Damages — Set-off — Cross-claim — Equitable right of set-off — Parties entering into two separate contracts for supply and installation of goods — Appellant terminating installation contract — Respondent seeking summary judgment of claim for damages — Appellant counter-claiming for damages for repudiation of installation contract and relying on right of set-off — Judge granting respondent summary judgment — Whether appellant entitled to set off counter-claim for damages — Appeal allowed
The appellant was the main contractor engaged to carry out building work on commercial premises. It entered into two subcontracts with the respondent, the supply contact to purchase pressure vessels for the plant, and the installation contract to install storage tanks on the plant site. Clause 24 of the supply contract provided that the appellant was entitled to setoff against the purchase order price all amounts lawfully due from the respondent, whether under that purchase order or otherwise.
The appellant alleged that the respondent was in breach of the installation contract and issued a default notice. It failed to pay the respondent’s invoice for goods supplied. The respondent refused to continue with the installation work until the appellant paid the invoices relating to both contracts.
The appellant issued a notice of termination under the installation contract. The respondent commenced proceedings to claim the cost of the equipment that the appellant had purchased under the supply contract; the appellant counter-claimed for damages for repudiation of the installation contract. The appellant accepted that the supply and installation contracts were separate contracts but submitted that the counter-claim was inseparably connected with the dealings and transactions that gave rise to the claim and should therefore be setoff against them. The appellant relied on three separate setoffs, which included its unliquidated, but provisionally quantified, claim for damages for repudiation of the installation contract in the sum of £5.3m (the third setoff).
Summary judgment was given in favour of the respondent. The judge considered the third set-off in the light of clause 24 of the supply contract but did not construe the words “all amounts lawfully due”. He took the view that those words did not cover unliquidated damages. The appellant appealed. An issue arose as to whether either common law doctrines of equitable set-off or a special set-off clause in the supply contract permitted the appellant to set off a counter-claim for damages for repudiation of the installation contract.
Held: The appeal was allowed.
The principle that only cross-claims that impeached the title of legal demand could be setoff should no longer be used; it was an unhelpful metaphor in the modern world. There was a formal requirement of close connection, as all the modern cases maintained, but the “inseparable connection” test applied in more recent cases – from Hanak v Green [1958] 2 QB 9 to Bim Kemi AB v Blackburn Chemicals Ltd (No 1) [2001] EWCA Civ 457; [2001] 2 Lloyd’s Rep 93 – also did not provide a helpful metaphor: Rawson v Samuel (1841) Cr&Ph 161 considered; Bank of Boston Connecticut (formerly Colonial Bank) v European Grain & Shipping Ltd (The Dominique) [1989] AC 1056 applied.
The test of inseparable connection was one formulation of the close connection test, but it was not the only one. There was also a functional requirement that it would be unjust to enforce the claim without taking into account the cross-claim. The test for equitable set-off therefore involved considerations of both the closeness of the connection between the claim and cross-claim and of the justice of the case, but it was not appropriate to speak in terms of a two-stage test. Instead, there was a formal and a functional element. The best restatement of the test, without reference to the concept of impeachment, was whether the cross-claims were so closely connected with a claimant’s demands that it would be manifestly unjust to allow it to enforce payment without taking into account the cross-claim: Federal Commerce & Navigation Co Ltd v Molena Alpha Inc (The Nanfri) [1978] QB 927 applied; Newfoundland v Newfoundland Railway Co (1888) LR 13 App Cas 199 considered.
By insisting on the payment of the supply contract invoices as a precondition of returning to work under the installation contract, the respondent had brought the two contracts into an intimate relationship which became inseparable and irrevocable when the appellant terminated that installation contract on the basis of the respondent’s poor performance under the installation contract together with its insistence on prior payment. Thereafter, it became unjust to enforce payment under the supply contract without taking into account the cross-claim for repudiation of the installation contract.
Furthermore, business sense and the intention of clause 24 indicated that the clause referred to amounts that were claimed to be due and that were recognised or recognisable at law. Thus, the appellant was entitled to setoff its counter-claim under that clause.
David Friedman QC and Alexander Hickey (instructed by Hill Dickinson LLP) appeared for the appellant; Stephanie Barwise QC (instructed by Kennedys) appeared for the respondent.
Eileen O’Grady, barrister