Fotometría

• an ADI’s default in respect of a customer’s deposit may result in the customer defaulting on its mortgage loan. In this situation, the mortgage loan and the deposit could be regarded as so closely connected that it would be unjust not to allow the customer to set off the deposit against the mortgage loan.

Generally speaking, the more closely the contracts under which the claims arise are related, the more likely it will be that an equity will arise to allow a set-off.

8.4 Contractual set-off

Two parties can enter into an agreement to set off their respective liabilities to each other so that there is only, as between them, a single liability for the balance. Contractual set- off takes effect according to its terms and is enforceable until one of the parties to the agreement becomes bankrupt or insolvent.

In the context of the relationship between an ADI and one of its customers, contractual set-off will only apply if there is an agreement to this effect in the documents regulating the rights between them. It is usual that the documentation in relation to a mortgage loan will provide the ADI with a right to combine the accounts of the customer. The correct classification of such a combination of accounts clause is that it is a form of contractual set-off.

8.5 Insolvency set-off

Insolvency set-off arises where one of the claimants is insolvent or bankrupt. Insolvency set-off is governed by statute (section 86 of the Bankruptcy Act 1966 for individuals and section 553C of the Corporations Act for companies).

The two sections are identical and provide that where there have been mutual credits, mutual debts or other mutual dealings (see section 8.6) between the bankrupt (or insolvent) person and a person claiming a debt in the bankruptcy (or insolvency):

“(a) an account will be taken of what is due from one party to the other in respect of those mutual dealings;

(b) the sum due from one party must be set off against any sum due from the other party; and

(c) only the balance of the account may be claimed or is payable.”

Insolvency set-off, when it applies, is mandatory and applies to the exclusion of statutory, equitable and contractual set-off. Unlike other forms of set-off it cannot be excluded by agreement between the parties (see section 8.7).

8.6 Mutuality

For statutory set-off or insolvency set-off to be permitted there must be mutuality. The general principle underlying mutuality is that the claim of one person should not, without agreement, be used to satisfy the liability of another ie. “one man’s money shall not be applied to pay another man’s debt” (Jones v Mossop

(1844) 3 Hare 568).

For there to be mutuality, each claimant must be the beneficial owner of the claim owed to it. Generally, set-off will not be available if the claims are legally mutual, but not equitably mutual. For example, a debt due to a party in its own right cannot be set off against a sum owed by the party in its capacity as trustee.

In the securitisation of loans outlined above, and prior to perfection of title, the ADI is the legal owner of the sold loans, but the special purpose vehicle is the owner in equity. After perfection of title, the ADI will be neither the legal nor equitable owner of the sold loans.

The mutuality principle therefore, on its face, seems to prevent statutory or insolvency set-off by the customer as a result of the change in equitable ownership of the loan. Generally the time for determining mutuality is when the set-off is being asserted (or, for insolvency set-off, as at the commencement of the

insolvency). The most important variation from this principle is in the context of the assignment of a debt (which is relevant here). Where there is an assignment of a primary debt, the assignee takes subject to the equities. This means, in the situation under discussion, that the special purpose vehicle takes a sold loan subject to the right of the customer to assert against the special purpose vehicle the same set-off rights that it could have asserted against the ADI. However, once the customer receives notice of the assignment, this crystallises the equities and the customer cannot thereafter set up as against the special purpose vehicle any new and independent equities which subsequently arise (subject to some exceptions which are not relevant here). In practice, this means that once the customer is advised of the assignment of its loan it will not be able to claim a set-off for any new deposits that it makes with the ADI (but will retain its rights in relation to any existing deposits).

However, this result and the principle that an assignee takes subject to the equities, does not apply if the customer agrees otherwise. Often, loan documentation explicitly states that the ADI may assign the loan free of all equities. A provision of this type is effective subject to the matters discussed in section 8.7. The absence of mutuality is relevant only for statutory and insolvency set off. Strictly speaking, mutuality is not an essential ingredient for contractual set-off. There is no principle of law preventing A, B and C agreeing that A’s liability to B can be set off against B’s liability to C.

Mutuality also is not strictly essential for equitable set-off (but in most circumstances mutuality will effectively be required as it will usually be inequitable to apply one person’s rights against another’s debts).

8.7 Contractual exclusion of set-off

Both statutory set-off and equitable set-off can be excluded by an express contractual provision to this effect.

In some early English cases it was held that statutory set-off could not be excluded by agreement. These cases are no longer good law. This was confirmed by the English Court of Appeal in

Coca-Cola Financial Corporation v Finstat International Ltd [1996] 3 WLR 849 (and, effectively, by the House of Lords in refusing leave to appeal the decision in this case). There have also been a number of Australian cases that confirm that statutory set-off may be excluded by agreement.

Contractual set-off is purely a creature of contract and will apply to the extent agreed.

In contrast to other forms of set-off, insolvency set-off is mandatory and may not be excluded by contract. Further, in the case of loans governed by the Consumer Credit Code (which includes all owner occupied mortgage loans originated after 1 November 1996), the stated principles are subject to the application of section 166 of the Code. Section 166(2) provides that a “debtor, mortgagor or guarantor has and may exercise the same rights in respect of [a] credit contract, mortgage or guarantee against the assignee [of the credit contract, mortgage or guarantee] as the debtor, mortgagor or guarantor has against the credit provider.”

The operation of the Code cannot be excluded by contract. It is not clear that section 166(2) applies to rights of set-off. Nevertheless section 166 throws doubt upon the operation of provisions in loans governed by the Code that allow the loan to be assigned by the ADI free of any equities. The section does not

have any impact on clauses in a loan that provide for payments to be made by a customer free of set-off, deduction or counterclaim as such clauses apply equally to the original credit provider and an assignee.

8.8 Customer’s ability to set-off against an insolvent ADI

For practical purposes a customer’s rights to set-off will only be relevant upon the insolvency of the ADI. If a customer exercises a right of set-off prior to the ADI’s insolvency, the agreement between the special purpose vehicle and the ADI will usually provide that the ADI must compensate the special purpose vehicle for, or make payments to the special purpose vehicle clear of, amounts set-off by the customer.

If the ADI becomes insolvent, the special purpose vehicle will then immediately perfect its title to the assigned loans. In these circumstances the customer will be endeavouring to set-off in respect of its obligations to the special purpose vehicle under its ADI loan and the insolvent ADI’s obligations to it in respect of deposit accounts. Applying the rules of set-off discussed above leads to the following conclusions:

Statutory set-off

When the customer’s loan is assigned in equity to a special purpose vehicle the customer will lose any rights of statutory set- off that it may have in relation to the loan and a deposit account held with the ADI. This is because there will no longer be any mutuality between the beneficial interests in respect of the ADI’s rights under the loan and obligations under the deposit account. Also, a customer will be bound by any provision in the loan or deposit account documentation that excludes the customer’s rights of statutory set-off or (subject to the possible application of section 166 of the Consumer Credit Code) allows the ADI to assign the mortgage loan free of such rights.

Equitable set-off

In certain circumstances, a customer may have a right of equitable set-off against its loan in respect of a deposit account held by the customer with the ADI. This may be the case not withstanding the lack of mutuality of beneficial or legal interests with respect to the loan and that deposit account. However, the customer will not have any right of set-off in respect of deposits made after the customer becomes aware of the assignment of the loan. Further, this result is subject to any provision in the mortgage loan or deposit account documentation that excludes the customer’s rights of equitable set-off or (subject to the possible application of section 166 of the Consumer Credit Code) allows the ADI to assign the mortgage loan free of such rights.

Contractual set-off

A customer will only have a contractual right of set-off if this is provided in the relevant loan or deposit account documentation. In our experience this is rarely the case.

Insolvency set-off

Insolvency set-off will only be relevant in these circumstances upon the insolvency of the customer or the ADI. In either case the other forms of set-off will cease to apply and, since there will be no mutuality between the customer’s rights under the deposit account (against the ADI) and its obligations under the loan (to the special purpose vehicle) at the time of the insolvency, insolvency set-off will not be permitted.

8.9 Conclusion

In the early days of securitisations by ADIs in Australia, there was considerable concern that set-off could lead to the result that a special purpose vehicle’s assets were not insulated from the ADI’s insolvency. As the industry worked through the complex rules regarding set-off it became clear that this is not the case where the underlying loan documents contain a waiver by the borrower of its set-off rights. This conclusion is particularly important as it enables securitisations by ADIs to proceed in Australia without the necessity for reserves to be established to compensate for any set-off risk.

9 Insolvency and securitisation