The important decision of the Court of Appeal in Geldof Metaalconstructie NV v Simon Carves Ltd [2010] EWCA Civ 667, 4 All E.R. 847, B.L.R. 401, 130 Con. L.R. 3 has cut through the complex and problematic case-law which used to bedevil this subject. The law on equitable set-off can now be simply stated.

Set-off operates as a defence. Thus it can be deployed in answer to an application for summary judgment. It may often be the only available defence and most litigators are accustomed to arguments about whether a cross-claim is or is not a set-off.

The effect of the numerous previous authorities was that reliance upon equitable set-off gave rise to a host of conceptual difficulties, including application of the problematic ‘impeachment’ test; the extent to which claim and cross-claim were required to be connected (i.e. should they be ‘inseparably’ connected?); whether they should arise from the same contract; and lack of clarity surrounding the requirement for ‘manifest injustice’ if set-off were to be refused.

The Court of Appeal’s decision in Geldof has resolved these difficulties. There is now a clear and workable test. The test is whether the cross-claim is so closely connected with the claimant’s demands that it would be manifestly unjust to allow him to enforce payment without taking into account the cross-claim.

This is a single test although it has two elements. Lord Justice Rix, giving the leading judgment, described the first element - the need for a close connection - as a formal requirement. He described the second - the need for manifest injustice - as a functional requirement. One need not be over-concerned, or perhaps concerned at all, with these labels. They are useful when considering earlier authorities. Some were primarily concerned with the formal requirement; others with the functional requirement. For the future what is most important is the fact that there is now a clear statement of the test to be used in all cases.

This decision is now the leading judgment on equitable set-off, and consideration of earlier authorities can be brief. In summary, it is now clear that:

  • The impeachment test should no longer be used.   
  • There has to be a close connection between claim and cross-claim but there does not have to be an “inseparable connection”.   
  • The cross-claim does not have to arise from the same contract or transaction as the claim, nor from the dealings and transactions which gave rise to the claim. It is sufficient if it is closely connected with the transaction which gave rise to the claim.  
  • Manifest injustice is an essential ingredient of the test.  

A point arose in Geldof, involving two contracts, which had not arisen in any earlier authority. It was held that, even if initially the two contracts were not sufficiently connected, there could be conduct by the parties which provided the necessary link and satisfied the manifest injustice requirement. There was such conduct in this case. Geldof refused to perform an installation contract unless payment was made under a separate supply contract. SCL relied on this refusal when terminating the installation contract. Thus the cross-claim arose from the use made by Geldof of its supply contract claim. Conduct created a close connection and it would be manifestly unjust to allow the claim to be enforced without taking account of the cross-claim.