Set-offs: what is a close enough connection?

15/06/2010

Simon Carves Limited ("Carves"), was the main contractor for the building of a bioethanol plant in Teesside. For the construction of the plant it needed to buy pressure vessels for the plant and to have storage tanks installed on the site. There was no connection between these items (other than they were required for the plant), and accordingly the fact that the supply contract was awarded to one party did not mean that the contract for the installation would also be awarded to the same party. As it turned out Carves did contract with one party Geldof Metaalconstructie NV ("Geldof ") for both contracts.

The first contract, concluded by acceptance of Carves' Purchase Order, was for the purchase of the pressure vessels ("the Supply Contract"). The price was more than 5 millions euros, with delivery on site between 22 and 29 September 2007. Payment terms were 10% on approval of drawings, 50% on receipt by Geldof of the main materials, 30% on delivery and 10% on completion.

The Purchase Order contained a term ("Clause 24") that provided that the "Purchaser, without waiver or limitation of any rights or remedies of Purchaser or Owner, 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".

The pressure vessels were delivered on site on 7 November 2008, and Geldof invoiced Carves for 30% of the price.

Geldof separately tendered for the contract for the installation of the storage tanks. The contract was awarded to Geldof on 21 December 2007 ("the Installation Contract"). Under the contract Geldof was to "design, supply, fabricate, deliver to site, erect, test and paint" the tanks. The contract was to be completed by 30 November 2008.

The contract was terminated before completion in January 2009. Carves had issued a default notice in August 2008 alleging failure to proceed regularly and diligently. By letter dated 23 December 2008 Geldof indicated that it would not restart work on 5 January 2009 under the Installation Contract unless payment had been made on six invoices: four of these invoices related to the Installation Contract and two to the Supply Contract.

Carves issued a further notice of default on 30 December. On 6 January, Geldof confirmed that it would not restart work unless payment was made. Carves issued a notice of termination under the Installation Contract on 13 January 2009. Geldof denied it had repudiated the contract.

Geldof commenced proceedings against Carves for the price of equipment bought under the Supply Contract. Carves sought to rely on three separate set offs. The first related to minor defects in the vessels supplied. The second was a claim for liquidated damages under the Installation Contract, and the third was Carves' unliquidated claim for the costs of the termination of the Installation Contract, provisionally assessed at around £5.3 million.

On an application for summary judgment, the Court allowed the first two set offs pursuant to Clause 24, but not the third because, inter alia, Clause 24 did not cover a disputed claim for unliquidated damages, particularly where it had not been adjudicated. Nor was there an equitable set off because there was not an "inseparable connection" between Geldof's claim and Carves' counterclaim. Carves appealed.

The Court of Appeal upheld Carves' appeal. The Court reviewed the previous case law relating to equitable set offs of unliquidated claims. It concluded that the impeachment of title test as derived from the 1841 case of Rawson v. Samuel should no longer be used to determine whether a set off was valid. What was required was that there was a sufficiently close connection between the claim and the cross-claim. This was what the Court described as the formal element of the test. The previous cases had put that requirement in various ways: the formulation of there being an "inseparable connection" between the claim and cross-claim was one formulation of that test. The Court held that there is a further requirement (the functional element of the test), that being to avoid injustice - it must be unjust to enforce the claim without taking into consideration the cross-claim. It stated that it was "not coherent to have a doctrine of equitable set-off which ignores the need for consideration of aspects of justice and fairness".

Specifically, the Court of Appeal held that Geldoff, by insisting on the payment of the invoices under the Supply Contract as a pre-condition of returning to work on the Installation Contract, had itself brought the two contracts "into intimate relationship with one another". That relationship became inseparable and irrevocable when Carves brought the Installation Contract to an end. Those events made it manifestly unjust to enforce payment under the Supply Contract without taking into account the cross-claim for repudiation of the Installation Contract.

Although the cross-claim did not arise from the Supply Contract or the claim made under it, it did arise from the use to which Geldof had sought to put its claim under the Supply Contract. Further, the Court noted the practical links between the two contracts (they were both related to the same project), even though they were formally separate contracts. Accordingly Carves was entitled to set off its counterclaim under the Installation Contract in equity against Geldof's claim under the Supply Contract.

The Court also reviewed Clause 24 and determined that Carves was entitled to claim a set off under that clause. The court held that the extension to "this Purchase Order or otherwise" was intended to be widely construed. Bearing in mind the width of the clause the Court held that the phrase "all amounts lawfully due" meant all amounts claimed and which are recognised or recognisable at law. Therefore Carves could set off its counterclaim pursuant to Clause 24.

(Geldof Metaalconstructie NV v. Simon Carves Ltd [2010] EWCA Civ 667)

Contact: clarkhood@city-law.net

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