Background

A defendant which disputes a claim may also make a counterclaim against the claimant. Even if the claimant is successful in the original claim (eg, at a summary judgment application), the existence of the counterclaim may prevent the claimant from enforcing the judgment. This is due to the doctrine of equitable set-off. If both claim and counterclaim arise from the same transaction (or closely related transactions), the court may find it unjust to allow enforcement without taking the counterclaim into account.

If both the claim and the potential counterclaim are for readily quantifiable sums which have already fallen due, the defendant is in a stronger position. It need not make a formal counterclaim, but can simply plead legal set-off as a defence to the original claim. The sums claimed need not have arisen from the same transaction or closely related transactions. Legal set-off frequently arises in situations where the parties have mutual debts.

Both types of set-off can be distinguished from set-off by judgment (sometimes referred to as ‘netting-off’). This occurs only when the amount of each liability has been established by agreement or by a court judgment. The court has the power to offset these liabilities when making a final award.  

However, set-off can be complicated in an international context. The claim may be quantified in one currency, but the counterclaim or opposing sum due may be quantified in another currency. This causes problems in respect of the date of currency conversion, the applicable interest rates and the treatment of legal costs. These issues were considered in the recent High Court case of Fearns v Anglo Dutch Paint.(1)  

Facts

The claimant was a car paint supplier. He bought paint from the defendant and sold it to end users, using the brand name Autopaint. He also had a number of franchisees to whom he sold paint. He found that the defendant had been supplying paint directly to his franchisees, using the same brand name. The claimant brought an action for passing off and trademark infringement. The defendant counterclaimed for money owed in respect of goods sold to the claimant. The judge awarded the claimant £438,569 in damages and assessed the claimant’s debt to the defendant to be €594,696.

It was common ground that equitable set-off applied. However, there was a dispute as to the date at which the amounts of the claim and the counterclaim should be converted into a common currency in order to allow set-off to be calculated. One possibility was 2005, when the claim arose; the alternative was 2010, when judgment was given.

As the pound depreciated against the euro between 2005 and 2010, the net results were significantly different. If 2005 rates applied, the claimant would have most of his claim extinguished by the debt and the defendant would owe him around £28.4k. If 2010 rates applied, the claimant would have the entirety of his award extinguished by the debt and would still owe the defendant around £57k. The position is set out in the table below.

Judgment on principles

The judge held that neither the existence nor the exercise of a right of equitable set-off permanently extinguishes or reduces the liability of one party to another. Equitable set-off simply prevents a party from enforcing or relying on its claim to the extent of the other claim where this would be manifestly unjust. If a counterclaim proves invalid, the other claim remains in existence and can be enforced in full.

As equitable set-off essentially operates as a provisional exercise, the currencies should not be converted at the date on which the right arose or was asserted. Rather, the currencies should be converted at the date on which the amount of the liabilities is finally established, which is usually the date of judgment. At this point, set-off by judgment is possible and there is a final extinction of liabilities.

The judge also held that interest should be added to each sum before implementing the currency conversion.

Judgment on facts

Applying these principles to the case, the judge ordered that set-off be calculated as of 28 July 2010, the date of judgment. The applicable exchange rate was therefore £1: €1.2.

This should have resulted in a net payment to the defendant. However, the judge also ordered interest on the claim at 5% above the Bank of England base rate and interest on the counterclaim at 1.5% above the European Central Bank rate. (The high rate of interest awarded to the claimant was based on evidence of the high cost of borrowing for a person in his difficult financial circumstances.) This swung the balance back in favour of the claimant, who was due a net balance of around £36.8k.

However, the judge considered that the defendant had been the successful party in the case overall. The argument at the heart of the claimant’s case had failed and he had emerged with a net award only as a result of chance interest rate differences. The judge therefore ordered the claimant to pay 70% of the defendant’s costs, with an interim payment of £300k. The judge also applied the interim costs payment as a set-off, principally because the claimant was insolvent. The defendant therefore emerged with a net interim award of over £263k.

Comment

The judgment confirms that equitable set-off does not permanently extinguish one party’s liability to another; this will occur only if the parties reach an agreement or if the court makes an order.

From a practical perspective, the case demonstrates that a claim and a related counterclaim in different currencies have a potentially wide range of possible financial outcomes. This is particularly true when two related claims are close in value. Parties to these actions face considerable uncertainty as to their likely net recovery, and may even be unsure as to whether they will be net winners or losers. There are two main reasons for this.

First, where equitable set-off applies, the currency conversion will not usually crystallise until the date of judgment. If a case takes five years from cause of action to judgment, as in this case, there may be significant currency movement in the interim. The pound has depreciated by around 17% against the euro in the past five years. There will be an even greater impact where claims involve the currencies of some emerging markets - over the same period the pound has depreciated by 25% against the Chinese renminbi and by 32% against the Brazilian real.

Second, many contractual interest rates are calculated by reference to a central bank rate, which will vary by currency. Added to this is the possibility of awarding different rates of interest according to the circumstances of the claims, as in this case. The later the date at which set-off takes place, the greater may be the interest rate disparities affecting the final award.

In certain circumstances a party will be able to reduce the uncertainty by adding damages for currency loss to its claim. In essence, this will depend on a party being able to show that it would have paid the debt in one claim but for the existence of the related claim. The outcome of this approach will depend on the facts of the case.

The present case also demonstrates that a party which is a net winner may still be penalised in costs if it advances fallacious arguments and achieves a net award purely as a result of chance currency fluctuations or interest rate differences.