England and Wales Court of Appeal (Civil Division) Decisions

IN THE HIGH COURT OF JUSTICE
COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM MANCHESTER DISTRICT REGISTRY TECHNOLOGY & CONSTRUCTION COURT
HIS HONOUR JUDGE RAYNOR QC
(SITTING AS A JUDGE OF THE HIGH COURT)
TCC10109

		Royal Courts of Justice Strand, London, WC2A 2LL
		11/06/2010

Lord Justice Rix :

1. This is an appeal about rights of set-off. The appellant, Simon Carves Limited ("SCL"), seeks to set off a counterclaim for damages for repudiation of an installation contract into which it entered with the respondent, Geldof Metaalconstructie NV ("Geldof"), against Geldof's's claim for the price of equipment which it, SCL, bought from Geldof under a separate supply contract. The issue is whether either common law doctrines of equitable set-off or a special set-off clause in the supply contract permits SCL to do that. The judge, HHJ Raynor QC, sitting in the Technology and Construction Court as a judge of the High Court, held by his judgment dated 29 September 2009 that SCL was not entitled to the set-off claimed and gave judgment against it for €1,329,437.55. That order was made on an application for summary judgment brought by Geldof. A trial of the counterclaim is due later this summer.

The supply contract

2. The background to the making of both contracts was that SCL was the main contractor for the building of a bioethanol plant in Teesside for Ensus UK Limited. As such, it needed to purchase pressure vessels for the plant, and also required storage tanks to be installed on the plant site. It turned to Geldof for both these needs, and discussions took place leading to Geldof tendering for both contracts. The two companies held a meeting on 5/6 June 2007 to discuss the tenders. Other than that both the pressure vessels and the storage tanks were necessary ingredients of the bioethanol plant, there was no connection between these items.
3. The first of the two contracts to be made was the supply contract. This was concluded by the acceptance, on or about 3 July 2007, of SCL's purchase order dated 21 June 2007. The price of the pressure vessels was €5,640,000. The contract description was "3960C – Bio Ethanol Plant". Delivery was to be at the plant at Teesside, between 22 and 29 September 2007. Payment terms provided for 10% to be paid on approval of drawings, 50% on receipt by Geldof of the main materials, 30% on delivery, and the final 10% on completion. Invoices were to be paid on a 45 day basis. The pressure vessels were covered by a warranty which was to last for 24 months "after start up of the main plant" but no later than 36 months after the ex-works delivery date. The warranty was to extend not only to SCL as purchaser but also to the biothenol plant's owner, Ensus UK. The purchase order was "subject to General Supplier Quality Surveillance (SAS) Requirements, Ensus UK Ltd Bioethanol Plant Project Number 3960C". There was provision for liquidated damages for late delivery. A documentation clause, clause 14, stated that "All documentation is to be sent to 'Document Controller – Ensus Project".
4. Clause 24 was headed "Right to Offset" and provided as follows:

"Purchaser, without waiver or limitation of any rights or remedies of Purchaser or Owner, shall be entitled, shall be entitled from time to time to set off against the Purchase Order Price any amounts lawfully due from the Supplier to the Purchaser whether under this Purchase Order or otherwise."

That is the clause which was the subject-matter of one of the two issues at the hearing below, and again on this appeal. It raised the question whether, irrespective of common law rights of set-off, SCL could bring its counterclaim within the words "any amounts lawfully due".

5. 5. The judge referred to one other clause as relevant to that question, namely clause 10, which excluded consequential losses. It read:

"Unless expressly stipulated in the Purchase Order neither Purchaser nor the Supplier shall be liable for any claims, loss or liability arising out of or in connection with the Purchase Order for indirect or consequential damage. The term indirect and consequential damage shall include loss of profit or anticipated profit, loss of production, loss of contracts, loss of revenue, or other similar financial or economic loss."

6. Clause 36, headed "Responsibility for Completeness" put upon Geldof the obligation, without additional charge, to –

"provide all equipment, fittings, material supplies and/or Services which are necessary or useful for erection, commissioning and efficient operation of the Goods…"

7. Clause 37, headed "Performance Test", provided for such a test to be carried out after the equipment had been installed. A successful test would lead to an acceptance certificate. An unsuccessful test required Geldof to carry out corrective action, and failure to correct a fault on the part of Geldof would lead to liquidated damages.
8. Clause 38, headed "Supply of Site Services", provided for Geldof's role in SCL's installation of the vessels:

"Upon Purchaser/Owner/Project Manager request, which shall be mutually discussed and agreed, the supplier shall make available qualified supervisory personnel capable of performing the supervisory and advisory Services for the installation, commissioniong and performance testing of the equipment and material covered by the Purchase Order in the environment they will be called upon to work at the project Site. The Purchasers Site Conditions Form 330B will apply in addition to any other Terms and Conditions of the Purchase Order…"

9. On 7 November 2008 the vessels were delivered to site. On 12 November 2008 GM issued its invoice for 30% of the price of those vessels in the sum of €1,692,000. This is the invoice whose payment Geldof was claiming as a matter of summary judgment in the application it made to the judge. Its payment was due 45 days later on 27 December 2008.

The installation contract

10. The installation contract was separately tendered for, and was concluded on 21 December 2007. The conclusion of the supply contract did not mean that the installation contract would necessarily be given to Geldof as well. That concerned separate storage tanks. There was evidence that it is normal industry practice for the installation of vessels and tanks to be dealt with separately. Vessels have a longer lead-in time and are more complicated to procure and thus are generally dealt with earlier in a project. Geldof's obligations under the installation contract were to "design, supply, fabricate, deliver to site, erect, test and paint" the designated tanks. The installation contract contained complex standard sub-contract terms, as amended, on the form of "The Yellow Book", in its 2003 third edition. The commencement date for the sub-contract works was given as 22 October 2007, for the installation works as 3 March 2008, and completion was due by 30 November 2008.
11. The judge briefly described the difficulties into which the installation contract descended, and its termination, short of completion, in January 2009, in the following passage of his judgment:

"11. [SCL] alleged that [Geldof] was in breach of the installation contract and issued notice of default on 29 August 2008 alleging failure to proceed regularly and diligently. Payment under the invoice which forms the subject matter of the application for summary judgment was due by 27 December 2008 but was unpaid. By letter dated 23 December 2008, on which [SCL] particularly relies, [Geldof] made it clear that it would not restart works under the installation contract on 5 January 2009 unless payment had been made of the sums claimed in 6 invoices, four of which had been issued under the installation contract and two under the [supply contract], including the invoice which is the subject matter of the application for summary judgment. There followed a second notice of default dated 30 December 2008 and [Geldof] then, on 6 January 2009, again made it clear that the works would only restart if payment was made of five of the invoices which I have mentioned, including the invoice the subject matter of the application. That was unacceptable to [SCL] who, on 13 January 2009, issued notice of termination under clause 43.2 of the installation contract. [SCL] alleges that it was entitled to terminate by reason of the default and repudiation of [Geldof]."

12. That brief description matched SCL's pleaded defence, which was to the effect that –

"45. Geldof did not return to site since the Christmas break in 2008 or at any time thereafter. Geldof's actions constituted an unlawful suspension and/or abandonment of the works, alternatively a suspension or abandonment without reasonable cause…

54. Further or alternatively without prejudice to SCL's contention that SCL's letter dated 13 January 2009 constitutes notice of termination under clause 43.2, SCL by its actions in giving Geldof the said letter accepted Geldof's repudiatory breaches of contract as ending Geldof's employment and bringing the primary obligations under the Installation Contract to at end at common law. SCL will contend at trial that it is entitled at common law to rely upon all the breaches by Geldof whether or not set out in the letter dated 13 January 2009 and/or the letters dated 29 August 2008 and/or 9 January 2009."

13. In its reply, Geldof pleaded inter alia that SCL's notices of default were defective and invalid. As for the plea of acceptance of repudiatory breach made at para 54 of SCL's defence (cited above), Geldof said this:

"66. Paragraph 54 is denied. The matters alleged do not constitute repudiatory breaches. Further the matters alleged were largely historic and were not continuing at the relevant time. It is denied that the purported exercise of a contractual right to determine could amount to an acceptance of a repudiation at common law on the facts of this case."

14. SCL's counterclaim arising out of the termination of the installation contract was quantified provisionally at £5,311,118 at the time of its defence (at para 59) and of the hearing before the judge. The counterclaim arose out of the need to complete the work which should have been done by Geldof under the installation contract.

The disputed set-off

15. Before the judge SCL relied on three separate set-offs. One related to certain comparatively minor defects in the vessels supplied under the supply contract. This was ultimately quantified in or by the time of the hearing before the judge in the sum of £76,430. The second related to liquidated damages which arose under the installation contract, quantified in the sum of €278,674.71. The third was SCL's unliquidated but provisionally quantified claim for damages for repudiation of the installation contract in the sum of about £5.3m.
16. The judge held that SCL was entitled to set off the first two counterclaims, but not the third. He appears to have considered that the first set-off was a matter of abatement and thus within the common law of set-off, and that the second set-off, although arising under the separate installation contract, was within clause 24 of the supply contract, viz as within the expression "all amounts lawfully due…whether under this Purchase Order or otherwise". That second set-off appears to have been a matter of concession (see para 12 of the judgment). The first set-off was disputed on the ground that Geldof had held back in its summary judgment application on a further supply contract invoice (for which it claimed) which more than covered the set-off in question. The judge held that Geldof could not pick and choose which invoice to allow a conceded set-off against. That is not to say that these two set-offs were decided in SCL's favour, only that the corresponding counterclaims could be set off pending adjudication. The effect of the judge's conclusions was that he gave summary judgment against SCL in the net sum of €1,329,437.55, but that in all other respects the parties' disputes had to await trial.
17. No issue arises on this appeal with regard to the first two set-offs. But SCL submits that the judge was wrong not to accord its third counterclaim the status of a set-off as well.

The judgment

18. The judge first considered the disputed third set-off in the light of clause 24. He did not construe the critical words "all amounts lawfully due", but considered that whatever those words meant, they did not cover unliquidated damages, or possibly did not cover such damages when they had not been the subject of adjudication. He put the matter thus:

"17…To my mind, the phrase, "all amounts lawfully due", is not apt and on the true construction of the agreement does not cover a disputed claim for unliquidated (but quantified) damages which has not been the subject of adjudication. It would have been quite easy for the contract to have provided, if that was the intention, that the amount of any such claim could be set off, and I note in this connection…the provisions of clause 10 of the Standard Terms, which bar claims for indirect or consequential damage arising out of or in connection with the Purchase Order. If such claims are barred even when arising out of the Purchase Order, they would hardly be contemplated under a separate contract. The phrase "amounts lawfully due" to my mind is plainly narrower than that contended for and whatever it means (and I do not find it necessary to attempt an exposition) I am quite clear that it does not include the claim which is asserted for unliquidated damages."

19. The judge then turned to the common law of equitable set-off. He concentrated on Bim Kemi AB v. Blackburn Chemicals Ltd [2001] 2 Lloyd's Rep 93, since the parties were agreed that the relevant and applicable law was to be found there. (Unfortunately they do not appear to be agreed as to what that case taught.) Having set out significant citations from Bim Kemi, the judge appears to have directed himself on the basis that it was for SCL to show that there was an "inseparable connection" between claim and counterclaim, and that it would be manifestly unjust to allow the former to be enforced without regard to the latter. As to that test, he concluded as follows:

"23. In this case, it does not seem to me that the claim and counterclaim have the necessary close and inseparable connection, or in those circumstances that it is manifestly unjust to allow the enforcement of the claim without regard to the counterclaim.

24…The other contract, although also relating to the Teesside plant, was a separate contract, concluded some 5½ months or thereabouts after the first contract. In my judgment, and adopting the words of Potter LJ [in Bim Kemi], the counterclaim does not flow from the transactions and dealings giving rise to the claim. Those dealings were the supply and delivery to Teesside of the pressure vessels under the Sales Contract, which gave rise to the entitlement to 30% of the Purchase order Price under clause 4 of the Special Conditions. In no way did the counterclaim arise from those dealings, nor, unlike the case of Bim Kemi, did breach of the installation contract constitute a breach of the Sales Contract. True it is that the claimant demanded, as a condition of proceeding with the installation contract from 5 January 2009, the payment of sums due under the Sales Contract as well as those claimed under the installation contract, but it does not follow from that that the counterclaim arose from the dealings which gave rise to the claim or that there was a requisite degree of closeness between claim and counterclaim to allow an equitable set off, and in my judgment there was not."

The jurisprudence of equitable set-off

20. Although most of the written and oral submissions before us on this appeal related to the correct test for equitable set-off, at the end of the day it was not clear either how the parties differed from one another as to the test, or how the test, when identified, would affect its application on the particular facts of this case.
21. Nevertheless, if only because there appears to be some uncertainty on the subject, I would hazard the following observations as to the jurisprudence.
22. It is generally considered that the modern law of equitable set-off dates from Hanak v. Green [1958] 2 QB 9. Morris LJ's judgment there has been described as a masterly account of the subject (Gilbert Ash (Northern) v. Modern Engineering (Bristol) Ltd [1974] AC 689 at 717 per Lord Diplock). In Dole Dried Fruit v. Trustin Kerwood Ltd [1990] 2 Lloyd's Rep 309 at 310 Lloyd LJ said that for all ordinary purposes, the modern law of equitable set-off is to be taken as accurately stated there. Morris LJ set out the law in these terms:

"The position is, therefore, that since the Judicature Acts there may be (1) a set-off of mutual debts; (2) in certain cases a setting up of matters of complaint which, established, reduce or even extinguish the claim; and (3) reliance as a matter of defence upon matters of equity which formerly might have called for injunction or prohibition…The cases within group (3) are those in which a court of equity would have regarded the cross-claims as entitling the defendant to be protected in one way or another against the plaintiff's claim" (at 23).

However, that did not mean that all cross-claims may be relied on as defences to claims. In his examination of Bankes v. Jarvis [1903] 1 KB 549, Morris LJ identified two factors as critical: it would have been "manifestly unjust" for the claim to be enforced without regard to the cross-claim; and "there was a close relationship between the dealings and transactions which gave rise to the respective claims" (at 24).

23. For these purposes the facts of Bankes v. Jarvis, which Morris LJ set out, are instructive. There were two separate but related transactions. The plaintiff was acting as agent or trustee for his son. The son had bought a veterinary surgeon's practice from the defendant. As part of that transaction he had also agreed to pay the rent and otherwise indemnify the defendant against liability under a lease of premises from which the practice was carried on. That was one transaction. However, the son decided to leave the country, and gave the plaintiff authority to sell the practice. The plaintiff sold it on his son's behalf back to the defendant. That was the second transaction. The defendant owed £50 under that second transaction, but the son owed the defendant £21 for rent and a further £30 for failure to perform covenants in the lease, under the first transaction. That was a quantified counterclaim for unliquidated damages. When the plaintiff sued the defendant for the £50, the defendant claimed to be able to set off the £51. As Morris LJ explained: "It was held that the defendant could set up as a defence to the claim against him that the plaintiff's son (the cestui que trust of the plaintiff) was indebted to the defendant in a sum for unliquidated damages exceeding the amount of the claim."
24. In Hanak v. Green itself the claim was against a builder for failing to complete the works. The builder made three counterclaims and relied on them by way of set-off. One arose under the building contract itself, for loss caused by the plaintiff's refusal to admit the builder's workmen; a second arose out of a quantum meruit for extra work performed outside the contract; and the third was for trespass to the builder's tools, and thus arose in tort. Morris LJ left the third item aside, for the first two by themselves overtopped the plaintiff's claim. He said, "it seems to me that a court of equity would say that neither of these claims ought to be insisted upon without taking the other into account" (at 26). Sellers LJ considered that all three items could be set off, for the first "arises directly under and affected the contract on which the plaintiff herself relies", and the other two were "closely associated with and incidental to the contract" (at 31).
25. Some twenty years later in Aries Tanker Corporation v. Total Transport [1977] 1 WLR 185, the House of Lords had to consider the long-standing historical rule that a cargo owner or charterer could not set off a claim for damage to cargo against the shipowner's claim for freight. Lord Wilberforce said (at 191):

"One thing is certainly clear about the doctrine of equitable set-off – complicated though it may have become from its involvement with procedural matters – namely, that for it to apply, there must be some equity, some ground for equitable intervention, other than the mere existence of a cross-claim (see Rawson v. Samuel (1839) Cr. & Ph. 161, 178 per Lord Cottenham L.C., Best v. Hill (1872) L.R. 8 C.P. 10, 15, and the modern case of Hanak v. Green But in this case counsel could not suggest, and I cannot detect, any such equity sufficient to operate the mechanism, so as, in effect, to over-ride a clear rule of the common law on the basis of which the parties contracted."

Lord Simon of Glaisdale spoke to similar effect (at 193).

26. Shortly thereafter in Federal Commerce & Navigation Co Ltd v. Molena Alpha Inc [1978] 2 QB 927 (The "Nanfri") this court had to consider whether claims against a shipowner could be set off against time charter hire. The issue had to be decided against the background of the historical rule excluding set-off against voyage charter freight (see The Aries just cited) and special terms in the time charter in question permitting deductions in certain circumstances. That therefore was a special case arising in a one contract only situation. This court fashioned its own solution to that problem, which does not concern us here. However, The Nanfri's importance is that it was the occasion for a further consideration of the doctrine of equitable set-off. Lord Denning MR said (at 974G/975A):

"It is now far too late to search through the old books and dig them out. Over 100 years have passed since the Judicature Act 1873. During that time the streams of common law and equity have flown together and combined so as to be indistinguishable the one from the other. We have no longer to ask ourselves: what would the courts of common law or the courts of equity have done before the Judicature Act? We have to ask ourselves: what should we do now so as to ensure fair dealing between the parties? See United Scientific Holdings Ltd. v. Burnley Borough Council [1978] A.C. 904 per Lord Diplock. This question must be asked in each case as it arises for decision: and then, from case to case, we shall build up a series of precedents to guide those who come after us. But one thing is clear: it is not every cross-claim which can be deducted. It is only cross-claims that arise out of the same transaction or are closely connected with it. And it is only cross-claims which go directly to impeach the plaintiff's demands, that is, so closely connected with his demands that it would be manifestly unjust to allow him to enforce payment without taking into account the cross-claim. Such was…Hanak v. Green..."

27. In Leon Corporation v. Atlantic Lines and Navigation Co Inc [1985] 2 Lloyd's Rep 470 (The Leon), in another case which raised the issue of the extent to which a time charterer could set off a counterclaim against time charter hire, Hobhouse J refused to depart from the line drawn by this court in The Nanfri, although he was pressed to do so on the ground of "fairness". The submission led to the following observations (at 474/5):

"It is also correct that equitable principles derive from a sense of what justice and fairness demand and should therefore include the capacity to develop and adapt as the need arises…But this does not mean that equitable set-off has been reduced to an exercise of discretion. Since the merging of equity and law, equitable set-off gives rise to a legal defence. This defence does not vary according to the length of the Lord Chancellor's foot. The defence has to be granted or refused by an application of legal principle.

The relevant principle is that identified by Lord Cottenham in Rawson v. Samuel (1841) Cr. & Ph. 161, at p. 179: "The equity of the bill impeached the title to the legal demand". What this requires is that the Court or arbitrator should consider the relationship between the claim and the cross-claim. This is why not every cross-claim, even though it arises out of the same transaction, necessarily gives rise to an equitable set-off. This element of the cross-claim impeaching the plaintiff's demand is to be found in all the modern cases and is a recognition that the principle being applied is essentially the same as that stated by Lord Cottenham."

28. In Bank of Boston Connecticut v. European Grain and Shipping Ltd [1989] AC 1056 (The Dominique) the House of Lords held that the historical rule of no set-off against voyage-charter freight extended to a counterclaim for damages for repudiation of the charterparty. It was another single contract case. It was decided on the basis that there was no good reason to distinguish between the case of a counterclaim for mere breach and the case of a counterclaim for repudiatory breach: see at 1106E/1109C. Therefore the historical rule prevailed. In reaching this conclusion, Lord Brandon of Oakbrook, with whose speech the rest of their Lordships agreed, dealt with three reasons which had been advanced by the counterclaiming charterers for making the distinction which the House ultimately rejected. The first reason was that a repudiatory breach satisfied the impeachment test for a defence by way of equitable set-off laid down in Rawson v. Samuel. That had been the major submission of counsel for the charterers, see Mr Eder arguendo at 1079:

"It was said in The Leon that the suggestion of manifest injustice being the relevant test was wrong and that the proper test was impeachment of title whatever that might mean, and when one looks at The Nanfri, pp. 974-975, the test is; does the cross-claim go directly to impeach the plaintiff's demands?"

Lord Brandon dismissed this primary argument of the charterers head-on, and swiftly. He said (at 1106F):

"I find it difficult, however, to see how, when a charterparty expressly provides, in effect, that the legal title to advance freight is to be deemed to be complete on the signing of bills of lading, a subsequent breach of the charterparty, even one of a repudiatory character, can properly be regarded as impeaching that title."

29. Despite this direct treatment of the charterers' major argument, Lord Brandon had in fact gone out of his way in the course of his speech to displace the impeachment rationale of Rawson v. Samuel. He said it was necessary to explain briefly the "nature, origins and basis of a defence by way of equitable set-off" (at 1101E). Making no express mention of Morris LJ's judgment in Hanak v. Green, nor of The Nanfri, he reached back to "see whether such cross-claim is of such a character that it would before the coming into force of the Supreme Court of Judicature Acts 1873 and 1875 have led a court of equity to prohibit by injunction the enforcement of the common law claim" (at 1101G). He referred to Rawson v. Samuel as the authority "most relied on as providing the relevant test" (at 1101H). However, he rejected that test as of continuing use in the modern world in the following passage:

"The concept of a cross-claim being such as "impeached the title of the legal demand" is not a familiar one today. A different version of the relevant test is to be found in the decision of the Judicial Committee of the Privy Council in Government of Newfoundland v. Newfoundland Railway Co. (1888) 13 App. Cas. 199…It is to be observed that the criterion which Lord Hobhouse applied, 13 App Cas 199, 213, in deciding whether the government's cross-claim for unliquidated damages could be set off against the company's claim was not that the cross-claim "impeached the title to the legal demand," as in Rawson v. Samuel, 1 Cr. & Ph. 161, 179, but rather that it was a cross-claim "flowing out of and inseparably connected with the dealings and transactions which also give rise" to the claim."

30. However, even though Lord Brandon had gone out of his way to dethrone the rationale of impeachment, he did not use that dethronement as an answer to Mr Eder's submission in the dispositive part of his speech (see at para 28 above). Indeed, he only returned to the Newfoundland Railway case in order to deal with a separate point ("Question (4): Set-off as between charterers and bank", see at 1109Hff), which was whether the plaintiff bank, as assignee of the shipowner's claim for freight, could equally rely on the shipowner's immunity from set-off against freight. That, however, followed from, or at any rate as a rational counterpoint to, the decision in the Newfoundland Railway case itself, where the assignee of an underlying claim which was susceptible to set-off, had to take the claim subject to that equity.
31. It may be noted, however, that Lord Brandon said nothing about the other element of Mr Eder's submission, which was that "the suggestion of manifest injustice being the relevant test was wrong". Lord Brandon said nothing about the concept of fairness, and that has led in the current case to submissions that the Newfoundland Railway test is a single exclusive test for equitable set-off and has either supplanted or must be regarded as somehow incorporating the fairness aspect of Morris LJ's test in Hanak v. Green and of Lord Denning's test in The Nanfri. I will have to revert to that question, but I would in the meantime observe that Lord Brandon's main concern in the passage cited above was to replace the impeachment test by something which was easier to understand and apply in the modern world. He did not address the concept of fairness, and perhaps did not need to do so in a situation where the underlying rule of no set-off against freight was so well ensconced. As Lord Wilberforce and Lord Simon had said in The Aries, the parties had contracted against the background of it, and could not be heard to say that they had an equity which ran directly contrary to the rule.
32. I think this view of the matter is confirmed by going back to the Newfoundland Railway case itself. The suit there was brought by the railway company and its assignees (trustees for bondholders) against the Government of Newfoundland. The underlying contract was one whereby the company was to build a railway and the government was to pay a subsidy. The railway was not completed. There was an issue as to whether the contract was an "entire" contract whereby no part of the subsidy was payable unless the railway as a whole was completed, but that issue was decided in favour of the company: the subsidy was payable, in part, as each section of the line was completed. There was also a counterclaim by the government for non-completion of the line. Could that be set off against the company's entitlement to subsidy? There was no issue between the parties that it could, at any rate as between company and government (at 209). It might have been argued that the severance of the payment of the subsidy to relate to each completed section of the line presented difficulties for a set-off premised on the uncompleted sections of the line, but it was not. In any event the Privy Council emphasised the intertwined nature of the obligations under the railway contract and said that it "had no hesitation in saying that in this contract the claims for subsidy and for non-construction ought to be set against one another" (at 212/213). What was said was that the set-off could not be made as against the assignees: that once notice of the assignment of the debt had been given, "the debt or claim is so severed from the rest of the contract that the assignee may hold it free from any counter-claim in respect of other terms of the same contract" (at 210). However, the Privy Council distinguished between a set-off properly allowable under the contract itself, which bound an assignee of a debt due under that contract, and a cross-claim which might "arise from any fresh transaction freely entered into by [the government] after notice of assignment by the company" (at 212). In the former case, "It would be a lamentable thing if it were found to be the law that a party to a contract may assign a portion of it, perhaps a beneficial portion, so that the assignee shall take the benefit, wholly discharged of any counter-claim by the other party in respect of the rest of the contract, which may be burdensome" (at 212). That was the context in which the Privy Council said (at 213):

"Unliquidated damages may now be set off as between the original parties, and also against an assignee if flowing out of and inseparably connected with the dealings and transactions which also give rise to the subject of the assignment."

33. It may be observed that in the circumstances of the structure of the argument in the Newfoundland Railway case there was no particular need to emphasise the requirements of justice and fairness. The set-off between the original parties was not controversial. And the disputed set-off as against the assignees was argued on a more technical level depending on the assignment. Even so, the ultimate answer given by the Privy Council was, in effect, that the assignees took subject to equities: and this was explained in terms of it being "a lamentable thing" if it were otherwise, and that the claims and cross-claims "ought" to be set against one another.
34. At any rate, it was not long before Lord Brandon's exegesis in The Dominique was considered, albeit in the context of a two contract case. In Dole Dried Fruit and Nut Co v. Trustin Kerwood Ltd [1990] 2 Lloyd's Rep 309 the plaintiff had made the defendant its exclusive distributor in England. Pursuant to that distributorship agreement, the plaintiff repeatedly sold its products to the defendant under separate contracts of sale. The plaintiff was now claiming the price of goods sold under the latest of such sale contracts, and the defendant was seeking to set off its counterclaim for repudiation by the plaintiff of the distributorship agreement. This court held that the counterclaim could be set off and that there was thus an arguable defence to the claim for the price of goods sold.
35. In the court below Webster J had applied the Newfoundland Railway test, as approved by Lord Brandon, which he regarded as being narrower and more specific than the test to be found in The Nanfri. Even so, he had found in favour of the defendant's set-off. On appeal, the plaintiff argued that the impeachment test from Rawson v. Samuel still survived and was narrower still. This court, however, disagreed. Lloyd LJ regarded the impeachment test and the Newfoundland Railway test as merely "the same test in different language". He referred to the exceptional rule about no set-off against freight, and continued (at 310/311):

"But for all ordinary purposes, the modern law of equitable set-off is to be taken as accurately stated by the Court of Appeal in Hanak v. Green…It is not enough that the counterclaim is "in some way related to the transaction which gives rise to the claim". It must be "so closely connected with the plaintiff's demand that it would be manifestly unjust to allow him to enforce payment without taking into account the crossclaim": see The Nanfri per Lord Denning at p. 140…

The authority of these cases has not been diminished by The Dominique. They establish that the mere existence of a crossclaim is insufficient. The claim and crossclaim must arise out of the same contract or transaction, and must also be so inseparably connected that the one ought not to be enforced without taking into account the other."

36. I observe that it is possible to see there Lloyd LJ moulding (at least part of) the Newfoundland Railway test ("inseparably connected") into and within the previous jurisprudence, which he states continues to hold authority. I would also respectfully observe that something appears to have gone wrong with the text to the effect that "claim and crossclaim must arise out of the same contract or transaction". That, I believe, has never been the position, unless the connection "arise out of" is given an unhelpfully broad scope. It is better to be transparent about the matter. As Lord Denning stated in The Nanfri: "It is only cross-claims that arise out of the same transaction or are closely connected with it" (at 974/5, emphasis added) that fall within equitable set-off.
37. Thus, in upholding the set-off Lloyd LJ's critical reasoning (at 311) acknowledged that that was a two contract case. He accepted, at any rate as probably correct for the purposes of the summary judgment application, that the individual sale contracts were separate transactions not governed by the terms of the distributorship agreement. However –

"The whole purpose and intent of the agency agreement was that the parties should enter into contracts for the purchase and sale of the plaintiffs' goods. In those circumstances the claim and counterclaim are sufficiently closely connected to make it unjust to allow the plaintiffs to claim the price of goods sold and delivered without taking account of the defendants' counterclaim for damages for breach of the agency agreement."

So Lloyd LJ did not require claim and cross-claim to arise out of the same transaction.

38. Esso Petroleum Co Ltd v. Milton [1997] 1 WLR 938 concerned a licence agreement between an oil company plaintiff and a garage licensee defendant. The plaintiff sued for the price of petrol deliveries and the defendant counterclaimed for damages for repudiation of the licence agreement, which he sought to set off against the otherwise admitted claim. The plaintiff sought summary judgment. It appears that this was treated as a single contract case, that is to say that the petrol deliveries did not amount to separate contracts of sale (as in Dole Dried Fruit). The plaintiff raised three arguments as to why the alleged set-off should fail: (i) because under the contract the petrol had to be paid under direct debit arrangements, which it was submitted was like payment by cheque and thus amounted to an exclusion of a right of set-off; (ii) because of an express provision, clause 34, by which the defendant agreed not "for any reasons to withhold payment of any amount due to the plaintiffs"; and (iii) because there was insufficient connection between the claim in respect of past deliveries of fuel and the counterclaim for damages for loss of future profits. As to these three arguments, this court held as follows: (i) the direct debit argument succeeded (in the opinion of Thorpe LJ and Sir John Balcombe, albeit Simon Brown LJ dissented); (ii) clause 34 was unreasonably wide and thus unenforceable (per Simon Brown LJ and Sir John Balcombe, with Thorpe LJ not dealing with this point); and (iii) the counterclaim was insufficiently connected with the claim (per Simon Brown LJ and Sir John Balcombe, with Thorpe LJ also considering that the counterclaim was unarguable in itself).
39. We are interested in point (iii), but as will appear this point was not entirely separate from the other two. Simon Brown LJ considered that the modern law of equitable set-off was to be found in Hanak v. Green and The Nanfri. Thus he restated the position as follows:

"For equitable set-off to apply it must therefore be established, first that the counterclaim is at least closely connected with the same transaction as that giving rise to the claim, and second that the relationship between the respective claims is such that it would be manifestly unjust to allow one to be enforced without regard to the other."

That is very close to Lord Denning's statement of the test.

40. Simon Brown LJ went on to say that no case had been cited in which payment of a debt presently due had been required to await the resolution of a cross-claim for future losses: but it appears that Dole Dried Fruit, which would have supplied such a case, had not been cited. What, however, seems to me to be striking about Esso v. Milton are the following factors: first, the existence of the direct debit and clause 34 provisions, which even Simon Brown LJ (dissenting on point (i)) held to be relevant to his decision on point (iii) (see at 951H, "all of these provisions and considerations seem to me properly in play when deciding the overall justice of the case"); secondly, the deliveries of fuel were converted by the defendant almost immediately into cash; thirdly claim for future losses was merely speculative. These factors were of such a nature that Thorpe LJ, having decided that the counterclaim was in any event so speculatively unrealistic as to be unarguable (at 952E/F), went on to comment in strong terms (at 953B/H) about the inequity of the defendant's case, starting from the proposition that "As Simon Brown LJ has demonstrated, claims to equitable set-off ultimately depend upon the judge's assessment of the result that justice requires."
41. Finally, I refer to Bim Kemi v. Blackburn Chemicals Limited [2001] 2 Lloyd's Rep 93. It concerned a claim by the claimant for damages for repudiation of a 1994 distribution agreement for the supply of a product called Dispelair. The defendant denied the existence of the 1994 agreement, but in the alternative counterclaimed for damages for its repudiation by the claimant. The defendant also sought to set off a counterclaim for breach of the parties' 1984 licensing agreement relating to other products. The claimant sought to strike out that set off, but failed both at first instance and again in this court. Under the heading of "Close Connection" Potter LJ reviewed the authorities discussed above and commented as follows:

"29. The Dole Fruit case illustrates the wise refusal of this Court to become bogged down in the nuances of different [sc differences?] between the formulation of the test propounded in The Nanfri, both in relation to the earlier criterion of "impeachment of title" disapproved by Lord Brandon in the Bank of Boston case, and in relation to the need for a "close connection" between claim and cross-claim…It seems that, insofar as there may be a difference, the Court has been content for the outcome to be governed by the notion of fairness involved in the proposition that it must be "manifestly unjust" to allow one to be enforced without regard to the other. For myself, I consider that Lord Brandon's formulation is to be preferred because on the one hand it emphasizes that the degree of closeness required is that of an "inseparable connection", while on the other it makes clear that it is not necessary that the cross-claim should arise out of the same contract; all that is required is that it should flow from the dealings and transactions which gave rise to the subject of the claim…

30. That said, however, it is clear that the principle stated by Lord Brandon and applied in the Dole Fruit case is apt to cover a situation where there are claims and cross-claims for damages in respect of different but closely connected contracts arising out of a long-standing trading relationship which is terminated. That fact will not per se establish the requisite "inseparable connection" but, in an appropriate case, it may well be manifestly unjust to allow one claim to be enforced without taking account of the other…

36…I regard it as appropriate to apply the test propounded by Lord Brandon in the Bank of Boston case unconstrained by the former concept, difficult to define and apply, of "impeachment of title", which has since been replaced, or at least redefined, in terms of a cross-claim which "flows out of and is inseparably connected with the dealings and transactions giving rise to the subject of the claim"…"

42. Then, under the heading of "Manifest injustice", Potter LJ went on to say this:

"38. As treated in The Nanfri, the question of whether or not it would be manifestly unjust to allow a claimant to enforce payment of his claim is the criterion by which to judge the closeness of the connection between the claim and the cross-claim…Once Lord Brandon made clear in the Bank of Boston case that the question of closeness required inseparable connection with the dealings and transactions giving rise to a claim, without reference to the issue of "manifest injustice", it is difficult to envisage in what circumstances, assuming his test to be satisfied, it would be other than just to allow an equitable set-off, save in certain established categories of cases where the Court has traditionally taken a strict view of the right of a claimant to be paid the liquidated sum which he claims free of any set-off. Examples are to be found in claims for rent, freight, and sums due under bills of exchange. Nonetheless, as it seems to me, it is appropriate in every case to give separate consideration to the question of manifest injustice; cf the approach of Lord Justice Brown in Esso Petroleum v. Milton at 950D."

43. In my judgment, this jurisprudence allows the following conclusions:

(i) The impeachment of title test, although derived from the leading case of Rawson v. Samuel and still stated by Lord Denning in his formulation in The Nanfri, even if it is there immediately glossed by his "so closely connected…that it would be manifestly unjust" test, should no longer be used: The Dominique and Bim Kemi. It is an unhelpful metaphor in the modern world. In the light of the emphasis put on it by Hobhouse J in The Leon and the reliance sought to be placed on it by the charterers in The Dominique, it made sense for the House of Lords to go out of its way to downplay its significance.

(ii) There is clearly a formal requirement of close connection. All the modern cases state that, whether Hanak v. Green, The Nanfri, The Dominique (by reference to the Newfoundland Railway case), Dole Dried Fruit or Bim Kemi. The requirement is put in various ways in various cases. Morris LJ in Hanak v. Green spoke of a "close relationship between the dealings and transactions which gave rise to the respective claims". Lord Denning in The Nanfri spoke of claims and cross-claims which are "closely connected". How closely? "[S]o closely connected with his demands that it would be manifestly unjust to allow him to enforce payment without taking into account the cross-claim". The Dominique adapted the Newfoundland Railway test and spoke of a cross-claim "flowing out of and inseparably connected with the dealings and transactions which also give rise to the claim". Dole Dried Fruit returned to Lord Denning's test in The Nanfri but also spoke of a claim and cross-claim which was so "inseparably connected that the one ought not to be enforced without taking into account the other". Bim Kemi expressed a preference for the test in The Dominique, while warning against being caught up in the nuances of different formulations.

(iii) Thus the Newfoundland Railway test of "inseparable connection" is one formulation of the close connection test, but it is not the only one. Potter LJ wisely referred to the wise refusal of the courts to become bogged down in the nuances of formulation. Oddly enough, both the Newfoundland Railway case and The Dominique were single contract cases, and therefore probably rather unhelpful contexts in which to judge what is meant by "inseparable connection". In truth, where separate contracts (or dealings or transactions) are concerned, the metaphor of inseparability is not all that helpful. Ex hypothesi, the contracts are separate (as in Bankes v. Jarvis, the case about the veterinary surgeon's practice discussed by Morris LJ in Hanak v. Green). I am not aware of the "inseparable connection" test being used to exclude a set-off, where some other formulation of the close connection requirement would have allowed it. It was not used to exclude a set-off in either the Newfoundland Railway case, nor in The Dominique nor in Bim Kemi. Nor is the test all that helpful in single contract cases: as Potter LJ remarked in Bim Kemi, where a case concerns a claim and cross-claim arising out of the same contract, although that fact is not in itself enough to ensure an equitable set-off, it is on the whole likely to take a special rule excluding set-off, such as the rules about freight, rent and cheques (and now direct debits, see Esso v. Milton), to prevent a set-off. In this connection, Modern Engineering (Bristol) Ltd v. Gilbert-Ash (Northern) Ltd [1974] AC 689 emphasises that an equitable set-off for defective work is not easily excluded even in building contracts where sums are payable under an architect's certificate. On the other hand, The Nanfri itself shows that in the context of maritime adventures and time charter hire, and against the background of the rule as to freight, a special regime of limited but not general set-off has been fashioned for cross-claims under the charterparty.

(iv) There is also clearly a functional requirement whereby it needs to be unjust to enforce the claim without taking into account the cross-claim. This functional requirement is emphasised in all the modern cases, viz Hanak v. Green, The Aries, The Nanfri, Dole Dried Fruit, Esso v. Milton, and Bim Kemi. The only modern authority cited above which does not in terms refer to the functional requirement of injustice is Lord Brandon's discussion in The Dominique. This has led Potter LJ in Bim Kemi (at para 38) to remark on the absence of reference to "manifest injustice" by Lord Brandon: but nevertheless it did not lead him to dispense with that requirement (ibid). It seems to me impossible to do so: it is not coherent to have a doctrine of equitable set-off which ignores the need for consideration of aspects of justice and fairness. Mr David Friedman QC, on behalf of SCL, has submitted that the test of "inseparable" connection contains inherently within it the need for a requirement of manifest injustice. That is what, he submits, "inseparable" means. In my judgment, such lack of transparency in a test would be undesirable, and I do not believe that it is as Mr Friedman submits. But I do not in any event think that Lord Brandon was intending to use the Newfoundland Railway formulation as an exclusive test for equitable set-off. Rather, he was using it to dethrone the concept of impeachment.

(v) Although the test for equitable set-off plainly therefore involves considerations of both the closeness of the connection between claim and cross-claim, and of the justice of the case, I do not think that one should speak in terms of a two-stage test. I would prefer to say that there is both a formal element in the test and a functional element. The importance of the formal element is to ensure that the doctrine of equitable set-off is based on principle and not discretion. The importance of the functional element is to remind litigants and courts that the ultimate rationality of the regime is equity. The two elements cannot ultimately be divorced from each other. It may be that at times some judges have emphasised the test of equity at the expense of the requirement of close connection, while other judges have put the emphasis the other way round.

(vi) For all these reasons, I would underline Lord Denning's test, freed of any reference to the concept of impeachment, as the best restatement of the test, and the one most frequently referred to and applied, namely: "cross-claims…so closely connected with [the plaintiff's] demands that it would be manifestly unjust to allow him to enforce payment without taking into account the cross-claim". That emphasises the importance of the two elements identified in Hanak v. Green; it defines the necessity of a close connection by reference to the rationality of justice and the avoidance of injustice; and its general formulation, "without taking into account", avoids any traps of quasi-statutory language which otherwise might seem to require that the cross-claim must arise out of the same dealings as the claim, as distinct from vice versa. Thus, if the Newfoundland Railway test were applied as if it were a statute, very few of the examples of two-contract equitable set-off discussed above could be fitted within its language. I note that in Chitty on Contracts, 30^th ed, 2008, Vol II, at 37-152, the test for equitable set-off is formulated in terms of Lord Denning's test.

The application of the test

44. It remains to apply that test to the facts of this case. On behalf of SCL, Mr Friedman acknowledges that the supply contract and the installation contract are separate contracts, concluded at separate times, separately tendered, and ultimately independent of one another in their origins. Nevertheless, he emphasises a number of elements about the two contracts which link them together. Thus both are related to the same site and the same main contract which SCL has made with Ensus UK. Both tenders were discussed together at the meeting of 5/6 June 2007. Above all, however, he relies on the way in which Geldof itself linked the two contracts together by demanding payment of invoices under the supply contract, the invoices upon which it sues in these proceedings, as a condition of continuing with performance of the installation contract. That in turn led to the acceptance of that conduct as a repudiation of the installation contract, which is one of the ways in which SCL's counterclaim is pleaded. In such circumstances, he submits that the counterclaim is inseparably connected with the dealings and transactions which also gave rise to the claim.
45. On behalf of Geldof, on the other hand, Ms Stephanie Barwise QC submits that the judge was right to say that there was no equitable set-off here. In this respect, the primary case that she seeks to make in her oral submissions is that SCL's reliance on an acceptance of repudiatory breach, as pleaded, was bad: because the letter of 13 January 2009 by which it pleads its acceptance of Geldof's repudiation said nothing to that effect but rather constituted an express notice of termination under clause 43.2 of the installation contract in reliance on previously notified defaults of which it had complained in notices of default under that clause dated 29 August 2008 and 30 December 2008. That appears to be a new point, not mentioned in the judge's judgment, and for which there is no respondent's notice. In any event, in my judgment it is a bad point. It has little if anything to do with the doctrine of equitable set-off and amounts to a submission that SCL's counterclaim is unsustainable. In effect, she is asking us to uphold Geldof's summary judgment, not so much on the ground of its inability to present a cross-claim as a set-off, but on the ground that there never was an acceptance of Geldof's conduct, of refusing to complete the installation contract until the supply contract invoices were paid, as a repudiation of the installation contract. However, it is trite law that a repudation, if one occurs, may be accepted without giving reasons and even by giving the wrong reasons. Moreover, it is arguable that a repudiation may be shown to have been accepted even where a contract comes to an end under an express right to terminate: see Stocznia Gdynia SA v Gearbulk Holdings Limited [2009] EWCA Civ 75 [2010] QB 27.
46. Alternatively, Ms Barwise submitted that the judge was right to say that the counterclaim did not arise from the dealings which gave rise to the claim and lacked the requisite degree of closeness. However, in my judgment, neither the judge nor Ms Barwise explained why that was so. Geldof itself, by insisting on the payment of the supply contract invoices as a pre-condition of returning to work on the installation contract, was bringing the two contracts into intimate relationship with one another, even if unjustifiably, and that relationship became inseparable and irrevocable when SCL brought the installation contract to an end, as it arguably did, in reliance on Geldof's poor performance under the installation contract coupled with its insistence of prior payment. Even if the two contracts had not been connected up to that point, those events brought the two contracts into a close and inseparable relationship with one another, and, in my judgment, made it manifestly unjust to enforce payment under the supply contract without taking into account the cross-claim for repudiation of the installation contract. It is true that, in one sense, the cross-claim did not arise from the supply contract and the claim made under it by Geldof in these proceedings. But it did arise from the use to which Geldof had sought to put its supply contract claim. In my judgment, that would suffice, on any formulation of the test for equitable set-off. Such a point may not have been the subject of previous decision, but I would regard it as within the rationale of the test for equitable set-off.
47. In this connection, the practical links between these two contracts, even if they were also formally separate contracts, should in any event not be underestimated. Both supply contract and installation contract in their separate ways were dedicated to the bioethanol plant project, as many terms in both contracts emphasised. The vessels to be supplied under the supply contract were of no use to SCL unless the installation contract was itself to be properly performed. The warranty under the supply contract was linked to practical completion of the plant, and that could not occur without proper performance of the installation contract. It would not be fair for Geldof to be able to enforce payment under the supply contract, especially payment to be triggered by the arrival of the vessels at the plant site, if SCL's responsibilities as the plant's main contractor were prejudiced by Geldof's repudiation of its performance obligations under the installation contract.

Clause 24

48. In the event, the interpretation and application of clause 24 is not critical. However, in my judgment, the clause assists SCL to make good its right to set off its counterclaim. It is common ground that clause 24, which expressly reserves all existing rights ("without waiver or limitation of any rights or remedies"), should be interpreted as adding something further. Therefore the words "any amounts lawfully due" must be regarded as going beyond the common law, including the law of equitable set-off. It is also common ground that those words refer to amounts recognised or recognisable by law. Ms Barwise accepts moreover that such amounts may be unliquidated. But she insists that there must be an adjudication in place, before such amounts may be set off.
49. The judge considered that "amounts lawfully due" did not encompass claims for unliquidated damages. However, Ms Barwise does not rely on that reasoning, for she accepts that the phrase may encompass unliquidated damages, provided that they have been adjudicated upon. She then accepted that there ought to be no distinction for these purposes between adjudication and agreement.
50. My mind has wavered on this question, but in the end I have concluded that SCL should be entitled to bring itself within this clause. Clauses which limit or exclude the common law right to set off are frequently found, but a clause which extends the right is a rare animal. Moreover, the phrase "whether under this Purchase Order or otherwise" demonstrates that the extension is intended to be a wide one. It should not therefore be read in a niggardly fashion. After all, the general business purpose of such clauses is to regulate the extent to which disputed claims may be used to protect the cash flow of a business, faced by a demand which may otherwise have to be met. It is essentially a matter of cash flow rather than ultimate entitlement. (The position may be different on insolvency, of course, but that situation has its own rules.)
51. The judge did not say what the words in the clause meant, so that there is little in the judgment below, save his decision, to guide us. However, he gave three reasons for his decision, viz that the cross-claim was unliquidated, that it was unadjudicated (but that may have been a description rather than a matter essential to his reasoning), and that clause 10 of the supply contract was a pointer that a cross-claim of such a kind was not intended to be covered.
52. The first reason is not relied on by Ms Barwise. The third reason is in my judgment of no assistance. Clause 10 certainly excludes according to its own terms any liability under the supply agreement "for indirect or consequential damage". That is directed against certain heads of quantum, not against damages for repudiation as a whole. But in any event, we are not here concerned, under clause 24, with the scope of an exception clause under the supply agreement, but with the legitimate scope of a cross-claim under a separate contract ("or otherwise"). In my judgment, the reliance on clause 10, pursued by Ms Barwise, is misconceived.
53. As for the question of adjudication, this appears to me to be an unnecessary limitation on the width of the clause, and in any event cannot sensibly be distinguished from agreement. However, if a cross-claim is fully adjudicated or agreed, then there is no need of a set-off agreement. If, however, the adjudication (or agreement) of an unliquidated cross-claim has not reached the stage of identifying the sum ultimately due, it will not assist very much in defining, even if it vindicates, the cross-liability in question.
54. The ultimate question is therefore one of construction: does the phrase "all amounts lawfully due" mean amounts which have been adjudicated or agreed to be due, or does it mean amounts which are claimed to be due and which are recognised or recognisable at law? It seems to me that either is possible as a matter of language, but that business sense and the intended width of the clause points to the latter construction. In this connection, I note that Geldof conceded below that the liquidated damages cross-claim under the installation contract was to be regarded as falling within clause 24: but there is no adjudication nor agreement regarding that cross-claim. Geldof's instinctive (and presumably well-considered) concession, accepted by the judge, undercuts its submission and supports the conclusion which I prefer. Therefore, for this reason too SCL is in my judgment entitled to set off its counterclaim, even if I am wrong to think that it fell within the scope of equitable set-off.

Conclusion

55. In sum, I would allow this appeal, and quash the summary judgment given below.

Lord Justice Patten :

56. I agree.

Lord Justice Maurice Kay :

Vice President of the Court of Appeal Civil Division

57. I also agree.