Payment Protection Insurance Claims and Insolvency

John Briggs and James Boddy1

Introduction

Payment Protection Plans have been the subject of consideration, assessment

and redress by the (former) FSA2 in its Policy Statement of August 2010 “The

assessment and redress of Payment Protection Insurance complaints” and to

some extent by the courts.3 The cost of putting right “misselling claims” is an

enormous and continuing financial and administrative burden for financial

institutions.

“PPI” - as it will be called in this article - was usually sold to customers as an

intrinsic part of a loan or credit agreement regulated by the Consumer Credit

Act 1974 (CCA 1974) and the terms set out in the agreement or in separate

documentation. In some cases the PPI was underwritten by a third party,

sometimes associated with the lender directly as a subsidiary or associate

company, and sometimes not.

“Mis-selling” constitutes improper conduct on the part of the financial

institution and the FSA’s Policy Statement refers in terms to failings under the

FSA principles, ICOB and ICOBS rules.4 Such “common failings” could also

constitute an “unfair relationship” for the purposes of section 140A of the

CCA 1974, in other words, the relationship arising out of the agreement is

unfair to the debtor because of any of the terms of the agreement or a related

agreement (a “linked transaction” – section 140C) or anything done or not

done by the creditor5.

It goes without saying that because of the high incidence of consumer debt in

the UK, PPI “misselling claims” include many cases where the borrower is the

subject of an IVA or bankruptcy and may be unaware that he has such a claim

or even that a loan that he has taken out includes PPI.

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On 19 April 2013 the RPBs6 issued a Guidance Note on PPI mis-selling

claims (the RPBs Note). The stated intention of the paper is to provide

guidance to officeholders dealing with IVAs or bankruptcy cases on the issues

that may arise when the debtor may have been mis-sold PPI.

The RPBs Note is divided into ten sections, namely (1) Background, (2) Asset

at commencement of insolvency or IVA, (3) Set-Off, (4) (5) & (6) Power and

Obligation to make PPI mis-selling claims: Open Cases, Closed Cases & New

Cases, (7) Taxation, (8) Office holders’ fees and costs, (9) Claims Companies

and (10) Limitation.

The main purpose of this article is to discuss briefly some of the arguments

that lie behind a number of the sections in the Note giving guidance to office

holders particularly as there are recommendations in the Note that

officeholders obtain legal advice regarding whether the PPI is an asset in the

IVA and whether set-off applies.

It should be borne in mind that PPI mis-selling is only an instance of financial

product mis-selling and the issues raised have some parallels with other cases

of mis-selling, for instance set-off issues in interest-rate swap claims7.

Making a PPI claim and ascertaining the existence of a PPI claim

Advancing a claim for mis-sold PPI is not a complex process. The FSA has

repeatedly stressed that making such a claim is free and straightforward, and

that consumers can do this for themselves without the assistance of Claims

Management Companies.8 That is certainly the case for most borrowers – or at

least for those with the time and inclination to engage with the obfuscation and

sometime intransigence of certain lenders. But it is emphatically not the case

for borrowers who are the subject of an IVA or bankruptcy.

As this article will demonstrate, the legal effect of the IVA on the underlying

PPI claim is often uncertain and open to debate. For a borrower in this

circumstance the position can be highly confusing. There is ample opportunity

for lenders to find (or invent) reasons to refuse to pay out on legitimate claims.

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Navigating the pitfalls of the process and the tactics of the lender will usually

require professional expertise.

By way of example, the writers are aware of one major lender which until

recently flatly refused to correspond on PPI claims advanced on behalf of

borrowers in IVAs. Their justification for this approach was that the borrowers

had no standing to make such claims, because they were in IVAs. That

contention is wrong in law – but it took significant pressure before the lender

agreed to reconsider its approach. How many borrowers acting for themselves

would have dropped their claim following the lender’s initial response?

Even for the professional adviser, there are practical difficulties in advancing

PPI claims on behalf of a borrower in an IVA or bankruptcy. One such

difficulty is ascertaining whether the borrower had PPI in the first place. The

office holder’s record of the many loans and credit agreements taken out by

the borrower is often incomplete – and in any event PPI can be well disguised

in the underlying documentation. In practice, the first step is to provide the

borrower with a detailed questionnaire seeking information on the various

loans taken out, the relevant circumstances and especially PPI. This is

followed by analysis of the information and any documents provided.

Sometimes this process produces sufficient information to advance a PPI

claim. Where it does not, various strategies have been adopted, ranging from a

request for information under the CCA 1974,9 to a speculative claim being

advanced and the lender only then confirming the existence of PPI. Clearly the

more detail supporting the PPI claim the better, but instances of lenders paying

out on PPI have been known to occur even where the borrower has merely

enquired as to whether PPI was present on the relevant loan. This is an area

where lenders are often motivated as much by the need to clear their books of

potential liabilities as they are by the legal merits of a particular complaint.

Is the PPI claim an asset in the bankruptcy or IVA?

Bankruptcy

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The RPBs Note advises that where a PPI policy has been sold prior to the date

of the bankruptcy the mis-selling claim vests in the trustee in bankruptcy

because the mis-selling took place prior to bankruptcy. Discharge makes no

difference.

This guidance is clearly correct and accords with the decision in Ward v The

Official Receiver in 201210 where DJ Khan ruled that the PPI claim was an

asset in the bankruptcy since it constituted property within the meaning of

s.436(1) of the Insolvency Act 1986 (IA 1986). He considered it was either an

interest incidental to property or alternatively it was a “thing in action”.

For good measure, the Insolvency Service takes the view that a PPI claim is a

bankruptcy asset and has issued its own brief guidance and has cautioned

bankrupts from using claims management firms because they may remain

responsible for the commission charge if an award is paid to the OR or trustee

in bankruptcy11

IVA

As the RPBs Note emphasises in bold type12 the issue of whether a PPI claim

falls into an IVA is dependent on the terms of the IVA. The Note distinguishes

between “all asset” IVAs and “Defined asset” IVAs.

In the first category fall the R3 Standard Conditions. These define “property”

as having the meaning given to it in s.436 of the IA 198613. The

miscellaneous definitions define “Excluded Assets” as those assets identified

in the proposal as being excluded from the arrangement14. “Arrangement

Assets” are defined by para 26 as:

“Property other than excluded assets belonging to or vested in the Debtor at

the date of commencement of the Arrangement which would form part of the

Debtor’s estate in a bankruptcy shall be subject to the Arrangement and be an

asset thereof.”

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Accordingly, if the IVA is governed by the R3 Standard Conditions then

unless a PPI claim is specified as an “Excluded asset” (which would be very

unlikely), the PPI claim will fall within the IVA.

As the RPBs Note goes on to advise, an IVA governed by the Protocol

Standard Conditions15 with an “all assets clause” would be of similar effect.

For instance, after identifying specific excluded assets the IVA proposal goes

on to say: “I do not have any further assets that are to be excluded from the

Arrangement”.

As for “Defined Asset” IVAs, the RPBs Note states that unless the IVA terms

specify PPI mis-selling claims as forming part of the IVA estate they are not

included and it identifies the Protocol Standard Conditions as being an

example of such a case.

We note that many IVA proposals identify the specific assets included in the

IVA (“Included Assets”). In addition, the proposal will identify the debtor’s

assets and particular assets to be excluded (no doubt in compliance with rule

5.3(2)(a) of the Insolvency Rules 1986 (IR)) but fail to give an all -embracing

definition of “property” under “Included Assets” such that the IVA can be

considered to catch all species of property. PPI claims could therefore fall into

the “black hole” between “Included assets” and “Excluded assets”16.

No doubt with these problems in mind the RPBs Note goes on to say that it

has been argued by some that the proceeds of PPI claims would be available as

“after-acquired assets” (or “windfalls”) but opines that: “It would be difficult

to argue that PPI mis-selling claims existing prior to the commencement of the

IVA fall into this category”17.

Since the argument is likely to arise in the context of a Protocol Standard

Conditions IVA consideration should be given to its terms.

“After-acquired Assets” is defined in clause 1 (f) as meaning “any asset,

windfall, redundancy payment or inheritance with a value of £500, other than

the excluded assets that you acquire or receive between the date the

arrangement starts and the date it ends or is completed, if this asset could

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have been an asset of the arrangement had it belonged to or have been vested

in you at the start of the arrangement.”

It is hardly the case therefore that the definition of “after-acquired assets”

would include a PPI claim existing (or notionally existing) at the date of the

commencement of the IVA and arising out of a pre-existing loan agreement

since it is an asset which belonged to or vested in the debtor at that time.

Occasionally, the debtor’s proposal is approved at the meeting with

modifications including an expanded “windfall” clause along the following

lines:

“Should the debtor inherit any assets, or receive or become entitled to any

assets that have not been foreseen in the Proposal, details shall be notified to

the Supervisor IMMEDIATELY and such sums shall be paid into the IVA until

all costs, creditors claims and statutory interest have been paid in full and the

debtor’s other obligations under the arrangement shall continue and shall not

be reduced.”

Alternatively, better still, a “windfall” provision along these lines:

“In the event that I shall come into possession of any monies or assets of value

whatsoever, including any inheritance or bonus, during the period of the

arrangement or there were assets owned at the date of the arrangement which

have been inadvertently omitted, I will inform the Supervisor of such windfalls

or assets and these are to be included in the arrangement to the extent that the

creditors claims are paid up to 100p in the £1 plus the costs of the

arrangement. However, the Supervisor will have the discretion to exclude

windfalls if the amount is less [than] £500 and it would not be cost effective to

distribute it to the creditors.”

The first of the above two modifications is often HMRC driven. Since the

Protocol Standard Conditions state that “The conditions are part of the

arrangement, if any ambiguity or conflict arises between the conditions and

the proposals and any modifications to it, then the proposal (whether modified

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or not) will prevail”18, the modified windfall clause applies to the IVA and

would catch the PPI claim.

Duty of debtor to disclose the PPI claim

This is hardly touched upon in the RPBs Note save by reference to the office

holder enquiring of the debtor at an early stage about such a possible claim19.

It is the debtor’s duty to disclose his assets in his proposal (or at least those

“within his immediate knowledge”) pursuant to r.5.3(2)(a) of the IR and this is

supplemented by the requirement in r.5.5(1) and (3)(a) for the debtor to deliver

to the nominee a statement of his affairs comprising, among other things, by

way of supplementing or amplifying so far as is necessary for clarifying the

state of the debtor’s affairs, those already given in his proposal – a list of his

assets, divided into such categories as are appropriate for easy identification,

with their submitted values assigned to each category.

The importance of this requirement is signified by the fact that the statement

must be verified by a statement of truth made by the debtor (r. 5.5(5)). Its

importance is also signified by the fact that any false representation or

fraudulent doing or omitting to do anything for the purpose of obtaining the

approval of his creditors to a proposal for a voluntary arrangement constitutes

an offence even if the proposal is not approved and the person guilty of an

offence under the section in question, s.262A, is liable to imprisonment or a

fine or both.

Given that PPI claims arising out of loan agreements are all too common in the

consumer debt context, it would also be expected that a Nominee in preparing

his report under s.256 or s.256A of the IA 1986 would require further

information to be provided by the debtor or require him to give access to his

records as the nominee may require (pursuant to r. 5.6(1)(c) and (3)). In this

way, the nominee could ascertain the possibility of such a PPI claim even if

the debtor is unaware of circumstances which may give rise to his having such

a claim.

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We are aware that in some IVAs, where the debtor advises the Supervisor that

he never obtained PPI, the debtor is asked to sign a declaration to this effect.

The issue arises, however, of what the Supervisor can do about it if the debtor

is unwilling to cooperate by refusing to seek a PPI repayment or sign such a

declaration or if the Supervisor discovers that the debtor has a PPI claim of

whose existence the latter was genuinely unaware.

The obvious recourse in the case of a debtor who is unwilling to cooperate by

refusing to seek a PPI refund (whether payable into the IVA or available as

set-off) or to sign a declaration that he never obtained PPI, is for the

Supervisor to institute the provisions dealing with breach or non-compliance

by the debtor with his IVA obligations. Part IV of the Protocol Standard

Conditions has just such a provision in clause 9. The debtor is regarded as in

breach of the IVA arrangement if, among other things, he fails to do anything

that the Supervisor may for the purposes of the arrangement reasonably ask of

him, and failing to remedy the breach results in a report by the Supervisor to

the creditors and their agreement to one of the following:

(i) vary the terms of the arrangement; or

(ii) issue a certificate (“Certificate of Termination”) ending the arrangement

because of the breach; or

(iii) present a petition for the debtor’s bankruptcy.

The requirement to sign a declaration that the debtor never obtained PPI would

no doubt be regarded as “reasonable” within the meaning of clause 9(1)(iv) of

the Protocol Standard Conditions.

On the other hand, what can the Supervisor do about it if the debtor is

cooperative but inadvertently omitted to mention the PPI claim because he

knew nothing about it, and the IVA arrangement makes no provision for its

inclusion within the assets available for creditors?

Inadvertent failure to include a PPI claim with the result that the benefit of

such claim is not included in the IVA for creditors would nevertheless provide

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grounds for a “default bankruptcy petition” by the Supervisor or a creditor

bound by the arrangement under s.276 (1) of the IA 1986. For this purpose,

the court has to be satisfied as follows:

“(a) that the debtor has failed to comply with his obligations under the

voluntary arrangement, or

(b) that information which was false or misleading in any material

particular or which contained material omissions –

(i) was contained in any statement of affairs or other documents

supplied by the debtor under Part VIII to any person, or

(ii) was otherwise made available to the debtor by his creditors at or

in connection with a meeting summoned under that Part, or

(c) that the debtor has failed to do all such things as may for the purposes of

the voluntary arrangement have been reasonably required of him by the

Supervisor of the arrangement.”

The critical phrase is “information …which contained material omissions”.

So, despite the earlier use of the words “false and misleading”, the application

of the section does not depend upon proof of culpability; culpability may

however become relevant when the court exercises its discretion for or against

making a bankruptcy order.

This was so held by Jacob J in Re Keenan [1998] BPIR 205 where the IVAs

of a Mr & Mrs Keenan included a provision that shares in a company be sold

and the proceeds form part of the assets of the IVAs. The shares were not sold

and the Supervisor therefore presented petitions and bankruptcy orders were

made. On the debtor’s appeal, and for the purpose of the appeal, it was agreed

that it was through no fault of the debtors that the shares were not sold. In

dismissing the debtors’ appeal, Jacob J considered the test as objective: that is

to say, if the debtor supplies false and misleading information it does not

matter whether he intended so to do or not. In the Judge’s view, it would be a

startling proposition that creditors should be bound by an IVA which they

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have accepted in lieu of bankruptcy when they have been given false

information for whatever reason.

It remains the case however that the seriousness of the omission and the effect

that it would have on creditors, and how they would have voted, is an issue

which the court would have to consider in the exercise of its discretion as to

whether to make a bankruptcy order20. If the creditors voted for the

Supervisor presenting a bankruptcy petition, the court would undoubtedly be

seriously influenced by that factor.

Since IVA arrangements usually have a variations clause, the sensible course

is for the Supervisor to indicate to the debtor that he should agree to a

modification of the IVA arrangement, failing which the creditors are likely to

vote for a bankruptcy petition to be presented.

Set-off in IVAs and bankruptcy

It will often be the case that a debtor who has a PPI claim against a financial

institution has an outstanding loan and the PPI formed an intrinsic part of the

transaction, as described in the Introduction above. The issue of set-off

arises.

It is with regard to this topic that the RPBs Note is at its most cautious

describing “mutuality of dealings” as a most complicated area of law

depending among other things on the nature of both the original debt and the

mis-sold PPI proceeds, the identity of the parties and in the case of an IVA,

the terms of the IVA. Office holders are told that they may consider seeking

legal advice when in doubt about whether set-off should apply.

Various arguments have been raised why set-off in a bankruptcy or IVA will

not apply or, on the other hand, will apply. The arguments are dependent to an

extent on the meaning of “mutual dealings” in s.323 of the IA 1986 and the

materially identical provisions in para 7 of the R3 Standard Conditions, and

the set-off provisions in the Protocol Standard Conditions contained in clause

17(6). The Note is most coy in relation to the latter, describing this clause

17(6) as open to a number of possible interpretations.

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Without being exhaustive we will briefly consider some of the set-off

arguments.

In the context of IVAs, three main arguments have been advanced by the

financial institutions in support of set-off, which are broadly as follows:

(1) Under the terms of the IVA, the creditor only agreed to accept the

reduced sum on the basis that the debtor agreed not to pursue any claim

of any nature against the creditor [“unfair to deny the right of set-off”].

(2) Clause 17(6) of the Protocol Standard Conditions permit the creditor to

set-off repayments made to the debtor [“clause 17(6) of the Protocol”].

(3) The right of equitable set-off and/or paragraph 7 of the R3 Standard

Conditions and section 323 of the IA 1986 [“section 323 / para 7 and

equitable set-off”].

Unfair to deny the right of set-off

It is a matter of interpretation of the IVA proposal in question whether set-off

expressly or impliedly operates – or is excluded. Set-off is not required by the

IVA provisions in Part 8 of the IA 1986 – compare the special protection for

secured and preferential creditors in s.258. Since an IVA is a form of a

statutory contract21 it would be possible for the terms of the IVA to exclude its

operation.

While the purpose of insolvency is “to do substantial justice between the

parties”, per Parke B in Forster v Wilson (1843) M&W 191, 204 and Lord

Hoffmann said in Stein v Blake [1996] AC 243 at 251 that it is often said that

the justice of the rule is obvious, and it has been part of the English law of

bankruptcy since at least the time of the first Queen Elizabeth, he

acknowledged that “the rule is by no means universal”.22 On the other hand, it

is so entrenched as a feature of English bankruptcy law, including the former

law of compositions (see s.16 (18) of the Bankruptcy Act 1914), that the court

would be slow to find the rule impliedly excluded23 and if expressly excluded,

very likely a matter of “unfair prejudice” which may cause the court to revoke

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the IVA (s.262). It is significant that both the R3 and Protocol Standard

Conditions contain set-off provisions.

It is argued by those against the application of set-off that the basis of the IVA

is that creditor claims are not compromised until the IVA is successfully

completed and all the debtor’s assets reduced into the IVA. There is no

“settled account” at the effective date of the insolvency.

However, the fact that there is no compromise for creditor claims until

completion is a distinction with bankruptcy, but not a true difference in the

scheme of things. The purpose of a bankruptcy and a composition with

creditors is to give rise to an “orderly administration of debtors’ affairs” which

would likely be defeated if the debtor were free to litigate with his creditors.

The “settled account” as described by Lord Hoffman in Stein v Blake in

relation to s.323 is a notional process where the trustee in bankruptcy has to

estimate the value of claims dependent on contingencies. In an IVA, the

creditor claims have to be evaluated, assets collected in and funds distributed

in the expectation that the IVA will be successful even if this may not

eventually be the case. This is not, it is submitted, a reason why set-off cannot

apply.

Clause 17(6) of the Protocol

Appearing in the Standard Conditions under the heading “Dividends and

Claims”, in Part VII, this clause reads as follows:

“Where any creditor agrees, for whatever reason, to make a repayment to the

debtor during the continuance of the arrangement, then that payment shall be

used solely in reduction of that creditors’ claim in the first instance. If such

payment results in the creditor’s claim being entirely extinguished (after the

application of set-off) any surplus will be treated as an after-acquired asset

and offered to the Supervisor for the benefit of the arrangement.”

As para 3.4 of the RPBs Note says, this clause is “open to interpretation” and

then goes on to give six possible interpretations (not even intended to be

definitive or exhaustive)24 and ends, unhelpfully, by saying: “…pending such

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clarification by the court, officeholders may wish to consider taking legal

advice where they feel it would be proportionate to do so and in any event

fully document their decision-making processes.”

The authors believe that within the IVA industry various arguments have been

put forward why clause 17(6) does not permit set-off in the PPI context.

For example, that a creditor has not “agreed” anything but is compelled by

FSA guidance to make the PPI refund. Another, that the PPI repayment is not

repayment but compensation, or that one element, compensatory interest

(presumably notional statutory interest) is not repayment even if return of the

premium paid and historic interest on the premium paid is “repayment”.

Clause para 17(6) is undoubtedly an oddly worded set-off provision. It

seemingly requires the creditor to agree. What if there is no agreement? Does

a judgement mean that a creditor is taken to agree? Or is there no set-off in

such a case?

In PPI claims, the issue of “agreement” hardly arises in practice since there is

usually agreement between the debtor or his agent with the lender over the

quantum of redress, following an offer by the lender, but only disagreement in

the insolvency context over whether set-off applies.

As to the argument that there has in truth been no agreement to make redress

since the banks have been compelled by FSA guidance to make the PPI refund

we believe the following observations are relevant. PPI Dispute Resolution is

dealt with in Appendix 3 of the FSA handbook. The background is that

FSMA 2000, ss.138 & 157 give the FSA power to make rules with regard to

the carrying out of regulatory activities for the purpose of protecting

consumers and guidance with respect to the operation of FSMA, rules

thereunder, the meeting of regulatory objectives and any other matters the

FSA considers desirable to give advice for information.

The finalised text of Appendix 3 published in the Policy Statement of August

2010 now forms part of the Dispute Resolution source book (DISP) in the

FSA handbook. The Policy Statement was challenged as unlawful by the

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BBA arguing that the FSA was seeking to augment the specific rules that were

in place at the time the sales were made and that the FSA was seeking to

circumvent the statutory procedure for consumer redress in s.404 of FSMA.

The court disagreed.25 There was nothing in s.404 that prevented the FSA

from choosing an alternative remedy. In any event, the guidance does not

purport to set up a compulsory industry-wide review. Only firms that have

identified recurrent or systemic problems are advised to take further steps in

giving guidance on how to undertake them.

Although many of the provisions of Appendix 3 use the word “should”, they

are almost all in the form of Guidance bearing the categorisation “G” as

opposed to “R” or “E”, e.g. scope DISP Appendix 3.1.1G. Once the financial

institution has considered the complaint, it makes an offer of redress which the

debtor is entitled to accept or reject and in the latter case, have the matter

referred to the FOS. In the circumstances we believe it is very likely a court

would regard acceptance by the complainant as “agreement”.

Before moving on in this topic of set-off, it is instructive to have regard to the

redress provisions in DISP Appendix 3.7. Para 3.7.4(1) deals with redress in

respect of live policies, and it provides:

“Additionally, where a single premium was added to a loan:

(1) for live policies

(a) subject to DISP Appendix 3.7.5E, where there remains an

outstanding loan balance, the firm should, where possible, arrange

for the loan to be restructured (without charge to the complainant

that using applicable cancellation value) with the effect of:

(i) removing amounts relating to the payment protection contract

(including any interest and charges); and

(ii) ensuring the number and amounts of any future repayments

(including any interest and charges) are the same as would

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have been applied if the complainant had taken the loan

without the payment protection contract; or …”

Unless the authors are mistaken, the FSA is advocating redress in the form of

set-off where there remains a loan account balance. This reflects the general

position at law (equitable set-off, legal set-off or contractual set-off) and in

insolvency where set-off is regarded “as doing substantial justice between the

parties” (see the dicta of Lord Hoffmann in Stein v Blake26).

As stated, agreement in clause 17(6) is directed at a “repayment”. Not

payment. So, is the set-off provision limited to an “over-charge” type

situation regarding a loan or provision of services or goods? This appears

likely since the Protocol Standard Conditions were a BBA induced solution

for straightforward consumer IVAs and the thinking behind this provision may

be situations where a bank has overcharged interest on an account or such like.

“Agreement” therefore will likely generate “repayment” in this sense and so

giving the clause a purposive effect set-off applies27. However, the statutory

interest agreed to be paid is, unlike contractual interest charged in the PPI

account, very arguably not “repayment” but compensation for loss and lies

outside the notion of “repayment”. As would be the case with costs.

Para 7 of R3, s.323 and equitable set- off

“Improper conduct” on the part of the financial institution is an argument

raised against the operation of s.323 and therefore para 7 of R3 on the grounds

that the respective transactions between debtor and creditor are not “mutual

dealings”. (It is to be noted that the Protocol clause 17(6) makes no reference

to “mutual dealings”; to the contrary: “…..creditor agrees, for whatever

reason, to make a repayment to the debtor…”)

Some argue that the fact that the PPI policy would been underwritten by a

separate insurance company and the loan is separate from the insurance

product means that set-off would not apply.

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Para 7, headed “Mutual credit and set-off” in the R3 Standard Conditions

repeats materially the provisions of s.323 of the IA 1986 with modifications

for IVAs. It reads:

“7(1) [Application] This Paragraph applies where before the commencement

of the Arrangement there have been mutual credits, mutual Debts or

other mutual dealings between the Debtor and any Creditor other than

in the circumstances to which paragraph 79 of these Conditions apply.

7(2) [Account to be taken] An account should be taken of what is due from

each party to the other in respect of the mutual dealings and the sums

due from one party shall be set-off against the sums due from the other.

7(3) [No account where creditor has notice] Sums due from the Debtor to

another party shall not be included in the account taken under sub-

paragraph (2) if that other party had notice at the time they became

due that a bankruptcy petition relating to the Debtor was pending or

that an interim order was made in relation to the Debtor.

7(4) [Restriction on post-commencement set-off] Other than as provided

for in this Paragraph, set-off shall not be available in respect of any

Debt or item of Property.

7(5) [Balance provable or to be paid] Only the balance (if any) of the

account taken under sub-paragraph (2) is provable in the Arrangement

or, as the case may be, to be paid to the Debtor or, if the Proposal so

provides, to the Supervisor.”

The addition of the words “or other mutual dealings” to “mutual credits and

mutual debts” in what is now s.323(1), and reproduced in para 7 above, were

added for the first time by s.39 of the Bankruptcy Act 1869. To cite Lord

Hoffmann in Secretary of State v Frid:28 “The purpose was to broaden it [the

original formula].” In Booth v Hutchison29 Malins VC said that the additional

words: “were intended to give a more extended right of set-off than previously

existed” and in Peat v Jones,30 Sir George Jessel said: “Now the enactment as

to mutual credit is a very old one, first appearing in 5 GEO C30, but the

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whole tendency of the subsequent legislation, as of the legislation in respect of

provable debts, has been to extend the principle upon which it is founded.”31

After referring to the judgment of the High Court of Australia in Gye v

McIntyre32 which discussed the ambit of the expressions mutual credits,

mutual debts and mutual dealings, Lord Hoffmann went on to say:

“24. All that is necessary therefore is that there should have been

“dealings” (in an extended sense which include the commission of tort

or the imposition of 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.”

As can be seen from the above extract, “improper behaviour” in the nature of

fraudulent misrepresentation is cited by Lord Hoffmann as an example of a

“dealing”, for the purpose of “mutual dealings”.

The distinction between conduct which is a dealing and conduct which is not

was brought out in the early case of Eberle’s Hotels & Restaurant Company

Ltd v E Jonas & Bros33 where the supplier of a company in liquidation sought

to set-off against the debt which was owed by the company the value of a

large quantity of cigars deposited with it as security for other transactions.

The liquidator brought an action of detinue for the cigars. In discussing

whether this was a case of mutual dealings, Lord Esher said:

“On the one side there was the deposit of goods to secure a debt. There are,

no doubt, matters which give rise to claims, but are not dealings within the

section. If one man assaults another or injures him through negligence, that

gives rise to a claim, but it is not a dealing; but I am disposed to think that

whatever comes within the description of an ordinary business transaction

would be a dealing within the section … If the claim on one side of the section

and the counterclaim on the other were such as would both result in a money

claim, so that for the purpose of the action there would be merely a pecuniary

liability on each side, the case would, I think, come within the section. I

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should, speaking for myself, desire to give the widest possible scope to the

section, and, in my opinion, wherever in the result the dealings on each side

would end in a money claim, its provisions would be applicable.”

So, while the commission of a tort can constitute a “dealing”, an assault is not

a dealing even though it gives rise to a claim. This affords the distinction

between the cases such as Manson v Smith34 in which misfeasant directors

were denied the right of set-off (and see further Smith v Bridgend County

BC35), and the current scenario where in general terms the lenders have been

guilty of breach of duty or misrepresentation. Misappropriation of assets or

theft of money or a conversion of property is not a “dealing”.36

While mutuality also requires that there can be no set-off in respect of debts

owing to and by a person in different capacities such as debts due to or from

him as a trustee in his individual capacity,37 this does not preclude set-off

where the bankrupt and creditor have been involved in more than one role or

other parties have been involved in the dealings or the dealings give rise to

different claims between other parties or between the same parties in different

beneficial interests: Gye v McIntyre.38 In this Australian case, Gye was

fraudulently induced to enter into a contract to purchase property from a

company by McIntyre who lent Gye money secured on the property to enable

him to finance part of the purchase price.39 The fact that the lenders were

involved both in lending and “advising” did not take the transactions outside

the ambit of mutual dealings.

It has been argued that the offer of redress is made after the IVA commences

and that this too takes it outside the mutual set-off provisions. This argument

is not sound. While the requirement of mutuality in insolvency set-off means

that debts or claims arising from other dealings must be “commensurable”, in

other words ultimately sounding in money, that does not mean that they must

be in possession or liquidated at the decisive date, provided that they exist as

contingent at that date and are of a kind which will ultimately mature into

pecuniary demands. This is taken from the Australian case of Gye v McIntyre

but the same principles are to be drawn from English case law which

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particularly refers to the need for the officeholder to take an account and to

estimate the value of claims.40

Creditors are also relying on equitable or contractual set-off. While this basis

of set-off will be relevant in a non-insolvency context, in an IVA the

respective rights of creditors and debtor are governed by the statutory

hypothesis of being bound by the terms of an arrangement made by the debtor

at the meeting and binding every person who is entitled to vote at the meeting

or would have been so entitled if he had notice of it as if he were a party to the

arrangement (s.260 (2) of the IA 1986). It is to be noted in this context that

paragraph 7(3) & (4) of the R3 Standard Conditions, like s.323 (3), restrict the

right of set-off. As Lord Hoffmann emphasised in Stein v Blake41 bankruptcy

set-off, unlike legal set-off between solvent parties, affects the substantive

rights of the parties against each other, while legal set-off addresses questions

of procedure and cash flow.

Hence there can be no set-off in respect of a debt which at the date of the

commencement of the bankruptcy or IVA has been assigned to some other

person.42 Similarly, where at the date of the commencement of the bankruptcy

or IVA no right to set-off exists, it cannot be acquired by virtue of any

subsequent assignment.43 However, the position is unclear under the Protocol

Standard Conditions as regards a post-IVA dealing: compare para 17(6) under

which set-off appears to be unrestricted in time, with set-off in respect of tax/

excise/VAT and Government department claims in clause 26 which appears to

operate on a pre- and post-approval basis.

The authors are of the opinion, on balance, that set-off will apply in the typical

case unless the lender assigns its debt before the commencement of the

bankruptcy or IVA.

Power and obligation to make PPI mis-selling claims and office holder’s fees in the

bankruptcy or IVA

The RPB’s Note deals at some length with the power and obligation to make

PPI mis-selling claims and advises that this is dependent on the terms of the

IVA and the likelihood of substantial benefit to the estate44.

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The RPBs Note is categorical on fees and summarises the position in Open

cases in sub-paras 8.1, 8.2 & 8.4. Sub-para 8.4 deals with the vexed issue of

remuneration as a percentage of realisations:

“8.4 The basis of the officeholder’s remuneration has been fixed as a

percentage of realisations, it is the RPB’s view that these fees can only

be properly charged on actual receipts in to the estate, net of any

deductions for set-off. However, it is open to creditors to agree

otherwise where they consider there to be a benefit to the estate.”

The concern of office holders adverted to in sub-para 8.4 is that dealing with

the claims of lenders guilty of misselling PPI is likely to be onerous given that

it is widespread in consumer debt.

The argument is that even if a successful mis-selling claim only results in set-

off, there has been successful realisation of an asset for the benefit of all

creditors as the financial institution will prove in the IVA for a substantially

lower debt. In further support of this argument, it is said that the Supervisor

has authority to assist the debtor with the PPI claim and an obligation to

appropriately adjudicate on the set-off. This process involves time and

expense from which other creditors benefit by a higher dividend.

While the authors have sympathy with the argument, it is not considered

correct. It is the terms of the IVA which primarily govern the right to

remuneration, set against the background of the bankruptcy legislation.

Remuneration fixed as a percentage of realisations or “realisable assets” or

“further realisations” is wording directed at the debtor’s assets available for

distribution (subject to fees and expenses). In other words, what are

commonly called “free assets”. The set-off of a claim owed by the creditor is,

on the other hand, a “form of security” in the creditor’s hands and has a

similar status. It is only the balance (if any) owed to the debtor which is

assignable. In other words, only that element which can be regarded as a

realisable asset: see the judgment of Lord Hoffmann in Stein v Blake.45

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1 John Briggs is a Barrister and Deputy Registrar in Bankruptcy and Companies practicing from South

Square, Gray’s Inn, London (johnbriggs@southsquare.com). James Boddy is a Barrister and an

Associate with Ferguson Financial a unit of Ferguson Solicitors LLP, of 11 Gough Square, London,

specialising in the pursuit of PPI claims, particularly in realtion to insolvent debtors (www. ferguson-

financial.co.uk). 2 now the FCA

3 Harrison & another v Black Horse Ltd [2011] EWCA Civ 1128 and R on the application of the

British Bankers Association v FSA and others [2011] EWHC 999 (Admin), Ouseley J. 4 Para 2.7

5 It is under this provision that the borrowers sought recovery of the cost of PPI in the Harrison case

cited in the endnote above. 6 R3, IPA, ICAEW, ACCA, ICAS, CAS, Law Society, and Debt Resolution Forum

7 Here the claims may encompass compensation for substantial financial loss. See the

FCA’s website at http://www.fca.org.uk/consumers/financial-services-products/banking/interest-

rate-hedging-products/review 8 See e.g. http://www.fca.org.uk/consumers/financial-services-products/insurance/payment-protection-

insurance/claim-ppi 9 Sections 77-79

10 [2012] BPIR 1073 Manchester CC

11 www.gov.uk/insolvency/personalinsolvency/ppi-misselling-claims-and-bankruptcy

12 Para 2.3

13 Para 1(m)

14 Para 1(j)

15 produced by the IVA Forum, revised January 25 2008 and further revised July 2012

16 The Guidance Note suggests they might be caught as additional income in the hands of the debtor.

17 Para 2.4 of the Note

18 Para 2 of the Protocol Standard Conditions

19 Para 6.1 of the Note

20 Para 3.2 of the Note

21 To adopt the wording of Blackburne J in Davis v Martin-Sklan [1995] 2 BCLC 483

22 In some jurisdiction, France is an example, it is regarded as giving a creditor a preference over other

creditors 23

IVAs often say that creditors are likely to accept the proposal since the terms replicate the treatment

of creditor claims in the bankruptcy or they would be no worse off than they would be in a bankruptcy 24

Contractual set off, set off conditional on creditor agreeing to make repayment, conflict between set

off and any surplus being after-acquire property, a creditor is taken to agree where legally obliged to

make payment, payment of compensation and contractual interest constitutes repayment but not

statutory interest, neither compensation nor interest constitutes repayment 25

R on the application of BBA v FSA and others [2011] EWHC 999 (Admin) Ouseley J 26

[1996] AC 243 at 251 27

The ultimate aim in construing a document is to determine what the parties meant by the languag e

used. Commercial good sense has a role to play and the court will adopt the more rather than the less

commercial construction: see speech of Lord Hope in BNY Corporate Trustee Services Ltd and others v

Neuberger Berman Europe Ltd [2013] UKSC 28 at para 64 28

[2004] UKHL 24 29

(1872) LR15 Eq 30, 35 30

(1881) 8 QBD 147, 149 31

At para 22 32

(1991) 171 CLR 609 33

(1887) 18 QBD 459 at 465 34

[1997] 2 BCLC 161 at 164; see also the old case of Re Anglo-French Society ex p Pelly (1882) 21 Ch

492 where Lord Esher described the drawing of funds from the company as an “offence” under the

165th

section (the predecessor of s.212 of the IA 1986) so as not to afford the director the right of set -

off in respect of money lent to the company

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35

[2001]UKHL 58 36

This appears also to be the view of text book writers: see Derham on Set-Off at p.361 & 420/421 37

Middleton v Pollack (1875) 20 Eq 29 38

The Australian case cited above and cited with approval in Frid 39

This is a simplification of the facts 40

See generally Stein v Blake (1993) BCC 587, MS Fashions v BCCI [1993] Ch 425 and Re Charge

Card Services Ltd [1987] Ch 150 41

[1996] AC 243 at p.251C 42

In Re Asphaltic Wood Pavement Company (Leon Chapman’s case) (1885) 30 Ch D 216 43

In Re Milan Tramways Company, ex p Theys (1884) 25 Ch D 587; and see specifically the provisions

of para 7(4) in the R 3 Standard Conditions 44

Paras 4 (Open Cases), 5 (Closed Cases), and 6 (New Claims) 45

[1996] AC 243 at p.251E & 257H and following