Court of Appeal gives guidance on anti-set off provisions in security documentation

A borrower's right of set-off may be excluded in loan and security documentation (subject to limited exceptions), with the commercial aim of the lender to secure payment, free from potential cross-claims. The recent Court of Appeal decision in Woodeson & Anor v Credit Suisse (UK) Ltd [2018] EWCA Civ 1103 provides helpful guidance as to the operation of such anti-set off provisions in the context of secured property. This decision is likely to be welcomed by both financial institutions and finance lawyers. It should contribute to the certainty of anti-set off provisions in mortgage documentation, thereby enhancing the security position of secured lenders.

Firstly, the Court of Appeal confirmed that the requirement to draw to the attention of a counterparty any "particularly onerous or unusual" provisions would not ordinarily apply to anti-set off clauses included in mortgage documentation. Distinguishing Interfoto Picture Library v Stiletto [1989] QB 433, the Court of Appeal commented that anti-set off clauses were "by no means unusual in mortgage transactions" and the contractual documentation containing the set-off clauses was signed by the claimants in the instant case. Where the contractual documentation is signed, the Interfoto principle will have no (or at least extremely limited) application as per Peekay v Australia and New Zealand Bank [2006] EWCA Civ 386.

Secondly, the Court of Appeal made significant obiter remarks on the application of the principle in Spencer Day v Tiuta International Ltd & Anor[2014] EWCA Civ 1246. The Court of Appeal confirmed that a mortgagor cannot - by asserting an equitable right of set-off - prevent a mortgagee from enforcing its security by taking possession of and selling the mortgaged property and recovering the mortgage debt (without giving credit for the mortgagor's claim) from the proceeds of sale. It said this was so, even if the cross-claim asserted by the mortgagor was sufficiently connected with the mortgage debt to satisfy the general test for an equitable set-off. The commercial reasoning behind this principle is that such mortgagor claims can only be pursued as freestanding claims for damages, as they are not claims which are secured on the mortgaged properties or the proceeds of sale thereof. To allow otherwise would in effect give the mortgagor a secured position (Samuel Keller (Holdings) Ltd v Martins Bank Ltd [1971] 1 WLR 43 (a first instance decision affirmed by the Court of Appeal)).

While obiter remarks do not have precedent value and are not binding, they may be persuasive in future cases. The obiter dicta here is likely to carry weight given that the comments were made by a Court of Appeal judge whose express and sole intention was to clarify the law in this area - the judgment of Leggatt LJ (concurring with the leading judgment given by Longmore LJ) was entirely devoted to clarifying the law in this area. Further, the court did not technically make any new finding of law, but rather consolidated previous decisions of the High Court and Court of Appeal.

It should be noted that one important limitation in relation to anti-set off provisions, is that parties are not permitted to contract out of the mandatory rules of insolvency set-off. Notwithstanding the anti-set off provisions in this case, the insolvency set-off rules would have applied if the claimants in these proceedings (who were individuals) had been declared bankrupt.

In addition to its findings on the anti-set off provisions, the Court of Appeal confirmed the position in relation to extending a time-barred claim where a declaration, rather than damages, is sought. In such cases, the court will look at the basis on which the declaration is sought and consider whether that base action is time-barred. As such, a claimant cannot seek a declaration, instead of damages, to improve its position if it would otherwise be time barred from bringing the cause of action.

Background

The claimants (who were individuals) owned a property, which they re-mortgaged with Credit Suisse (UK) Limited (the "Bank") in 2008, pursuant to an interest only Swiss franc loan for a term of five years. The sum borrowed was far greater than necessary to repay the previous mortgage. The surplus funds were used to invest in sterling deposits (i.e. a carry trade).

The claimants' intention was to benefit from the interest rate difference by receiving a higher interest from the sterling deposits while paying lower interest on the Swiss franc mortgage. However, this deal proved to be "disastrous" when the Bank of England base rate fell sharply from October 2008 and the exchange rate of the Swiss franc to sterling declined significantly. When the loan matured, the claimants failed to repay it and the Bank subsequently appointed Receivers over the mortgaged property. The Receivers commenced proceedings seeking possession of the mortgaged property. The claimants commenced the present action as a form of "counter-attack" to dissuade the court from granting possession of the property (see details of this claim below). The claimants were not successful and an order granting the Receivers possession of the mortgaged property was granted.

High Court Decision

In the instant proceedings, the claimants sought a number of declarations. These included a declaration that the claimants were entitled to set off (against sums due to the Bank under the mortgage) a cross-claim for damages. The cross-claim for damages allegedly arose from the Bank's mis-selling of the Swiss franc facility pursuant to s.138D of the Financial Services and Markets Act 2000 ("FSMA"), in the tort of negligence and/or deceit.

The Bank applied for summary judgment on the basis: (1) that the claims on which the declarations were founded were statute-barred; and (2) that the claimants had contracted out of the right of set-off, and therefore the claims did not provide any defence to the Bank's claim to recover the debt through the possession proceedings.

The High Court granted summary judgment in respect of all claims (except for the deceit claim), finding that the claims were time-barred. The first instance decision is not publicly available, but it appears that the High Court held that the anti-set off provisions arguably operated in relation to the claims based on negligence and breach of statutory duty. As to the deceit claim, the High Court held that it was arguable that the time for a deceit claim was extended pursuant to s.32 of the Limitation Act 1980 and that it was arguably unreasonable pursuant to the Unfair Contract Terms Act 1977 to seek to apply the anti-set off provisions to a deceit claim.

The result of the High Court judgment was that the claimants could only pursue their claim in deceit. The claimants appealed this decision.

Court of Appeal Decision

The claimants appealed on the following grounds:

1. Their claims for equitable relief in the form of declarations were not time-barred (and could be granted and then used as defences as and when the need arose);
2. That the Bank deliberately concealed the facts relevant to the claims in negligence and breach of s.138D FSMA (as well as deceit); and
3. That because the Bank did not draw the claimants' attention to the no-set off clauses and explain their effect, the clauses could not be relied on by virtue of the application of Interfoto.

The Court of Appeal dismissed the three grounds of the claimants' appeal and refused a stay of the order that the Receivers take possession of the mortgaged property. The key issue which is likely to be of interest to financial institutions is the Court of Appeal's decision in relation to the anti-set off clauses, which is dealt with first below (followed by a very brief summary of the other issues).

1. Anti-set off provisions

The claimants relied on the principle established in Interfoto, namely that any "particularly onerous or unusual" provisions must be drawn to the attention of the other party. They argued that, unless the presence of the anti-set off clauses were specifically brought to the attention of the claimants, they could not be relied upon by the Bank.

The Court of Appeal distinguished Interfoto, where the clause in question: (a) was considered by the court to be unreasonable on its face; and (b) was contained in a document which had not been signed by the party whose rights were affected by the clause. The Court of Appeal noted that the anti-set off clauses were "by no means unusual in mortgage transactions" and the contractual documentation containing the set-off clauses was signed by the claimants in the instant case. It referred to Peekay, as authority for the principle that where the contractual documentation is signed, the Interfoto principle will have no (or at least extremely limited) application. Accordingly, the Court of Appeal held that the anti-set off clauses could (in principle) be relied on by the Bank.

In addition to its main finding on this issue, the Court of Appeal also made significant obiter remarks on the application of the "Spencer Day principle". This was reference to the Court of Appeal decision in Spencer Day v Tiuta International and "a long line of binding decisions of the Court of Appeal" which confirmed that claims asserted by a mortgagor could not - as a matter of law - be set off against a mortgage debt (irrespective of any anti-set off clause). Such mortgagor claims could only be pursued as freestanding claims for damages.

The claimants submitted that the Spencer Day principle was confined to claims for possession of the mortgaged property and did not extend to cases where the bank had a money claim or to cases where the mortgagor sought an account of what was truly due to the bank after considering any cross-claims. The Court of Appeal rejected this proposition, finding it was inconsistent with Spencer Day and the cases cited therein. The Court of Appeal confirmed that a mortgagor cannot - by asserting an equitable right of set-off - prevent a mortgagee from enforcing its security by taking possession of and selling the mortgaged property and recovering the mortgage debt (without giving credit for the mortgagor's claim) from the proceeds of sale. This was so, even if the claim asserted by the mortgagor was sufficiently connected with the mortgage debt to satisfy the general test for an equitable set-off.

Applying the Spencer Day principle, the Court of Appeal's view was that the claimants had no right to prevent the property from being sold and the proceeds used to repay their debt to the Bank, without giving credit for any cross-claim for damages. However, these conclusions did not form part of the Court of Appeal's binding decision, because the Spencer Day point was not pursued by the Bank at first instance, nor before the Court of Appeal. The Court of Appeal noted that this was "unfortunate", as significant time and cost might have been saved in relation to the anti-set off clause issue.

2. Limitation and concealment

The Court of Appeal affirmed the first instance decision that the claims for declaratory relief (based on claims for negligent advice and breach of statutory duty) were time-barred.

The Court of Appeal applied P&O Nedlloyd BV v Arab Metals Co [2005] 1 WLR 3733 and held that it was necessary to look at the basis upon which a declaration is sought to consider whether a claim is time barred. In this case, the claimants' cross-claims were based on actions in tort and breach of statutory duty, which had a six-year time period in which to be commenced (unless time could be extended by deliberate concealment – see below). As the basis of the claimants' action was time barred, the claimants could not improve their position by seeking the remedy of a declaration rather than damages. The Court of Appeal said the fact that a claim was time-barred would not normally preclude it being used to establish a defence of equitable set-off (as opposed to a free standing claim), but this would be inconsistent with the Spencer Day principle discussed above.

The Court of Appeal went on to consider the claimants' argument that their declaratory relief claims in tort and breach of duty should not be time barred, pursuant to s.32 of the Limitation Act 1980, on the basis that the Bank concealed the relevant facts giving rise to those causes of action. However, the Court of Appeal found that the relevant facts for the claimants' right of action were apparent more than six years before the claim was commenced and so s.32 of the Limitation Act would not assist.