Generally speaking, in the liquidation of a company, creditors of equal ranking in the liquidation are treated equally. So, if there are funds to distribute, they will all receive the same proportion of the amount that they have claimed. This is known as the Pari Passu Rule.
The exception to this rule is when there is a mutual set-off between the company in liquidation and another party that is both a creditor to whom the company owes money, and a debtor that owes the company money.
The requirement for the mutual set-off is set out in section 310 of the Companies Act 1993 as follows -
310 Mutual credit and set-off
(1) Where there have been mutual credits, mutual debts, or other mutual dealings between a company and a person who seeks or, but for the operation of this section, would seek to have a claim admitted in the liquidation of the company,—
(a) an account must be taken of what is due from the one party to the other in respect of those credits, debts, or dealings; and
(b) an amount due from one party must be set off against an amount due from the other party; and
(c) only the balance of the account may be claimed in the liquidation, or is payable to the company, as the case may be.
Note that the wording of the section includes the use of “must”, meaning, in a liquidation, if the conditions for a mutual set-off are met, then it is mandatory and cannot be contracted out of.
There are further provisions in S 310 that place restrictions on the ability to claim the mutual set-off because of the timing of the relevant transactions, in relation to the date of the company’s liquidation, or the other party’s relationship to the company in liquidation.
The key legal requirements for set-off in liquidation are:
• The claims must exist at the start of the liquidation. At that time, there must be mutual dealings capable of being subject to an accounting between the parties.
• The claims must be measurable at the commencement of the liquidation. In effect, there must be money claims each way. The claims must be provable in liquidation but need not be for a liquidated amount or an amount due at the date of liquidation. This would include damages, whether liquidated or not, contingent claims, secured debts and future debts due to mature after the commencement of the liquidation.
• The parties must be the same and the claim must be in the same right. No set-off can be asserted against a person in different capacities, for example, debts due from a person in their capacity as a trustee or partner cannot be set-off against a claim against that person in a personal capacity.
The requirement to use the mutual set-off provisions in a liquidation is an exception to the pari-passu rule. It is there to avoid the injustice that could occur if a liquidator could require a person, who is both a debtor and a creditor of the company, to make payment in full of the amount they owe to the company in liquidation, when the same person, as a creditor of the insolvent company, may potentially receive nothing at all.
If you would like more information about mutual set-offs, or any other matters relating to insolvency procedures, please contact one of the McDonald Vague team.