Stein v Blake (No.2)

JurisdictionUK Non-devolved
CourtHouse of Lords
JudgeLord Keith of Kinkel,Lord Ackner,Lord Lloyd of Berwick,Lord Nicholls of Birkenhead,Lord Hoffmann
Judgment Date18 May 1995
Judgment citation (vLex)[1995] UKHL J0518-1
Date18 May 1995

[1995] UKHL J0518-1

House of Lords

Lord Keith of Kinkel

Lord Ackner

Lord Lloyd of Berwick

Lord Nicholls of Birkenhead

Lord Hoffmann

Stein (A.P.)
(Respondent)
and
Blake
(Appellant)

OPINIONS OF THE LORDS OF APPEAL FOR JUDGMENT IN THE CAUSE

Lord Keith of Kinkel

My Lords,

For the reasons given in the speech to be delivered by my noble and learned friend Lord Hoffmann, which I have read in draft and with which I agree, I would dismiss this appeal.

Lord Ackner

My Lords,

I have had the advantage of reading in draft the speech prepared by my noble and learned friend Lord Hoffmann. For the reasons he gives I too would dismiss this appeal.

Lord Lloyd of Berwick

My Lords,

I have had the advantage of reading in draft the speech prepared by my noble and learned friend Lord Hoffmann. For the reasons he gives I too would dismiss this appeal.

Lord Nicholls of Birkenhead

My Lords,

I have had the advantage of reading in draft the speech prepared by my noble and learned friend Lord Hoffmann. For the reasons he gives, with which I agree, I too would dismiss this appeal.

Lord Hoffmann

My Lords,

1

The issues

If A and B have mutual claims against each other and A becomes bankrupt, does A's claim against B continue to exist so that A's trustee can assign it to a third party? Or is the effect of section 323 of the Insolvency Act 1986 to extinguish the claims of A and B and to substitute a claim for the net balance owing after setting off the one against the other? And if the latter is the case, can the trustee assign the net balance (if any) before it has been ascertained by the taking of an account between himself and B? If yes, is that what the trustee in this case has done? These are the issues in this appeal.

2

The facts

The plaintiff Mr. Stein was adjudicated bankrupt on 16 July 1990. He was at the time a legally aided plaintiff engaged in suing the defendant Blake. It is unnecessary to go into the details save to say that Mr. Stein was claiming damages for breach of contract and a declaration that he was entitled to be indemnified against certain tax liabilities. Mr. Blake was counterclaiming for damages for misrepresentation and had in addition an indisputable cross-claim under various orders for costs in any event. Mr. Blake perhaps hoped that Mr. Stein's trustee, in whom the right of action (if any) had vested, would decide that it was not in the interests of creditors to spend money on pursuing the litigation. If so, he was right, but the trustee did not abandon the claim. Instead he executed a deed dated 4 April 1991 by which he assigned the benefit of the action back to Mr. Stein in return for 49% of the net proceeds. Mr. Stein again obtained legal aid. Mr. Blake applied to have the proceedings dismissed on the ground that a claim subject to a set-off under 323 of the Insolvency Act 1986 could not validly be assigned. The application succeeded before the judge but his decision was reversed by the Court of Appeal, Mr. Blake now appeals.

3

Bankruptcy set-off

Section 323 reads, so far as relevant, as follows:

"(1) This section applies where before the commencement of the bankruptcy there have been mutual credits, mutual debts or other mutual dealings 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. (3) … (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."

4

Bankruptcy set-off compared with statutory legal set-off.

Section 323 is the latest in a line of bankruptcy set-off provisions which go back to the time of Queen Anne. As it happens, legal set-off between solvent parties is also based upon statutes of Queen Anne. But the two forms of set-off are very different in their purpose and effect. Legal set-off does not affect the substantive rights of the parties against each other, at any rate until both causes of action have been merged in a judgment of the court. It addresses questions of procedure and cash-flow. As a matter of procedure, it enables a defendant to require his cross-claim (even if based upon a wholly different subject-matter) be tried together with the plaintiff's claim instead of having to be the subject of a separate action. In this way it ensures that judgment will be given simultaneously on claim and cross-claim and thereby relieves the defendant from having to find the cash to satisfy a judgment in favour of the plaintiff (or, in the 18th century, go to a debtor's prison) before his cross-claim has been determined.

Bankruptcy set-off, on the other hand, affects the substantive rights of the parties by enabling the bankrupt's creditor to use his indebtedness to the bankrupt as a form of security. Instead of having to prove with other creditors for the whole of his debt in the bankruptcy, he can set off pound for pound what he owes the bankrupt and prove for or pay only the balance. So in Forster v. Wilson (1843) 12 M. & W. 191, 204, Parke B. said that the purpose of insolvency set-off was "… to do substantial justice between the parties. …" Although it is often said that the justice of the rule is obvious, it is worth noticing that it is by no means universal. ( Wood, on English and International Set-Off (1989), paras. 24-49 to 24-56. It has however been part of the English law of bankruptcy since at least the time of the first Queen Elizabeth, ( op. cit., para. 7-26.)

Legal set-off is confined to debts which at the time when the defence of set-off is filed were due and payable and either liquidated or in sums capable of ascertainment without valuation or estimation. Bankruptcy set-off has a much wider scope. It applies 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." This is defined by section 382 of the Insolvency Act 1986 to mean:

"(1) … any of the following (a) any debt or liability to which he is subject at the commencement of the bankruptcy (b) any debt or liability to which he may become subject after the commencement of the bankruptcy (including after his discharge from bankruptcy) by reason of any obligation incurred before the commencement of the bankruptcy… (3) For the purposes of references in this Group of Parts to a debt or liability, it is immaterial whether the debt or liability is present or future, whether it is certain or contingent or whether its amount is fixed or liquidated, or is capable of being ascertained by fixed rules or as a matter of opinion: and references in this Group of Parts to owing a debt are to be read accordingly."

5

Taking the account under section 323

Bankruptcy set-off therefore requires an account to be taken of liabilities which, at the time of bankruptcy, may be due but not yet payable or may be unascertained in amount or subject to contingency. Nevertheless, the law says that the account shall be deemed to have been taken and the sums due from one party set off against the other as at the date of the bankruptcy. This is in accordance with the general principle of bankruptcy law, which governs payment of interest, conversion of foreign currencies etc., that the debts of the bankrupt are treated as having been ascertained and his assets simultaneously distributed among his creditors on the bankruptcy date: see In re Dynamics Corporation of America [1976] 1 W.L.R. 757, 762. It is clear, therefore, that when section 323(2) speaks of taking an account of what is "due" from each party, it does not mean that the sums in question must have been due and payable, whether at the bankruptcy date or even the date when the calculation falls to be made. The claims may have been contingent at the bankruptcy date and the creditor's claim against the bankrupt may remain contingent at the time of the calculation, but they are nevertheless included in the account. I consider next how this is done.

6

Quantifying the cross-claims

How does the law deal with the conundrum of having to set off, as of the bankruptcy date, "sums due" which may not yet be due or which may become owing upon contingencies which have not yet occurred? It employs two techniques. The first is to take into account everything which has actually happened between the bankruptcy date and the moment when it becomes necessary to ascertain what, on that date, was the state of account between the creditor and the bankrupt. If by that time the contingency has occurred and the claim has been quantified, then that is the amount which is treated as having been due at the bankruptcy date. An example is Sovereign Life Assurance Co. v. Dodd [1892] 2 Q.B. 573, in which the insurance company had lent Mr. Dodd £1,170 on the security of his policies. The company was wound up before the policies had matured but Mr. Dodd went on paying the premiums until they became payable. The Court of Appeal held that the account required by bankruptcy set-off should set off the full matured value of the policies against the loan.

But the winding up of the estate of a bankrupt or an insolvent company cannot always wait until all possible contingencies have happened and all the actual or potential liabilities which existed at the bankruptcy date have been quantified. Therefore the law adopts a second technique, which is to make an estimation of the value of the claim. Section 322(3) says:

"The trustee shall estimate the value of any bankruptcy debt which, by reason of its being subject to any contingency or contingencies or for any other reason, does not bear a certain value."

This enables the trustee to quantify a creditor's contingent or unascertained...

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