Vol 7 (2010) - Issue 5

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Re Kaupthing Singer and Friedlander Ltd [2010] EWCA Civ 518: Set-off and Future Debts

If at least one good thing has come out of the credit crunch, it is that the English Courts have been given the opportunity to consider some of the ambiguities in the drafting of the Insolvency Rules 1986.
The decision in Re KSF provides timely clarification on the proper application of Rule 2.85 (dealing with set-off in an administration) and Rule 2.105 (debts payable at a future time). This is a technical area, but the practical consequences of the decision are important and will have a significant impact in bank insolvencies.
The problem which the case deals with is best illustrated by an example. Assume that a creditor of an insolvent company is owed GBP 100, repayable immediately. Assume also that the creditor owes the company GBP 1000, but that the debt does not become payable for 10 years and carries simple interest at 4%. The company and creditor have had mutual dealings which should be susceptible to insolvency set-off. But set-off must operate between like and like, and it would be unfair to set GBP 100 (currently due) against GBP 1000 (not due for 10 years). Some form of discounting must be applied to the GBP 1000 (as envisaged by Rule 2.105) in order to give its current value. The decision of the Court of Appeal (and that at first instance) consider how the discounting formula works and how the balance, if any, is quantified and recoverable by the company from the creditor.
This problem is relatively new as a matter of English law. Historically, contingent or future claims against the creditor by the company were not available for set-off purposes because it was considered unfair for a creditor to have his liability (or potential liability) to pay accelerated merely because the company had become insolvent (see Stein v Blake [1996] AC 243 at 253). Amendments to both Rule 4.90 and Rule 2.85 in 2005 reversed this position but, in order to address the unfairness identified in Stein v Blake, both rules provided that any balance remaining due after set-off in favour of the insolvent company would only be paid as and when it fell due and payable: Rules 2.85(8) and 4.90(8).
Although the explanatory note to the new versions of both Rule 2.85 and 4.90 emphasised that they had been designed to 'provide greater detail and clarify of meaning for the user', the KSF administration identified a number of areas of potential confusion. The nature of KSF's banking business was such that there were a considerable number of future debts due to the company. At first instance, Norris J [2010] 1 BCLC 222 held inter alia that:
1. a debt was a future debt for the purpose of Rule 2.85 if it was not due for payment at the date of the notice of intention to make a distribution;
2. future debts were, by reason of Rule 2.85(7), subject to the discounting formula in Rule 2.105 in order to ascertain their current value for set-off purposes;
3. post-administration interest payable on debts due to or from the company was not to be taken into account for the purpose of set-off;
4. Rule 2.105 (and the discounting formula) applied to the entirety of a future debt. As a consequence, the balance (if in favour of the company) was the remainder of the debt discounted to its present value. Interest would be payable to the company on that balance in accordance with the contractual provisions of the agreement between the parties. The judge rejected the suggestion that the company could add back in the interest which would have been payable in the period between the administration and the final maturity date of the debt.
The appeal concerned only point 4. In practical terms, the effect of the decision greatly benefited a creditor who could take advantage of insolvency set-off as compared to one who could not. That was because the balance payable would reflect the discounted current value of the debt. It would exclude the value of any interest which would otherwise have been payable on the debt in the period between the administration and maturity date. Etherton LJ described it at paragraph 24 as producing a result which was extraordinarily beneficial to the creditor in question, and highly detrimental to the body of creditors.
That result can be illustrated by the same example referred to above i.e. a creditor to whom GBP 100 is currently due, but who also owes the Company GBP 1000 (due in 2020, with interest payable in the intervening period on the full GBP 1000 at 4%).