House of Lords
|Session 2003 - 04
Publications on the Internet|
Secretary of State for Trade and Industry (Appellant) v. Frid (Respondent) (Civil Appeal from Her Majesty's High Court of Justice)
OF THE LORDS OF APPEAL
FOR JUDGMENT IN THE CAUSE
Secretary of State for Trade and Industry (Appellant)
(Civil Appeal from Her Majesty's High Court of Justice)
THURSDAY 13 MAY 2004
The Appellate Committee comprised:
Lord Nicholls of Birkenhead
Lord Hope of Craighead
Lord Phillips of Worth Matravers
Lord Brown of Eaton-under-Heywood
HOUSE OF LORDS
OPINIONS OF THE LORDS OF APPEAL FOR JUDGMENT
IN THE CAUSE
Secretary of State for Trade and Industry (Appellant) v. Frid (Respondent) (Civil Appeal from Her Majesty's High Court of Justice)
 UKHL 24LORD NICHOLLS OF BIRKENHEAD
1. I have had the advantage of reading in draft the speech of my noble and learned friend Lord Hoffmann. I agree that, for the reasons he gives, this appeal should be allowed.
2. On 10 March 1999 West End Networks Ltd ("the company") resolved to go into creditors' voluntary liquidation. Its assets included a credit of £7,185.77 with HM Customs and Excise in respect of overpaid VAT. Its liabilities included compensatory notice pay and redundancy payments due to nine former employees under sections 88 and 135 of the Employment Rights Act 1996. The company did not make these payments and the Secretary of State accordingly became liable under sections 166(1)(b) and 167(1) of that Act to pay all or part of them out of the National Insurance Fund. Pursuant to this obligation the Secretary of State paid the employees £11,574.49 and by virtue of section 167(3) all the rights and remedies of the employees against the company thereupon vested in her. The question of principle raised by this appeal is whether in determining the company's claims against the Crown or the Crown's right to prove in the liquidation of the company, the VAT credit must be set off against the Crown's subrogated claim under section 167(3).
3. The procedure by which this question has been brought before the House is somewhat unusual. Besides the claim of the Secretary of State under section 167(3), there were claims against the company for PAYE and National Insurance contributions which even by themselves exceeded the VAT credit. HM Customs and Excise allocated the credit rateably between the three Crown claimants and paid £2,344.03 to the Secretary of State (for the account of the National Insurance Fund) as her share. The Secretary of State submitted a proof in the liquidation for £9,230.46, giving credit for the £2,344.03 as having been set off against the VAT credit. The liquidator rejected the proof on the somewhat paradoxical ground that it was too low. He said that it should have been for the full sum of £11,574.49. The purpose of the rejection was to raise the question of principle without requiring the liquidator to bring proceedings against HM Customs and Excise. The matter has since been litigated on this basis.
4. The Secretary of State appealed to Mr Registrar Jacques, who upheld the liquidator's decision on the ground that he was bound by the decision of the Court of Appeal in In re A Debtor (No 66 of 1955), Ex p The Debtor v Trustee of Waite (A Bankrupt)  1 WLR 1226. A further appeal to Mr David Mackie QC, sitting as a deputy High Court judge, was dismissed for the same reason. Both the registrar and the judge expressed regret over their decisions, saying that they appeared to be contrary to justice and principle. As it appeared likely that the Court of Appeal would also consider itself bound by the earlier case, Mr Mackie gave leave for an appeal to be brought directly to your Lordships's House.
5. Set-off between an insolvent company and its creditors is currently governed by rule 4.90 of the Insolvency Rules 1986 (SI 1986/1925):
6. If the requirements of paragraph (1) are satisfied, the account and set-off required by paragraph (2) are mandatory and apply whenever it is necessary to ascertain the net amount owing by one party to the other: Stein v Blake  AC 243. Such an ascertainment is necessary for the purpose of determining the amount for which the Secretary of State is entitled to prove in the liquidation. So the question in this appeal is whether the requirements of paragraph (1) are satisfied.
7. The rule requires that there should have been "mutual credits, mutual debts or other mutual dealings" between the company and the Secretary of State before the company went into liquidation, that is to say, before the date of the resolution to wind it up. I shall call this "the insolvency date". In considering whether this requirement was satisfied, I shall put aside two matters for later consideration. One is the question of whether the Customs and Excise is the same party as the Secretary of State and the second is the effect of the words "or other mutual dealings". I shall consider first whether "mutual debts" existed at the relevant time between the company and the Crown, treating HM Customs and Excise and the Secretary of State as both being manifestations of the Crown.
8. There is no doubt that the liability to repay VAT was a debt which existed at the relevant time. It was quantified, due and payable. But nothing was yet due under section 167(3). The liability arose by virtue of the payment made by the Secretary of State under section 167(1) and her liability to make that payment had in turn arisen because the company had become insolvent: see section 166(1)(b). So Mr Davies QC, who appeared for the liquidator, says that there was no debt owing under section 167(3) at the insolvency date. There was only a possibility that such a debt would come into existence afterwards.
9. It not however necessary for the purposes of rule 4.90(2) that the debt should have been due and payable before the insolvency date. It is sufficient that there should have been an obligation arising out of the terms of a contract or statute by which a debt sounding in money would become payable upon the occurrence of some future event or events. The principle has typically been applied to claims for breach of contract where the contract was made before the insolvency date but the breach occurred afterwards (In re Asphaltic Wood Pavement Co Ltd (1885) 30 Ch D 216) or claims for indemnity by a guarantor where the guarantee was given before the insolvency date but the guarantor was called upon and paid afterwards (Jones v Mossop (1844) 3 Hare 568; In re Moseley-Green Coal and Coke Co Ltd, Ex p Barrett (1865) 12 LT (NS) 193.)
10. The effect of these and similar cases was summed up by Millett J in In re Charge Card Services Ltd  Ch 150, 182:
11. I agree that this principle was firmly established, but in view of the reasoning in In re A Debtor (No 66 of 1955), Ex p The Debtor v Trustee of Waite (A Bankrupt)  1 WLR 1226, which the registrar and the judge held to require a rejection of a set-off in this case, I should give some examples of its application to claims by guarantors under pre-insolvency guarantees. In Jones v Mossop (1844) 3 Hare 568 Mr Reed was holder of a bond for £500 given by Mr Jones, who had also guaranteed some loans to Mr Reed by third parties. Mr Reed died insolvent and Mr Jones was called to pay £377 to the lenders under the guarantees. When Mr Reed's assignee Mr Mossop sued Mr Jones on the bond, he brought proceedings in equity claiming to be entitled to set off the £377 he had paid. Because Mr Reed had never actually been made bankrupt, the then equivalent of rule 4.90 did not apply and Sir James Wigram V-C gave relief under general equitable principles, but he said, at p 571: "if Richard Reed had been bankrupt, I should have had no difficulty in deciding this case."
12. The same principle was applied to a winding up in In re Moseley-Green Coal and Coke Co Ltd, Ex p Barrett 12 LT (NS) 193. Mr Barrett owed the company money on his partly-paid shares for which calls were made after it went into insolvent liquidation. He had also guaranteed the company's liability for the purchase price of a coal mine, for which the vendor held security in the form of a mortgage and the company's promissory note. After the winding up Mr Barrett's sister paid off the vendor and took over the mortgage and promissory note. Mr Barrett then entered into an arrangement which was treated as a payment of the company's debt and he took over the promissory note. Lord Westbury LC held that he was entitled to set off the debt on the promissory note against his liability to pay calls on his shares. The facts give rise in my mind to some doubt about whether Mr Barrett could truly be said to have paid under his guarantee but, assuming that he had, the application of the principle of contingent liability is clear enough.
13. In re Fenton  1 Ch 85 was another case of a surety under a pre-insolvency guarantee, but this time he had not actually paid. Nor could he pay, because he was bankrupt and his assets had vested in his trustee. The creditor was still owed the money and entitled to prove in the liquidation. The Court of Appeal held, first, that one could not have more than one proof in respect of the same debt ("the rule against double proof"); otherwise, if there had been, say, four guarantors, there could have been five people receiving dividends on the same debt. Secondly, the Court of Appeal said that until the creditor had been paid, he had the superior right of proof and a proof by a surety was excluded. Thirdly, the court said that a debt which could not be proved could not be relied upon for set-off. There is no longer doubt about any of these propositions. But the judgments of Lawrence and Romer LJJ make it clear (that of Lord Hanworth MR is a little obscure) that if the guarantor had paid off the debt after the insolvency date, he would have been entitled to set it off against a debt which he owed to the company.
14. That brings me to In re A Debtor (No 66 of 1955), Ex p The Debtor v Trustee of Waite (A Bankrupt)  1 WLR 1226, which is the reason why leave was given to appeal to your Lordships' House. One Waite owed the debtor £101, being the balance of the price of goods sold and delivered. Waite was made bankrupt, having previously guaranteed the debtor's overdraft and deposited the deeds of his property as security. Waite's trustee paid the bank £133 out of the bankrupt's assets which had vested in him as trustee to pay off the overdraft and obtain the release of the deeds. When he claimed reimbursement, the debtor claimed to set off the £101 he was owed by Waite, for which he would otherwise have had to prove in the bankruptcy.
15. Danckwerts J, giving the judgment of himself and Harman J in the Divisional Court in bankruptcy (In re A Debtor (No 66 of 1955) Ex p The Debtor v Trustee of Waite (A Bankrupt)  1 WLR 480, 487) said that Waite and his trustee were not for this purpose the same person. Waite had held his assets for his own benefit. The trustee held the assets that vested in him for the benefit of the creditors:
16. My Lords, it is unnecessary to express a concluded view but, speaking for myself, I find this reasoning convincing. But the Court of Appeal  1 WLR 1226 seem to have put the matter on a much broader basis. I say "seem" because I agree with Millett J in In re Charge Card Services Ltd  Ch 150, 189 that the judgments of Lord Evershed MR and Hodson LJ are not easy to follow. But they both appear to have decided that a surety under a pre-insolvency guarantee is not entitled to set-off unless he has actually paid the debt before the insolvency date. The Moseley-Green case 12 LT (NS) 193 was distinguished ("depending upon its own special facts": p 1232) and the other cases were not mentioned. In Day & Dent Constructions Pty Ltd (In Liquidation) v North Australian Properties Pty Ltd (1982) 150 CLR 85, 94, 106 the High Court of Australia said that In re A Debtor was contrary to principle and authority and declined to follow it. Mr Davies on behalf of the liquidator did not support the broad reasoning of the Court of Appeal (although he did propose a third ground upon which the case could be supported, to which I shall in due course return.) I also respectfully think that the broad reasoning was wrong.
17. This means that if the Secretary of State had agreed by contract before the insolvency date to guarantee any future liability of the company to pay compensatory notice pay or make redundancy payments to employees under the 1996 Act, the contract of guarantee would have created a contingent liability on the part of the company to reimburse the Secretary of State which was a "debt" at the insolvency date and became capable of set-off when the employees were afterwards paid. The next question is whether it makes a difference that the contingent liability existed by virtue of a statute rather than a contract and, not being consensual, that it involved no direct contract or other relationship with the employees or the company.
18. The question of whether the set-off provisions apply to debts arising under statute was decided by Brightman J in In re D H Curtis (Builders) Ltd  Ch 162, a case which has since been consistently followed in this country and approved by the High Court of Australia in Gye v McIntyre (1991) 171 CLR 609. The debts in that case were, on the one side, the liability of the company to the Inland Revenue and the Department of Health and Social Security for PAYE and National Insurance contribution respectively and, on the other, the liability of HM Customs and Excise to the company for excess input VAT. All the debts were due and payable at the insolvency date. Brightman J, (at p 171), rejected the argument that the mutuality required by the statute meant that the claims sought to be set off "must be such as result in pecuniary liabilities arising out of contract". He said that the type of acts or events giving rise to the liabilities were immaterial provided that those liabilities were "commensurable", that is to say, capable of being expressed in money.
19. If a statutory origin does not prevent set-off in the case of debts due and payable at the insolvency date, I do not see why it should make any difference that the statute creates a contingent liability which exists before the insolvency date but falls due for payment and is paid afterwards. The term "mutual debts" does not in itself require anything more than commensurable cross-obligations between the same people in the same capacity. How those debts arose - whether by contract, statute or tort, voluntarily or by compulsion - is not material.
20. The analogy with a contractual guarantee appears to me exact. Indeed, section 167 was enacted to give effect to Council Directive (80/987/EEC) "on the approximation of the laws of the member states relating to the protection of employees in the event of the insolvency of their employer" (OJ 1980 L283, p 23) which required member states, by article 3, to:
21. The United Kingdom has complied with this directive by enacting that the Secretary of State is to be our "guarantee institution". In Mann v Secretary of State for Employment  ICR 898, 902 I described the provisions of section 166 and 167 as a "state guarantee" and, at p 904, said that the Secretary of State was a "guarantor, liable only for whatever the employee was entitled to be paid by his employer". In truth, however, it does not matter how the liability is characterised. The failure of the insolvent employer to pay is the contingency which crystallises the liability imposed upon the Secretary of State by sections 166 and 167 and the payment of those liabilities is in turn the contingency upon which the right of subrogation depends. But when it does become payable, it is a debt arising out of a statutory obligation which existed before the insolvency date.
22. My Lords, so far I have been concentrating upon the effect of the words "mutual debts". The words "or other mutual dealings" was added for the first time by the Bankruptcy Act 1869. These words, and particularly the word "other" create what the High Court of Australia in Gye v McIntyre 171 CLR 609, 623 tactfully called "a linguistic problem". The language suggests that the previous words "mutual credits, mutual debts" must be qualified by a requirement that the credits or debts can in some sense be described as "mutual dealings". But all the authorities since the 1869 Act have been unanimous in saying that Parliament in no way intended to restrict the ambit of the original formula. On the contrary, the purpose was to broaden it. In Booth v Hutchinson (1872) LR 15 Eq 30, 35, Malins V-C said that the additional words "were intended to give a more extended right of set-off than previously existed" and in Peat v Jones & Co (1881) 8 QBD 147, 149 Sir George Jessel MR said:
23. What then is the answer to the "linguistic problem" identified by the High Court of Australia in Gye v McIntyre (1991) 171 CLR 609, 623? That court gave a clear answer:
24. All that is necessary therefore is that there should have been "dealings" (in an extended sense which includes the commission of a tort or the imposition of a statutory obligation) which give rise to commensurable cross-claims. In Gye v McIntyre itself, the one party was liable to the other for money lent and the cross-claim was for damages in tort for fraudulently inducing the borrower to enter into a separate contract to which the lender was not a party.
25. In In re Charge Card Services Ltd  Ch 150, 189, Millett J suggested that an alternative ratio for In re A Debtor  1 WLR 1226 was that the contingent obligation of the principal debtor to his surety was not referable to any transaction between debtor and surety, the parties to the alleged set-off, but rather to the guarantee which the surety had given to the creditor. The implication is that a mutual transaction may be required by rule 4.90. But there is nothing in the term "mutual debts" which requires that both debts must be, as Millett J put it, "exclusively referable" to a contract or other "transaction" between the parties to the set-off. It is true that if it were not for the historical background, one might have been able to argue that such a notion was implied by the words "mutual dealings". But once one accepts that the debts need not arise from consensual transactions at all, but can arise from statutory obligations as in In re D H Curtis (Builders) Ltd  Ch 162 or torts as in Gye v McIntyre 171 CLR 609, such a requirement of mutuality in the transactions giving rise to the cross-claims becomes untenable. Mr Davies, in his written case, was constrained to say of Millett J's suggestion that it was "objectionable only to the extent that it appears to require an agreement rather than a dealing". But that, in my opinion, is a very large objection when one considers the extended meaning which has been given to "dealing". I can quite understand why Millett J wanted to find some reasoning to explain In re A Debtor which was not plainly and obviously wrong. But I respectfully think that the alternative explanation, though it may have served well enough for the case before him, is ultimately also unsuccessful.
26. The final question is whether there is mutuality between a claim against Customs and Excise and a claim by the Secretary of State on behalf of the National Insurance Fund. Mutuality requires that each party should be debtor and creditor in the same capacity. A claim by a trustee on behalf of a beneficiary cannot be set off against a debt owing to the trustee personally. The law is concerned with beneficial ownership and not mere legal title.
27. The constitutional accountability of the Crown to Parliament for the expenditure of public money means that, as a matter of public law, the Crown may have to deal differently with money from different sources. Part XII of the Social Security Administration Act 1992 prescribes what may be paid out of the National Insurance Fund, what must be paid in, how it must be invested and so forth. But these provisions do not in my opinion create a trust in private law: compare Swain v The Law Society  1 AC 598, 618, per Lord Brightman. In private law the Crown through its various emanations is the beneficial owner of all central funds. If it fails to comply with the provisions which require such funds to be segregated, the remedy lies in public law.
28. In fact, there has been no difficulty in reconciling the Crown's set-off with the segregation of the various funds. All that happened was that Customs and Excise, instead of writing a cheque to the company, wrote three cheques to the Inland Revenue, the Department of Social Security and CSL Management Group Ltd, which administers the Secretary of State's obligations to make payments under sections 166 and 167 and which paid the money into the National Insurance Fund. Thus were the proprieties of public finance preserved.
29. It follows that in my opinion the set-off of the £2,344.03 due to the Secretary of State under section 167(3) should have been allowed and the proof in the lesser sum accepted. I would allow the appeal accordingly.
LORD HOPE OF CRAIGHEAD
30. I have had the advantage of reading in draft the speech of my noble and learned friend Lord Hoffmann. I agree with it, and for the reasons which he has given I too would allow the appeal. I should like to add only two brief comments.
31. The first comment relates to the question whether it should make a difference for the purposes of rule 4.90 of the Insolvency Rules 1986 that sections 167(3) and 189(2) of the Employment Rights Act 1996, which enable the Secretary of State to recover the amounts paid to former employees in respect of redundancy payments and compensatory notice pay respectively, create contingent liabilities on the part of the company which exist before the insolvency date but fall due for payment and are paid afterwards. Section 411(1) of the Insolvency Act 1986 contains separate rule-making powers in relation to England and Wales on the one hand and to Scotland on the other for the purposes of giving effect to Parts I to VII of the Act. Rule 4.90 of the Insolvency Rules 1986, which reproduces the provisions regarding mutual credit and set-off in bankruptcy that are set out in section 323 of the 1986 Act (which do not extend to Scotland), has no counterpart in the Insolvency (Scotland) Rules 1986. In Scotland the question of set-off (or compensation, as it is usually referred to in Scots law) is regulated, both in personal bankruptcy and in the winding of a company, by the common law.
32. In Scotland it is well established that, while in compensation both debts must be due at the same time, this rule is applied only when both parties are solvent: Goudy, The Law of Bankruptcy in Scotland, 4th ed (1914), pp 550-553. As Goudy puts it at p 551, the term compensation as applied in insolvency has generally to be understood in a sense very closely akin to that of retention. It is based on a principle of equity which is designed to prevent the hardship of a debtor who is also a creditor being forced to pay in full, while he only receives a dividend for his debt. So every kind of claim may be set off in a case of insolvency, the only general restriction being that the debt sought to be set off against the bankrupt estate must be one that is capable of being ranked for.