House of Lords
(Lord Keith of Kinkel, Lord Ackner, Lord Lloyd of Berwick, Lord Nicholls of Birkenhead and Lord Hoffmann).
18 May 1995.
If A and B had mutual claims against each other and A became bankrupt, the effect of section 323 of the Insolvency Act 1986 (bankruptcy set-off) was to extinguish the claims of A and B and substitute a claim for the net balance owing after setting off the one against the other.
In such circumstances, A's trustee in bankruptcy was able to assign any net balance before it had been ascertained by the taking of an account between himself and B.
The House of Lords unanimously dismissed an appeal by the defendant, David Blake, against the decision of the Court of Appeal in favour of the plaintiff, Allan Stein.
Michael Mark (Maislish & Co) for the defendant; Edward Bannister QC and Philip Hoser (Bray Walker) for the plaintiff.
LORD HOFFMANN said Mr Stein was adjudicated bankrupt in July 1990. He was then a legally aided plaintiff suing the defendant Mr Blake, who had a counterclaim against him. Mr Blake perhaps hoped that Mr Stein's trustee, in whom any right of action had vested, would decide not to pursue the litigation. Instead, the trustee assigned the benefit of the action back to Mr Stein in return for 49 per cent of the net proceeds. Mr Blake successfully applied to have the proceedings dismissed, on the ground that a claim subject to a set-off under section 323 could not validly be assigned. But the Court of Appeal reversed that decision.
Section 323 provided: "(1) This section applies where before the commencement of the bankruptcy there have been mutual credits, mutual debts or other mutual dealing between the bankrupt and any creditor of the bankrupt proving or claiming to prove for a bankruptcy debt.
"(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 taken under subsection (2) is provable as a bankruptcy debt, or, as the case may be, to be paid to the trustee as part of the bankrupt's estate."
Unlike legal set-off, which did not affect the parties' substantive rights against each other (at any rate until both causes of action had been merged in a judgment), bankruptcy set-off did affect their rights by enabling the creditor to use his indebtedness to the bankrupt as a form of security. Instead of proving with the other creditors for the whole of his debt in the bankruptcy, he could set off pound for pound what he owed the bankrupt and prove for, or pay, only the balance.
Legal set-off was confined to debts which were due and payable and either liquidated or capable of ascertainment. But bankruptcy set-off applied to any claim arising out of mutual credits or other mutual dealings before the bankruptcy, for which a creditor would be entitled to prove as a "bankruptcy debt". The word "due" in section 323(2) merely meant treated as having been due at the bankruptcy date. An account therefore had be taken of liabilities which, at the time of bankruptcy, might be due but not yet payable or might be unascertained in amount or subject to contingency. Any claim against the bankrupt which was then still unascertained could be estimated.
The account under section 323 could be taken whenever it was necessary; it need not be linked with any formal step in the bankruptcy or litigation. The effect of the section was automatic and meant that the plaintiff's claim and the defendant's cross-claim both ceased to exist and were replaced by a claim to a net balance. Any subsequent litigation based on the claims was merely part of the process of retrospective calculation.
The next question was whether the trustee could assign the net balance. His Lordship could see no reason why not. The trustee in bankruptcy, in carrying out his duty to realise the assets vested in him, could assign a bare cause of action. There was no rule to prevent him assigning it to the bankrupt himself. So why should he not assign him the right to the net balance?
It was true that the trustee would ordinarily not be a party to the action between assignee and creditor. But there was no reason why a defendant should not, with leave, join the trustee as a defendant to his counterclaim. Even if the action had been brought by the trustee, the creditor would have needed the court's leave to make a counterclaim. There seemed little additional inconvenience in having to add the trustee as a party.
Finally, on the facts of the present case, his Lordship was satisfied the deed executed by the trustee did have the effect of assigning the net balance back to Mr Stein, who was therefore entitled to continue the action against Mr Blake.
LORD KEITH, LORD ACKNER, LORD LLOYD and LORD NICHOLLS agreed.
Paul Magrath, Barrister