Part E Guarantees and Security, 36 Lien and Set-Off
- Regulation of banks — Automatic set-off — Insolvency set-off — Transaction set-off
36.01 The banker’s rights of lien and set-off do not generally involve a taking of security in the manner contemplated by other chapters within this section. Yet those rights can in practice operate as a valuable form of security in the event of the customer’s insolvency, and it is thus appropriate to consider them here.
Right of Lien
36.02 It is generally accepted that a bank has a lien over all securities deposited with it by its customer.1 It appears that the lien arises by operation of law and it will accordingly apply in every case unless the circumstances imply a contrary intention on the part of both the banker and the customer. This may be contrasted with a pledge, where a positive intention to create the security interest must exist or be apparent from the circumstances of the case.2 In view of the distinction, it is necessary to ask whether the bank’s lien implies a power of sale in relation to the shares or other securities deposited with it? It is submitted that it does not, because a power of sale should not be implied where no security interest was intended by the parties in the first instance. The point may often be theoretical in any event. For example, if the bank is seeking to exercise a lien over share certificates, it may need a court order in order to achieve that objective since it will not hold the executed forms of transfer necessary to complete the sale.3 In addition, the bank may have a lien over payment (p. 650) instruments delivered to it for collection. However, in that instance, the point will again be largely academic. Whether or not the bank has a lien over such an instrument, it will be under an obligation to collect items presented for credit to the account. Once it has undertaken that task, its lien over the instrument will mutate into a right of set-off over its proceeds (see below). It has been decided that a possessory lien may be combined with a contractual power of sale at the time when goods or securities are deposited, and that such an arrangement does not constitute a charge; rather, it remains a lien because its efficacy rests on possession and, if the bank parts with possession, the ‘security’ is lost.4 Nevertheless, since the lien coupled with a power of sale does not amount to a charge, it does not require registration under section 860 of the Companies Act 2006.5
36.03 The general lien may be excluded either by an express agreement or by the intention of the parties as inferred from the circumstances of the case. Thus, if documents are delivered specifically for safe custody, it may be possible to infer that the lien has been excluded. However, if this is coupled with a duty for the bank to collect payments on financial securities, then it is likely that the lien will apply.6 Likewise, if securities are deposited to cover a specific loan facility, it may be implicit in that arrangement that the securities are not intended to cover a general overdraft facility.7 However, if the customer does not reclaim the securities following repayment of the specific facility, then it may be possible to infer that the bank’s ordinary lien is again intended to apply.8
36.04 As a general rule, of course, the lien can only extend to property which is beneficially owned by the customer himself. Thus, if the bank knows of a third-party interest in the securities at the time it receives them, then its lien will necessarily be subordinated to that interest. On the other hand, if the bank receives securities in good faith and without notice of a third-party interest, then the lien will remain effective.9
Bank’s Right of Set-off
36.05 The bank’s lien applies to securities and payment instruments deposited with it for collection. In contrast, the right of set-off applies to credit balances on the customer’s account with the bank. In the past, it was common to refer to a bank’s ‘lien’ over the customer’s deposits, but it is now clear that deposits are subject to a right of set-off, rather than to any form of lien, and it is thus necessary to draw a careful distinction (p. 651) between the two rights.10 The following points may be noted in relation to the right of set-off:
(a) a bank may, without any requirement to notify the customer, combine two current accounts so that a credit balance on the first account extinguishes or reduces the debit balance on the second;11
(b) the usual right of set-off can be varied by the express or implied intent of the parties.12 Consequently, if (for example) the bank has made a term loan to the customer to assist it in buying a property, and credit balances on the current account are used for the daily operation of the business, it will generally be an implied term that the bank will not combine the loan account with the current account since this will defeat the arrangements which the parties originally had in mind;13
(c) it has been said that the fact that the accounts are maintained in different currencies may be sufficient to imply an agreement excluding the general right of set-off.14 Yet the fact that a multinational company needs accounts in a variety of different currencies does not appear sufficient to justify this conclusion. If, however, the foreign currency accounts are held with branches of the bank in the other countries concerned, then the right of set-off probably is excluded because of the attenuated nexus between the accounts and because the foreign accounts will be governed by different systems of law which may not recognize the existence of such a right;
(d) the right of set-off cannot apply where one of the accounts is held by the customer as a trustee and the bank is aware of that fact.15 This point may seem obvious, but practical difficulties may arise. For example, the bank may be unaware of the third-party interest when it accepts the deposit, but may only be advised of it at a later stage. Under these circumstances, it is submitted that the bank should be able to exercise its right of set-off up to the amount owing as at the date on which such notice is received;
(e) if the right of set-off is excluded, whether expressly or by virtue of the types of arrangements described above, then it will come to an end on the liquidation of the customer or other termination of the relationship;16
(f) if the bank wishes to resume its rights of set-off, then it must give notice to that effect to the customer. The bank must continue to honour cheques on the overdrawn account but it may cease to do so as soon as the notice is received by the customer. If a period of notice had to be given, then the result would be that the customer would transfer the entire credit balance to another bank, thus entirely defeating the object of the exercise;17
(g) under the terms of its general right of set-off, the bank can only apply a credit balance against a debit balance which is due and payable. A bank must therefore repay an (p. 652) ordinary credit balance on demand and cannot retain it against a future or contingent liability of the customer;18 and
(h) the right of set-off may have a practical effect equivalent to a security interest but it does not of itself create a proprietary or security right in the credit balance on the account. Consequently, the prohibition on the enforcement of security following the appointment of an administrator19 would not appear to prevent the bank from exercising its general rights of set-off during that period.20
Other Rights of Set-off
36.06 Although a bank may enjoy the special rights of set-off noted above, this is not exclusive of more general rights which might be available to it. For example, a legal right of set-off may apply as between two fixed and matured debts which have arisen as between the bank and its creditor.21 As a result, a bank which is owed money by the beneficiary of a letter of credit issued by it may be able to exercise a legal right of set-off when documents are presented under the credit for payment, at least if there is a sufficiently close connection between the credit and the beneficiary’s indebtedness.22 However, a bank is generally obliged to repay its customer on demand, and cannot refuse payment on the basis that there is an arguable case that it has a right of set-off on the basis that a person other than the account holder is the beneficial owner of the credit balance and that the bank has valid cross-claims against that person.23 Set-off will only be permitted in this type of situation where the existence of the nominee or trust arrangements is very clear from the evidence; it will not be sufficient merely to prove that the account holder is acting as nominee for some third party, it must be shown that he is the nominee of the bank’s debtor in respect of which the set-off is claimed.24
36.07 The bank may also enjoy statutory rights of set-off in the event of the customer’s insolvency. Rule 4.90 of the Insolvency Rules 198625 provides for the set-off of ‘…mutual credits, mutual debts or other mutual dealings…’ which occurred between the parties prior to insolvency. The application of rule 4.90 is mandatory once the customer has gone into insolvency proceedings26 and, if the parties have agreed wider rights of set-off under a contractual arrangement (eg allowing set-off against liabilities of a third party), those rights will not be enforceable in the insolvency. They would have the effect of widening the rights (p. 653) to which the bank would be entitled, to the detriment of the general body of creditors, and this would be contrary to public policy.27 Nevertheless, that statutory right of set-off is itself relatively broad, and extends to the rights to value and set-off against liabilities which are merely contingent as at the date of the insolvency.28 Thus, a bank which has issued a guarantee or documentary credit at the behest of the insolvent customer will usually be entitled to retain the funds in the customer’s account and exercise a right of set-off representing the likely level of any demand.
36.08 Where the bank itself has become insolvent, then a guarantor of a customer’s debt— usually, a controlling shareholder of the borrower company—whose guarantee is expressed to be a primary obligation will be entitled to set off his obligation in that capacity against any deposits which the bank holds from the guarantor, because the obligation under the guarantee and the deposit will constitute ‘mutual dealings’ for the purposes of rule 4.90 of the Insolvency Rules 1986.29 If, however, the depositor has merely deposited cash with the bank by way of third-party security (ie without a personal obligation to pay), then there will be no mutual obligations which are capable of set-off in the bank’s insolvency.30 The result will be that the bank can instead sue the borrower itself and recover on any security which may be available to it. It can later have recourse to so much of the charged deposit as may be necessary but, subject to that, the guarantor has no particular right or remedy against the bank by virtue of his status, and must prove for his deposit in the liquidation.31 In other words, the controlling shareholder will effectively suffer a ‘double loss’, in that he will lose both the assets of his company and his charged deposit.32(p. 654)
2 This distinction was highlighted in Re Cosslett (Contractors) Ltd  Ch 495 (CA), where it was noted that both a pledge and a lien involve the physical delivery of goods or securities, but a pledge involves a positive intention to create security, whilst a lien merely implies a right to retain assets originally delivered for some other purpose.
3 Contrast the position where the bank takes a charge over such instruments: see generally Chapter 29 above. The bank’s lien may apply to instruments which are not readily and freely negotiable or transferable. Thus, both share certificates and deposit receipts may be subject to the lien: see respectively Re United Services Co. Johnston’s Claim (1870) 6 Ch App 232 and Jeffryes v Agra and Masterman’s Bank (1866) LR 2 Eq 674. In relation to title deeds to real property, the bank may retain those deeds until the outstanding obligations are paid, since that is the essence of a lien. Once again, however, it is submitted that it has no general power of sale. Apart from other considerations, the existence of such a power would be inconsistent with the provisions of s 2(1) of the Law of Property (Miscellaneous Provisions) Act 1989.
4 See Paget, para 14.3, citing Great Eastern Rly Co v Lord’s Trustee  AC 109; Re Cosslett (Contractors) Ltd  Ch 495 (CA) and Re Hamlet International plc  2 BCLC 506 (CA). The decision in Lord’s Trustee has been approved and applied in New Zealand: see Waitomo Wools (NZ) Ltd v Nelsons (NZ) Ltd  1 NZLR 484.
5 Re Hamlet International plc  2 BCLC 506 (CA). On registration of company charges, see paras 27.18–27.26 above.
11 Garnett v McKeown (1872) LR 8 Exch 10; Prince v Oriental Credit Bank Corp (1878) 3 App Cas 325 (PC); Halesowen Presswork, n 10 above.
13 Bradford Old Bank Ltd v Sutcliffe  2 KB 833 (CA), followed in Re EJ Morel (1934) Ltd  Ch 21 and approved in the Halesowen Presswork case, n 10 above.
16 Halesowen Presswork, n 10 above.
17 Halesowen Presswork, n 10 above.
20 This conclusion would appear to be justified by reference to the decision of the New South Wales Court of Appeal in Cinema Plus Ltd (administrators appointed) v ANZ Banking Group Ltd  NSWCA 195 although, of course, the relevant statutory provisions are framed in different terms.
22 Hong Kong and Shanghai Banking Corp v Kloeckner & Co AG  2 QB 514, noted by Paget, para 14.33. The bank’s general right of set-off plainly could not apply in this situation, since the debt was owing by the beneficiary of the credit and not by the bank’s customer (ie the applicant for the credit). On rights of set-off under letters of credit, see further Lehman Brothers Commodity Services Inc v Credit Agricole Corporate and Investment Bank  1 All ER (Comm) 254;  EWHC 1390.
26 See the decision in Halesowen Presswork, n 10 above.
30 The mere deposit of money with a bank by way of charge for a third party’s obligations has the effect of creating security in favour of the bank but, in the absence of express terms, does not impose a personal payment obligation on the depositor himself: see Tam Wing Chuen v Bank of Credit and Commerce Hong Kong Ltd (in liquidation)  BCLC 69 (PC).
31 This follows from the fact that a creditor is generally entitled to exercise his remedies in such order and manner, and at such times, as he sees fit: see China and South Sea Bank Ltd v Tan  1 AC 536 (PC).