extent of the cross-claim. Subsequently, in Brown, Shipley & Co Ltd v Alicia Hosiery Ltd,¹⁴⁵ Lord Denning once again expressed the principle in terms that ‘in the ordinary way’ judgment should be given upon a bill notwithstanding a cross-claim, although the discussion later in his judgment concerned the possibility that the court in its discretion may grant a stay of execution, and indeed the availability of a stay was the issue in the case. In Saga of Bond Street Ltd v Avalon Promotions Ltd,¹⁴⁶ the defendant against whom judgment had been given on a bill succeeded in an application to set aside the judgment because of a breach of contract by the plaintiff. In later cases, however, the courts have sought to distinguish the case (albeit unsatisfactorily).¹⁴⁷ In view of the Nova (Jersey) Knit case,¹⁴⁸ it is doubtful if it would now be followed.¹⁴⁹

5.31  The preceding discussion concerned the situation in which the unliquidated cross-demand either is unrelated to the transaction for which the bill of exchange or cheque constituted consideration or, if it arose out of the same transaction as the instrument, it merely gives rise to a case of partial failure of consideration. On the other hand, an acceptor of a bill of (p. 182) exchange has a defence to a claim brought against him or her by the drawer if his or her acceptance was procured by fraud, invalidity, or for a consideration which has totally failed.¹⁵⁰ Therefore, if there has been a total failure of the consideration for which the bill was given,¹⁵¹ the acceptor has a defence.¹⁵² Similarly, fraud in relation to the transaction in respect of which the bill constituted payment or security may provide a defence to an action on the bill by the drawer,¹⁵³ while it has been held in Australia that the principle under discussion does not apply where the cross-claim is to have the bill set aside or treated as a nullity pursuant to the Trade Practices Act 1974 (Cth), s. 87.¹⁵⁴ In addition, in Australia the Full Court of the Federal Court has suggested that the rule might not apply where the bill was obtained as a result of conduct that was misleading or deceptive in breach of s. 52 of the Trade Practices Act.¹⁵⁵

5.32  The principle precluding an equitable set-off against a claim on a cheque or similar instrument should not apply in the converse situation in which the holder is seeking to employ the debt on the instrument in a set-off. In Williams v Davies¹⁵⁶ Sir Lancelot Shadwell permitted a person who had obtained judgment on some promissory notes to set off the judgment against a damages liability to the maker of the notes. While the case has been criticized on the ground that the cross-demands were not sufficiently closely connected to give rise to an equitable set-off,¹⁵⁷ it nevertheless suggests that a claim on a negotiable instrument may be employed defensively in a set-off.

5.33  Further, the existence of a cross-demand may provide a ground for setting aside a statutory demand served under the Insolvency Act 1986, s. 268 as a prelude to a bankruptcy petition based upon non-payment of a cheque. Pursuant to the Insolvency Rules 1986, r. 6.5(4)(a), the court may grant an application for an order setting aside a statutory demand if the debtor appears to have a ‘counterclaim, set-off or cross demand’ which equals or exceeds the amount of the debt. ‘Cross-demand’ has a wider meaning than the technical terms ‘set-off’ and ‘counterclaim’.¹⁵⁸ The fact that the damages cross-claim would not have given rise to a defence to a claim on the cheque, and would not have constituted grounds for a stay of execution on a judgment on the cheque, does not mean that it is not a cross-demand for the purpose of r. 6.5(4)(a).¹⁵⁹ A similar principle applies in the case of a petition to wind up a company for failure to pay a cheque or other instrument. If the company has a genuine and serious cross-claim in an amount which exceeds the debt to the petitioner, the petition may be dismissed or stayed unless there are special circumstances which make it inappropriate to do so.¹⁶⁰

5.34  Similarly, a claim on a cheque or other instrument may be the subject of a mandatory set-off under the insolvency legislation in the event of a bankruptcy or a liquidation of the party liable on the instrument, provided that the other requirements of the insolvency set-off section are satisfied.¹⁶¹

5.35  While it is now settled that an equitable set-off based upon a cross-claim for damages is not available (save possibly in exceptional circumstances) as a defence to an action on a bill of exchange or other negotiable instrument, conflicting views have been expressed in relation to the availability of a set-off under the Statutes of Set-off in the case of mutual debts.

5.36  It is sometimes suggested that the principle which precludes an equitable set-off in respect of an unliquidated cross-demand also applies to the Statutes, so that generally the drawer of a cheque or the acceptor of a bill being sued for payment cannot raise as a defence an independent debt owing by the holder. There is one situation in which it is recognized that (p. 184) a set-off may arise under the Statutes, and that is when a cheque or other instrument is given as payment for goods sold or services performed and there is a liquidated cross-demand arising from a partial failure of consideration.¹⁶² That situation is referred to below.¹⁶³ But if the cross-debt is not connected in that way, it has been suggested that it cannot be set off.¹⁶⁴ This view is said to be supported by a comment by Sir Eric Sachs in Cebora SNC v SIP (Industrial Products) Ltd,¹⁶⁵ which has been referred to by the courts on other occasions with evident approval.¹⁶⁶ Sir Eric Sachs said that the courts will refuse to regard as a defence to a claim on a bill of exchange ‘any set off, legal or equitable, or any counterclaim, whether arising on the particular transaction upon which the bill of exchange came into existence, or, a fortiori, arising in any other way’.¹⁶⁷ There are four points to note in relation to this comment. The first is that, in so far as it extended to legal set-offs, it was obiter. The second is that the reference to ‘legal’ set-off may have had in contemplation the common law cases which have held that the principle of abatement¹⁶⁸ does not apply when the price had been paid by way of bill of exchange, as opposed to the form of set-off conferred by the Statutes of Set-off in the case of mutual debts.¹⁶⁹ The third is that the decision of the House of Lords in Nova (Jersey) Knit Ltd v Kammgarn Spinnerei GmbH¹⁷⁰ does not require the conclusion that the Statutes have a limited operation in the case of bills of exchange. The Nova (Jersey) Knit case concerned equitable set-off, not the statutory defence.¹⁷¹ The fourth point is that, if Sir Eric Sachs did intend to refer to the Statutes, it is not an accurate statement of the traditionally accepted position. The right of set-off in the (p. 185) case of mutual debts was not developed as an equitable or a common law doctrine, but rather it is statutory in origin. In the case of a defence conferred by statute the proper approach is to examine the words of the relevant legislation,¹⁷² and the Statutes of Set-off simply stipulated that a set-off could occur in the case of mutual debts. There is nothing in them to suggest that they were not intended to apply when the plaintiff is suing on a cheque or other instrument.

It was held that the circumstances referred to did not prevent the application of the principle that an indorsee of an overdue note takes free from rights of set-off available against the indorser. Parke B nevertheless recognized that, if the indorser instead had been the party suing on the bill, he could have been met by a set-off under the Statutes in respect of the debt that he owed to the acceptor. Nor is there anything in the report to suggest that the indorser's debt to the acceptor was connected with the transaction in respect of which the bill was given. These cases were decided after some of the early cases which had established that a claim on a bill of exchange given as payment of the price of goods sold and delivered cannot be met by a defence based upon a cross-claim for damages for a defect in the goods,¹⁸⁴ and it may be assumed that the judges were aware of those earlier cases.

5.38  There are instances in Victoria in which the courts have held that a debt arising otherwise than as a result of a partial failure of consideration could be set off under the Statutes against a claim on a negotiable instrument. One such case is Ingleton v Coates,¹⁸⁵ a decision of Madden CJ, in which the debt sought to be set off originated in a loan made to the person to whom the promissory note being sued upon had been indorsed, the debt on the loan having been assigned to the maker of the promissory note. In Mobil Oil Australia Ltd v Caulfield Tyre Service Pty Ltd¹⁸⁶ Young CJ, having quoted the passage from the judgment of Sir Eric Sachs in the Cebora case referred to above, suggested that the decision in Ingleton v Coates to allow the maker leave to defend may need to be reconsidered,¹⁸⁷ though the better view is that it was correct. Two other Victorian cases support that view. The first is Nisbet v Cox,¹⁸⁸ which concerned a set of bills. The report only takes the form of a short note, but it appears to have been accepted that a set-off under the Statutes was available once the last bill became due. The report simply states that a debt was alleged to be due from the plaintiff to the defendant acceptor. The nature of the debt is not mentioned, and presumably it was (p. 187) not regarded as significant. The second case is Woodroffe v Moss.¹⁸⁹ The defendant in an action brought against him on a cheque pleaded by way of defence that the plaintiffs had been his agents for the sale of some goods, and in breach of their duty as agents themselves purchased the goods and sold them on their own account at enhanced prices without accounting for the difference in price. The Full Court of the Victorian Supreme Court held that this could be pleaded as a defence of set-off. It has been suggested that the case turned on the circumstance that it involved delinquency by a fiduciary.¹⁹⁰ However, that point was not emphasized in argument or in any of the judgments. The whole discussion centred on whether the claim against the plaintiff was liquidated. It was held that it was. Therefore, a set-off was allowed under the Statutes.

5.39  Further, in Hongkong and Shanghai Banking Corporation v Kloeckner & Co AG¹⁹¹ Hirst J accepted as ‘well settled’ a general statement by counsel to the effect that a set-off is permissible against a claim on a bill of exchange when the cross-claim is liquidated though not when it is unliquidated.¹⁹²

5.40  The case of freight payable to a shipowner provides an analogy.¹⁹³ The position in relation to freight is similar to that applicable to bills of exchange, in that neither equitable set-off nor the common law defence of abatement may be asserted in answer to a claim for freight. But there is also authority in that context for the proposition that the principle which precludes those defences does not affect the application of the Statutes of Set-off when the case involves mutual debts.¹⁹⁴

5.41  Nevertheless, recent comments in the Court of Appeal support the more restrictive view. In Safa Ltd v Banque du Caire¹⁹⁵ Waller LJ, in a judgment with which Lady Justice Hale and Lord Justice Schiemann agreed, said in the context of bills of exchange that set-off is ‘only available between immediate parties in relation to liquidated sums’.¹⁹⁶ This was not expressly limited to the case of a partial failure of consideration,¹⁹⁷ although the discussion earlier in the judgment¹⁹⁸ suggests that he also had in mind that limitation. Thus, Mance LJ, in delivering the judgment of the Court of Appeal¹⁹⁹ in Solo Industries UK Ltd v Canara Bank,²⁰⁰ later referred to Waller LJ in Safa as having cited: ‘the principles governing bills of (p. 188) exchange, according to which set-off is not admissible, other than between immediate parties in cases of partial failure of consideration when the amount involved is both ascertained and liquidated …’ However, the justification for restricting the defence to immediate parties and to cases of partial failure of consideration remains unclear. When a bill of exchange is issued by reference to an underlying transaction,²⁰¹ and there has been a partial failure of consideration where the amount involved is liquidated and ascertained,²⁰² the case is one of mutual debts, and therefore the Statutes of Set-off prima facie apply. But the Statutes do not require any connection between the debts the subject of the set-off,²⁰³ and so the connection or otherwise between the debt sought to be set off and the transaction that gave rise to the instrument should not be relevant to the question whether the Statutes apply. For the same reason, it should not matter whether the parties are immediate or remote. The comments in the Safa and Solo Industries cases were obiter, and the point was not subjected to detailed analysis. In view of the earlier authorities suggesting that the defence is not so restricted, and in view of the language of the Statutes of Set-off themselves, those comments should not be regarded as having settled the issue.