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House of Lords
Session 1997-98
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Judgments - Morris and Others v. Rayners Enterprises Incorporated and Another
Morris and Others v. Agrichemicals Limited and Others


  Lord Goff of Chieveley   Lord Nicholls of Birkenhead   Lord Hoffmann
  Lord Hope of Craighead   Lord Hutton






ON 30 OCTOBER 1997


My Lords,

    I have had the advantage of reading in draft the speech of my noble and learned friend, Lord Hoffmann. For the reasons he gives I would dismiss these appeals.


My Lords,

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


My Lords,

1. The issue

    These appeals arise out of an application for directions by the joint liquidators of Bank of Credit and Commerce International S.A. ("B.C.C.I."). It concerns cases in which B.C.C.I. lent money on the security of a deposit which had been made with B.C.C.I. by a third party. The question on which the liquidators seek the directions of the court is whether B.C.C.I. can claim repayment from the borrower without resorting to the security or whether it is obliged to set off the loan against the deposit and treat the borrower as pro tanto discharged. If the first answer is correct, B.C.C.I. will be able to recover the loan in full and leave the third party depositor to prove in the liquidation. If the second answer is correct, B.C.C.I. will be able to recover only the excess, if any, of the loan over the deposit.

2. The facts

    To put flesh on the abstract bones of this question, B.C.C.I. have selected two test cases. In the first, B.C.C.I. lent about US $3.5m to a Panamanian company called Rayners Enterprises Inc. ("Rayners") for the purpose of investing in property in England. Rayners granted legal charges over the properties to B.C.C.I. to secure repayment of the loan. In addition, Mr. Mohammed Jessa, who is the beneficial owner of Rayners, gave B.C.C.I. additional security for part of the indebtedness in the form of charges over certain deposits with B.C.C.I. to which he was beneficially entitled. These secured repayment of about £1.4m. On 15 September 1992 the liquidators sent a letter to Rayners demanding repayment. There is no dispute that, apart from the questions arising out of the existence of the security over the deposits, the loans are due and payable.

    In the second case, B.C.C.I. advanced about £4.4m. and U.S. $4.2 million to companies in what was called the Solai Group. A Panamanian company called Société Générale de Gestion et Services S.A. ("S.G.G.S.") made deposits with B.C.C.I. in the sums of £3,037,741 and US $8,018,000 respectively and executed documents charging the deposits to B.C.C.I. to secure the repayment of the advances to the Solai Group. S.G.G.S. is beneficially owned by the controlling shareholders of the Solai Group. On 10 September 1991 the liquidators demanded repayment by the Solai Group companies and again it is accepted that the loans are due and payable.

    There is one difference between the two cases on which some reliance was placed in argument. In the first case, Mr. Jessa's deposits were already in existence for some time before he charged them to B.C.C.I. to secure the indebtedness of Rayners. He says that he was (wrongly) advised by B.C.C.I. that he would save tax if he borrowed money on the security of the deposit rather than simply using the deposited money to pay for the properties. In the second case, S.G.G.S. made the deposits as a condition of the grant of facilities to the Solai Group and in fact executed the letter of charge before the deposits had even been made. So it is said that in the second case the security involved the deposit of "new money" with the bank. I shall come back later to the way in which this distinction is said to be relevant.

3. The security documents

    The security documents executed by Mr. Jessa and S.G.G.S. were not in precisely the same form but the differences are immaterial. The material provisions of the "Letter of Lien/Charge" signed on behalf of Mr. Jessa on 3 February 1989 (which I give by way of example) were as follows:

      "In consideration of [B.C.C.I.] at our request providing from time to time banking facilities to [Rayners] ("the borrower") from time to time, I . . . hereby give a lien/charge on the balances maintained by me in my accounts with you for all of the outstanding liabilities of the borrower in respect of the banking facilities and so that you shall have the power to withdraw and utilise the proceeds thereof . . . for the reduction or adjustment of the outstanding liabilities of the borrower with the bank without reference to me. I undertake to execute such deeds and instruments as the bank may require hereafter further to secure my accounts and I shall bear the cost thereof.

      "I hereby declare that I have not encumbered, assigned or otherwise dealt with the accounts in any way and that they are free from all encumbrances and that I will not encumber, assign or deal with them or any renewal thereof.

      "It is understood that the balances held in the accounts under the lien/charge are not to be released to me, my heirs or assignees unless or until the entire outstanding liabilities of the borrower whether actual or contingent are fully repaid with interest, fees, commission etc. and the bank is under no obligation to provide or make available banking facilities to the borrower."

    The effect of the document may be summarised as follows. The first paragraph purports to grant the bank a proprietary interest, in the form of a lien or charge, over Mr. Jessa's deposit. The second paragraph is a warranty that he has not previously encumbered his interest in the deposit and a covenant that he will not do so in the future. And the third paragraph is a contractual agreement that the deposit will be repayable only if all the liabilities of Rayners have been repaid. The document does not contain any promise by Mr. Jessa to pay what may be due from Rayners to the bank.

4. Rights of a secured creditor

    The general rule is that a secured creditor is not obliged to resort to his security. He can claim repayment by the debtor personally and leave the security alone. In China and South Sea Bank Ltd. v. Tan Soon Gin (alias George Tan) [1990] 1 A.C. 536, 545, where the creditor's security consisted of a mortgage over shares and a personal guarantee from a surety, Lord Templeman said:

     "The creditor had three sources of repayment. The creditor could sue the debtor, sell the mortgage securities or sue the surety. All these remedies could be exercised at any time or times simultaneously or contemporaneously or successively or not at all."

    If the creditor recovers judgment against the debtor and the debt is paid, the security is released. But B.C.C.I. accepts that this will be the consequence of payment. The security created by the letter of lien/charge will be discharged and the deposit left unencumbered. Of course the depositor will only be entitled to a dividend in the winding up. But this would have been his position even if he had never granted the charge in the first place.

    In the present case, however, Mr. McDonnell (for Rayners) and Mr. Carr (for the Solai Group) have advanced a number of arguments as to why B.C.C.I. should not be entitled to sue them for money lent without first giving credit for the full amount of the sums deposited as security. I shall consider each in turn.

5. Bankruptcy set-off

    Rule 4.90 of the Insolvency Rules 1986 (reproducing earlier legislation) is headed "Mutual credit and set-off" and provides:

     "(1) This rule applies where, before the company goes into liquidation there have been mutual credits, mutual debts or other mutual dealings between the company and any creditor of the company proving or claiming to prove for a debt in the liquidation. (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. . . . (4) Only the balance (if any) of the account is provable in the liquidation. Alternatively (as the case may be) the amount shall be paid to the liquidator as part of the assets."

     When the conditions of the rule are satisfied, a set-off is treated as having taken place automatically on the bankruptcy date. The original claims are extinguished and only the net balance remains owing one way or the other: Stein v. Blake [1996] 1 A.C. 243. The effect is to allow the debt which the insolvent company owes to the creditor to be used as security for its debt to him. The creditor is exposed to insolvency risk only for the net balance.

    Not all jurisdictions recognise this kind of security in bankruptcy. The recent judgment of Sir Richard Scott V.-C. in In re Bank of Credit and Commerce International S.A. (No. 10) [1997] 2 W.L.R. 172 illustrates the problems caused by the fact that English law, as the law of the ancillary liquidation, recognises such a set-off but the law of the principal liquidation (Luxembourg) does not. In English law, it is strictly limited to mutual claims existing at the bankruptcy date. There can be no set-off of claims by third parties, even with their consent. To do so would be to allow parties by agreement to subvert the fundamental principle of pari passu distribution of the insolvent company's assets: see British Eagle International Airlines Ltd. v. Compagnie Nationale Air France [1975] 1 W.L.R. 758.

    The sense of injustice which is undoubtedly felt by the depositors in this case arises, I think, not so much from the operation of rule 4.90 but from the principle that a company is a person separate from its controlling shareholders. If the depositors had been third parties in economic reality as well as in law, I imagine that it would not have been thought particularly unfair that the liquidators had chosen to exercise their undoubted choice of remedies and to proceed against the primary borrowers rather than resort to the third party security which they held. But the separate personality of depositor and borrower was an essential element in the structure which the parties chose to adopt for their borrowings and it cannot be ignored now that B.C.C.I. has become insolvent.

    The appellants nevertheless say that on the facts of this case there was mutuality between the depositor and B.C.C.I. and that automatic set-off under rule 4.90 therefore took place; the sum owed by B.C.C.I. to the depositor (i.e. the amount of the deposit and interest) being set off against the amount owed by the depositor to B.C.C.I. The result was to extinguish the dept pro tanto for the benefit of both Mr. Jessa and Rayners, both being liable for the same obligation.

6. Construction of the security documents

    The difficulty about this argument is that the depositor did not owe anything to B.C.C.I. The only contract between him and B.C.C.I., contained in the letter of lien/charge, created no personal liability on his part. In Tam Wing Chuen v. Bank of Credit & Commerce Hong Kong Ltd. [1996] B.C.C. 388, the Privy Council had to construe a very similar document and held that no personal liability could be implied. Lord Mustill said:

     "One thing is clear, that nowhere in these clauses does the instrument actually say that the depositor is to have a liability equal to the amount of the deposit, or, for that matter, equal to the indebtedness of the company. Thus, if the depositor is to succeed he must show that the transaction as formulated cannot be given any meaning unless he is personally liable."

Mr. McDonnell said that in the present case, the only way in which the transaction as formulated could be given a meaning would be if it were construed as creating a personal liability on the part of the depositor to pay the borrower's indebtedness. Although it did not expressly do so, but instead purported to create a charge over the deposit, it was, he submitted legally ineffective for this purpose. A charge in favour of B.C.C.I. over a debt owed by B.C.C.I. to the depositor was, as the Court of Appeal held, conceptually impossible and created no proprietary interest in B.C.C.I. (In this respect, the present case was distinguishable from Tam Wing Chuen because in Hong Kong such charges had been legitimated by statute: see section 15A of the Law Amendment and Reform (Consolidation) Ordinance, Cap. 23). The only way in which the letter in this case could operate as an effective security was contractually. Mr. McDonnell submitted that to give effect to this intention, it should therefore be construed as imposing a personal obligation upon the depositor which B.C.C.I. would be entitled to set off against his claim for the return of the deposit. On the winding up of B.C.C.I., the effect of rule 4.90 was to make such a set-off mandatory.

(a)  M.S. Fashions Ltd.

    Mr. McDonnell relied upon M.S. Fashions Ltd. v. Bank of Credit and Commerce International S.A. [1993] Ch. 425 as a case in which this kind of reasoning had been approved. I do not think that this is right. The case involved a very unusual security document in which, although no personal obligation was expressly created, references were made to the liability of the depositor being that of principal debtor. It was only to give effect to these words that the document was construed as creating a personal liability limited to the amount of the deposit. This was held to result in a set-off between depositor and B.C.C.I. which, since depositor and principal debtor were jointly and severally and unconditionally liable for the same debt, discharged the principal debtor.

    There is no doubt that the decision in M.S. Fashions produces a rather anomalous result to which the Court of Appeal [1996] Ch. 245, 269, 273, drew attention. If the documents in that case had, as in this case, merely created a charge over the deposit or a contractual limitation on the right to withdraw the deposit (such as that in the third paragraph of the lien/charge letter which I have quoted), there would have been no cross-claim for the purposes of set-off. If the depositor had given a personal guarantee in the usual form and no demand had been made upon him before the bankruptcy date, his liability would have been merely contingent and would likewise have been incapable of set-off. But because the depositor was also personally liable jointly and severally with the borrower, an automatic set-off took place which discharged the borrower. The distinction is artificial because in no case would the bank wish to rely upon the depositor's personal liability, whether as principal or guarantor. It will simply keep his money in accordance with the letter of charge. It could be said that, for a bank which is thinking of becoming insolvent, the M.S. Fashions case is a trap for the unwary.

    The difficulty, as the Court of Appeal recognised, is to find a way of coming to a different answer which recognises the automatic and self-executing nature of set-off under rule 4.90 and the principle that joint and several debtors are liable for the same debt so that payment or deemed payment by the one discharges the other. In the case of a charged deposit, one possible answer is that the existence of the charge destroys mutuality: the bank's claim against the depositor is in its own right but the depositor's claim is subject to the equitable interest of the bank. This argument was somewhat cursorily rejected in M.S. Fashions at first instance and (advanced in a different form) at rather greater length in the Court of Appeal. In this case, the Court of Appeal suggested that reliance might be placed upon the retrospective effect of the collection and distribution of assets by the liquidator, so that the recovery of the debt from the principal debtor could be deemed to take place immediately before the operation of rule 4.90 and, by discharging the debt, prevent set-off from taking place. I record the debate without comment; it is something which may have to be decided in the unlikely event of documentation such as that in M.S. Fashions appearing in another liquidation. (The B.C.C.I. liquidators say that they have settled all their cases in which such documents were used.) But the point does not arise in this case because the letter of lien/charge simply cannot be construed as creating a personal joint and several obligation.

(b) Re Charge Card Services Ltd.

    The Court of Appeal rejected the argument that the letter was ineffective unless construed as imposing personal liability. They accepted Mr. McDonnell's submission that, by reason of conceptual impossibility, it could not operate as a charge over the deposit. But they said that it could provide perfectly good security by virtue of the contractual provisions in the third paragraph which limited the right to repayment of the deposit and made it what is sometimes called a "flawed asset." I agree and could stop there without commenting on the question of whether a charge is conceptually impossible or not. But the point has been very fully argued and should, I think, be dealt with.