Foreign Currency: Claims, Judgments and Damages

Michael Howard; John Knott and John Kimbell

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CHAPTER 11 Set-off

General

Introduction

11.1 At first consideration the concept of a set-off between opposing claims is a straightforward one and would seem to be simple to implement. In reality, however, the topic raises numerous difficulties and uncertainties.1 Among the questions that may arise are: Does set-off simply create a procedural bar to enforcement of the whole or part of a claim, or is it substantive in nature? If substantive, does it act to reduce or extinguish one party’s claim as soon as a cross-claim is founded, or only at the time of judgment? If the latter, how is set-off achieved where judgments on claim and cross-claim are given at different times? What difference is there between set-off involving liquidated and unliquidated claims or cross-claims? Does set-off have a bearing on the period for which interest may be awarded? What is the difference, if any, between reducing a claim by set-off and reducing it by a defence? What happens if set-off is available in a particular case in more than one form? All these questions can arise where claims are entirely in sterling. Where a claim or cross-claim calls for assessment in one or more foreign currencies whose exchange rates may fluctuate, and which may attract interest at different rates and for different periods, the potential additional complications make set-off a complex task. In this chapter we seek to identify the solutions to set-off questions that have so far evolved in relation to foreign currencies, examining them critically where necessary; and we also suggest possible answers to questions that may arise in the future. 11.2 Apart from having a core meaning of reducing cross liabilities to a single liability for the difference between them, the term ‘set-off has by usage a number of related meanings. In English law, set-off is of several main types, among which are legal set-off, Admiralty set-off, equitable set-off, contractual set-off, banker’s set-off and set-off in the context of insolvency.2 In Aectra Refining and Manufacturing Inc v

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Exmar NV3 Hoffmann LJ adopted a distinction4 between ‘independent set-off,5 ‘transaction set-off6 and set-off in the context of insolvency. 11.3 Legal set-off, which is a procedural device created by statute,7 does not affect the parties’ substantive rights but operates in suitable cases at the time of judgment, when successful claims and cross-claims are merged. It is available only where the claims are for sums that are due and which are either liquidated or can be quantified at the time of pleading without introducing estimates or valuations.8 The method of set-off applied in Admiralty cases stems from a procedure introduced in the late 19th century, which has the effect of reducing cross-liabilities to a single judgment.9 The doctrine of equitable set-off, which is considerably broader in concept, arises where a court of equity would have formerly granted an injunction to restrain a claimant from proceeding with a trial, or enforcing a judgment, where, typically, the defendant had a cross-claim which the court considered should be taken into account. Equitable set-off affects substantive rights.10 There are conflicting views as to whether it is capable of being relied on outside the context of legal proceedings.11 Contractual set-off, as its name suggests, arises out of a contract, by either express or implied terms, and can in principle apply to unliquidated and contingent liabilities.12 11.4 Banker’s set-off between multiple bank accounts may be available for the benefit of either a banker or his customer in the absence of an express or implied

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agreement to the contrary.13 In addition to these classes, set-off can also arise from mandatory provisions relating to bankruptcy or when a company is wound up.14 11.5 Apart from in these introductory remarks, this chapter is not concerned with the question of whether set-off is or is not available to a party in a particular case; or as to the validity of a particular set-off where one of the parties is, or becomes, insolvent; or with an examination of the circumstances in which a claim to set-off may give rise to a stay within an action or an arbitration. On those and similar questions, specialist works on set-off should be consulted.15 And the authors have tried to avoid entering too far into an esoteric debate as to whether certain types of set-off are substantive in nature (and, if so, precisely what effect that has) or whether they are procedural - a type of debate that occurs in several areas of the law. In many situations the outcome after set-off will be the same, whether the particular set-off is treated as substantive or procedural. Rather, this chapter examines several practical situations that arise once a right to set-off has been established in the context of litigation, where one or more foreign currencies are involved. It considers general principles which will be applicable to most occasions where set-off is called for under English law, but does not seek to explore the full details or procedures applicable to every type of situation in which a right to one or more types of set-off may arise.16 These are practically limitless and may involve claims and cross-claims between strangers (as in motor vehicle or ship collisions); or between employer and employee; or between parties to commercial arrangements such as charterparties and other shipping contracts; banking clearing house system, stock market and other financial market dealings; construction contracts; and contracts for the sale of goods or the provision of services, among others.17 Some instances of set-off will involve debts or other liquidated liabilities, whereas some will involve damages, and some will involve both debts and damages. The key features that emerge from the situations addressed by this chapter relate to mechanisms for striking a balance

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between various claims where at least one is in a foreign currency; and where interest may or may not be recoverable; and where the issue of liability may be determined at the same time as, or either before or after, the amounts of the claims are ascertained by agreement, or by judgment of a court, or by an arbitration award.18

The need for foreign currency set-off

11.6 Until the late 1970s, the possibility of set-off involving foreign currency claims in English courts and arbitrations did not arise (unless by special contract clauses which were held enforceable), as all claims had to be converted into sterling.19 Then, set-off simply involved deducting the smaller amount of pounds from the larger amount, when, owing to the principle of nominalism, the fact that sterling (and any currency from which it had been converted) may at different times have had a different international value or a different purchasing power was ignored. Following the change introduced by the trilogy of cases Miliangos,20 The Despina R 21 and The Folias,22 one of the most frequent situations in which set-off involving foreign currency claims occurs is in litigation arising from collisions between ships, or involving contractual disputes arising from charterparties or contracts of carriage. 11.7 There is a combination of reasons for this. Ship collisions occur in oceans, seas and rivers and other inland waters throughout the world, often between ships whose owners trade in different currencies. The resulting repairs may be carried out in any one or more of a large number of different countries and may be invoiced and paid in a variety of currencies; and other elements of loss may be sustained by each owner in yet other currencies.23 Accordingly, as English law is agreed between parties for the determination of a large proportion of disputes arising from ship collisions, it is not surprising that over the years since Miliangos the Admiralty Court, and arbitrators and practitioners involved in shipping disputes, have gained a good deal of experience in dealing with set-off in this context.24

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11.8 When The Despina R was progressing through the courts during the 1970s and the possibility arose of awarding judgment in a foreign currency for damages for a tort, the Admiralty judge gave consideration to how set-off could be achieved between foreign currency claims in ship collision actions. The procedure he suggested met with approval when the case reached the House of Lords. Since then, it has been applied to collision claims in contested court actions and arbitrations, and particularly (and as a result) during virtually all negotiated settlements of numerous such claims that do not reach trial. It is therefore convenient to start an examination of foreign currency set-off by looking at how it is achieved in Admiralty cases, in view of the considerable practical experience of it gained there. 11.9 Despite the fact that these are Admiralty cases involving collisions between ships, and that therefore the method of set-off was devised in the context of Admiralty case procedures, it should not be considered that the decisions and the principles they support are of no relevance to other types of disputes. On the contrary, and as will be seen, they are also suitable for taking account of the principles that underpin equitable set-off and probably most, if not all, other instances of set-off within the context of litigation. 11.10 Historically, cases in the Admiralty Court have been subject to various idiosyncratic and arcane procedures and practices, but (with a few important exceptions which we discuss separately) these have been brought into alignment with the more widespread procedures and practices derived from common law courts.25 11.11 In the days before the changes flowing from Miliangos, the procedure followed by the Admiralty Court for setting off cross-liabilities in Admiralty collision disputes was that laid down by the House of Lords in the 19th-century case The Khedive.26 The procedure involved giving a single judgment for the amount by which the larger recovery exceeded the smaller, once the apportionment of liability and the quantum of the claims had been taken into account, rather than giving separate judgments on claims and counterclaims.27 This procedure has been applied ever since.28

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Pre-insolvency set-off in foreign currency judgments

Procedure developed in Admiralty; 29 The Despina R30

11.12 The issue of liability in The Despina R was resolved on the basis that only the claimants would make a recovery, so the question of how cross-claims should be set off against each other did not arise for determination in that case; but it was nevertheless one of the important points of principle that the court considered.31 Brandon J, who was aware that an appeal against his judgment was inevitable, considered the question of set-off and proposed how this could be achieved in the event of future awards being made in cross-claims involving different currencies. 11.13 The method he proposed involved converting the smaller award into the currency of the larger award, and giving judgment in that currency for the difference.32 In this proposal, set-off would take effect as at the time of assessment of the claims by judgment or agreement. When the appeal from Brandon J’s decision reached the House of Lords, his proposal for set-off between different currencies was approved by Lord Wilberforce as a reasonable solution. And, although this approval was not binding, as set-off was not a feature of The Despina R, the Brandon Rule for currency conversion was thereafter adopted in settlements of Admiralty claims negotiated between practitioners, and in disputes reaching the court or arbitrators.33

Summary of the Brandon Rule for set-off between Admiralty claims

Set-off date: The date when claims are assessed by judgment or agreement.

Method of setting off: Convert the smaller-valued claim into the currency of the larger and deduct it from the larger claim. Give judgment for the balance.34

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Application of the Brandon Rule for set-off: The Nicos V

11.14 The question of how foreign currency cross-claims should be resolved in an Admiralty case first arose for decision in The Nicos V,35 where the parties had agreed to apportion liability equally. Sheen J carried out a review of The Khedive 36 and of Admiralty procedure relating to limitation of liability under the Merchant Shipping Acts, and concluded that in collision cases the Brandon Rule provided the most satisfactory solution to the task of achieving set-off between claim and cross-claim. He accordingly ordered that set-off should take place on the basis of the exchange rates applying at the time when the amount of the claimants’ claim had been agreed between the parties. Their claim was for a smaller amount than the defendants’ claim, which had been agreed earlier. So the claimants’ claim was to be converted into US dollars, which was the proper currency of the defendants’ claim, and the defendants were to recover the difference after set-off.37

Outcome of The Nicos V

Liability apportioned equally between the parties;

Defendants’ claim assessed in US dollars at date A;

Claimants’ claim later assessed in Italian lire at date B;

Set-off effected between Admiralty claims in accordance with the Brandon Rule 38 by converting the claimants’ (smaller) claim into dollars as at date B, deducting it from the defendants’ claim, and giving judgment for the defendants for the balance.

Effect of interest on the Brandon Rule: The Lu Shan 39

11.15 The Brandon Rule had met with general approval, had been applied in The Nicos V 40 and, given the single-liability rule based on The Khedive,41 was a

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sound solution, but in its original formulation it did not explicitly deal with all the potential features of set-off.42 For example, it did not deal specifically with interest. Historically, all the time that awards had been made in sterling, claims and counterclaims between commercial parties attracted the same rates of interest. And in ship collision disputes, as claims and cross-claims would often attract interest from the same, or approximately the same, date, it had usually been of little or no consequence under the old regime, as between the parties, whether interest was added to the damages before or after set-off.43 11.16 After The Despina R, however, that changed, because damages in claims and cross-claims might not be awarded in the same currency; and the practice gradually developed of awarding interest at a rate appropriate to the proper currency of the claim.44 Different currencies could, of course, be expected to have different interest rates, with rates generally being inversely proportional to the strength of a given currency. Accordingly, the question of whether interest was to be added to an award of damages before or after set-off was likely to be a matter of importance.45 11.17 In The Lu Shan 46 a dispute arose over this very point, where the situation was aggravated because there were significant differences not only between the interest rates for the two claims but also between the starting dates from which interest would normally run. Liability for the collision was apportioned equally between the parties. The claimants’ damages called for assessment in Australian dollars, for which interest had averaged 17 per cent a year, whereas the proper currency of the defendants’ claim was the US dollar, for which the average annual rate was 10 per cent. And, while the claimants had paid for the repair of their ship in February 1986, repairs to the defendants’ ship were deferred, and their invoice was paid in January 1987. Accordingly, the defendants would have benefited in two ways if interest were to run only from the time of set-off. 11.18 The claimants contended for interest to be added to each set of damages

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before set-off, whereas the defendants argued that interest should be added after set-off between the principal elements, and should run from that time only. This was an important issue, as there was a difference of about US$60,000 between the two approaches. In other cases the difference could be larger, and could even determine which party would make a net recovery. Clarke J held that - particularly where, as in that dispute, the balance of claims was being struck a considerable time after a collision - it was more appropriate to add interest before setting the two awards off against each other, partly in view of the relationship between the strength of a currency and its interest rate. Also, he thought it was illogical to give credit for a party’s capital loss as at the date the balance was struck between claim and cross-claim, but to disregard the loss of use of that capital up to that date - which is what the defendants’ argument would have entailed. He summed up his approach to the problem as follows:

The loss of each party should be assessed as at the date on which the balance is struck. That date should be taken for the purposes of converting the smaller claim into the currency of the larger. Interest should be calculated on both claims up to that date and a balance then struck between the claims inclusive of interest. That approach seems to me best to reflect both the capital loss caused by the collision and the inevitable fact that time will have passed between the collision and assessment.47

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