XCHRX WILLIAM YOUNG HONG YUI and Others v. BANK OF CREDIT AND COMMERCE HONG KONG LTD.

1993, No. MP806

IN THE SUPREME COURT OF HONG KONG

HIGH COURT

MISCELLANEOUS PROCEEDINGS

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J U D G M E N T

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1. The Plaintiffs were customers of the Defendant before it went into liquidation. The 1st Plaintiff was director of and the 1st and 2nd Plaintiffs were both shareholders in the 3rd Plaintiff. On 27th February 1991, the 1st Plaintiff signed documents to enable credit facilities to be given by the Defendant to the 2nd Plaintiff and 3rd Plaintiff. In each case the documents were:

1. Security over deposit in respect of 3rd party obligations. This was by way of a charge on a Canadian dollar deposit, which the 1st Plaintiff had with the Defendant.

2. A continuing guarantee.

3. Letter of set-off.

2. On 17th July 1991, the Defendant was ordered to be wound up. In due course, the 1st Plaintiff lodged a proof of debt for some $6.4 million being the value of his deposit on the date of winding up. Subsequently he was advised that as a matter of law there should be a set-off of his deposit against sums due to the Defendant by the 2nd and 3rd Plaintiffs under the facilities granted to them. The sums due amount to some $5,000,000.00. The 1st Plaintiff intends to withdraw his existing proof and to lodge a new proof for approximately $1.4 million.

3. By originating summons, the 1st Plaintiff now seeks declarations that:

1. The indebtedness of the 2nd and 3rd Plaintiffs was discharged by set-off of indebtedness of the Defendant to the 1st Plaintiff and the 1st Plaintiff's liability to the Defendant as a primary obligor in respect of the 2nd and 3rd Plaintiffs' indebtedness to the Defendant.

2. The sum of US$46,036.58 collected by the Defendant on behalf of the 3rd Plaintiff on 23rd December 1991 is held on trust for the 3rd Plaintiff.

4. The dispute arises because the liquidator of the Defendant does not accept that what is known as liquidation set-off arises in the circumstances relating to the 1st Plaintiff. Liquidation set-off is a statutory provision pursuant to section 264 of the Companies Ordinance, Cap 32 which imports into the winding-up of companies section 35 of the Bankruptcy Ordinance, Cap. 6 the relevant part of which reads:

"Where there have been mutual credits, mutual debts or other mutual dealings between a debtor against whom a receiving order is made under this Ordinance and any other person proving or claiming to prove a debt under the receiving order, an account shall be taken of what is due from the one party to the other in respect of such mutual dealings and the sum due from the one party shall be set off against any sum due from the other party and the balance of the account, and no more, shall be claimed or paid on either side respectively; but a person shall not be entitled under this section to claim the benefit of any set-off against the property of a debtor in any case where he had, at the time of giving credit to the debtor, notice of an act of bankruptcy committed by the debtor and available against him either side respectively ......"

5. The meaning and effect of that provision is not in dispute. The law has recently been the subject of intense scrutiny by the Court of Appeal when hearing appeals by three companies: M.S. Fashions Ltd., High Street Services Ltd. and Impexbond Ltd. in the winding-up of Bank of Credit and Commerce International. The appeals are reported compendiously under M.S. Fashions Ltd. and Others v. BCCI(1993) 3 WLR 220. At page 227, Hoffmann L.J. who heard the cases at first instance said:

"Insolvency set-off has been a creature of statute since the time of Queen Anne (see section 11 of 4 & 5 Anne c. 17.) The current provision applicable to companies is rule 4.90 of the Insolvency Rules 1986 (S.I. 1986 No. 1925):

"(1) This rule applies where, before the company goes into liquidation there have been mutual credits, mutual debts or other mutual dealings between the company and any creditor of the company proving or claiming to prove for a debt in the liquidation. (2) An account shall 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 .... (4) Only the balance (if any) of the account is provable in the liquidation. Alternatively (as the case may be) the amount shall be paid to the liquidator as part of the assets."

This language is substantially the same as that used in earlier bankruptcy statutes going back to the Bankruptcy Act 1869 (32 & 33 Vict. c. 71). Between the Supreme Court of Judicature Act 1875 (38 & 39 Vict. c. 77) and the Insolvency Rules 1986, the bankruptcy rule was also applied in company liquidations.

Certain principles as to the application of these provisions have been established by the cases. First, the rule is mandatory ("the mandatory principle"). If there have been mutual dealings before the winding up order which have given rise to cross-claims, neither party can prove or sue for his full claim. An account must be taken and he must prove or sue (as the case may be) for the balance. Secondly, the account is taken as at the date of the winding up order ("the retroactivity principle"). This is only one manifestation of a wider principle of insolvency law, namely, that the liquidation and distribution of the assets of the insolvent company are treated as notionally taking place simultaneously on the date of the winding up order: see In re Dynamics Corporation of America [1976] 1 W.L.R. 757, 762, per Oliver J. Thirdly, in taking the account the court has regard to events which have occurred since the date of the winding up ("the hindsight principle"). The hindsight principle is pervasive in the valuation of claims and the taking of accounts in bankruptcy and in winding up. A good example of the principle being applied outside the context of set-off is In re Northern Counties of England Fire Insurance co.; Macfarlane's Claim (1880) 17 Ch.D. 337, in which the value of a claim under a fire insurance policy was determined by reference to the loss suffered in a fire which occurred a month after the insurance company had been wound up.

In reading the cases, the interaction of these principles has to be borne in mind. Mr. Thomas for B.C.C.I., said that the right of set-off under rule 4.90 was procedural and that the mutual credits and debits of B.C.C.I. and the directors retain their separate existences until such time as the account is taken in the context of the director filing either a proof or a defence to a claim by the liquidator. This is of course true in the somewhat trivial sense that no account will be taken until something happens which makes it necessary to apply rule 4.90 and to take one. But that cannot in my judgment affect the substantive rights of the parties which, whatever the context in which the question may subsequently arise, are treated as having been determined by an account taken at the date of the winding up. This is a consequence of the mandatory and retroactivity principles.""

6. Hoffmann L.J. went on to declare that the directors were entitled to set off sums in their deposit accounts by which they had as "principal debtors" guaranteed repayment of loans to their respective companies. High Street Services Ltd. and Impexbond Ltd. each appealed. The Court of Appeal dismissed their appeals. At page 236, Dillon L.J., after referring to rule 4.90 of the Insolvency Rules 1986 (which are in substance identical to the provisions of section 35 of the Bankruptcy Ordinance), said:

"It is common ground that where there are such mutual credits, mutual debts or other mutual dealings the set-off is mandatory and cannot be excluded by any contract between the parties: see see Halesowen Presswork & Assemblies Ltd. v. National Westminster Bank Ltd. [1972] A.C. 785.

If there are indeed mutual credits or mutual debts or mutual dealings between a company, or a bankrupt, and a creditor, then the set-off applies notwithstanding that one or other of the debts or credits may be secured. See, for instance, the judgment of Lord Selborne L.C. in Ex parte Barnett; In re Deveze (1874) L.R. 9 Ch.App. 293 and the judgment of Dixon J. in Hiley v. Peoples Prudential Assurance Co. Ltd. (1938) 60 C.L.R. 468, 498. Dixon J. added: "To the extent that the secured debt is answered by set-off the security is freed."

7. The issue that divided the parties is whether the 1st Plaintiff is under an immediate as opposed to a contingent liability to the Defendant. If his liability was and still is contingent, the Defendant argues that there is no mutuality and mandatory set-off does not yet arise. I say "yet" because the Defendant accepts that if any contingency is later fulfilled, there will then have to be a set-off calculated as at the date of winding-up. I shall have to deal with the question of contingent claims later. In the meantime, the issue depends upon the construction of the documents. The crucial document is the continuing guarantee. The relevant clauses are:

"1. In consideration of your giving time credit and/or banking services and accommodation to"

the 2nd and 3rd Plaintiffs

"(hereinafter called "the Principal") I/we the undersigned as primary obligor and not merely as surety, hereby irrevocable and unconditionally guarantee the payment or discharge to you and undertake that the undersigned will on demand in writing made on the undersigned pay or discharge to you all moneys and liabilities which shall for the time being be due owing or incurred by the Principal to you whether actually or contingency and whether solely or jointly with any other person and whether as principal or surety including interest commission or other lawful charges and expenses which you may in the course of your business charge in respect of any of the matters aforesaid or for keeping the Principal's account (including any further advances made by you to the Principal and any other liabilities of the Principal to you arising during the three months period of notice hereinafter referred to) together also with:-

(i) such further sum for interest (whether or not the same shall have been compounded) and charges accruing due to you from the Principal before or after the date of demand or expiration of the said notice as the case may be; and

(ii) all costs and expenses recoverable by you from the Principal.

3. The undersigned hereby undertakes that, upon default by the Principal in the payment when due of any payment guaranteed hereunder, the undersigned will, on demand, make immediate payment thereof, at the place, in the funds and currency and in the manner required of the Principal and without any withholding or deduction whatsoever. You are entitled to make demand on the undersigned or otherwise enforce this Guarantee against the undersigned notwithstanding that you may have any outstanding right, power or remedy against the Principal or any other person and without proceeding or enforcing any claim against the Principal or any other person. The undersigned agrees that no time for limitation of liability in respect of this Guarantee shall begin to run in favour of the undersigned unless and until you shall have made demand on the undersigned, and if more than one demand is made, then only from the date and to the extent of each demand respectively.

5. A demand for payment or any other demand or notice under this Guarantee may be made or given by any manager officer or agent of yours or of any branch of yours by letter addressed to the undersigned and sent by post to or left at the last known place of business or abode of the undersigned or at your option in the case of a company its registered office and if sent by post shall be deemed to have been made or given at noon on the day following the day the letter was posted.

18. The undersigned hereby agrees that you may, at any time without notice, notwithstanding any settlement of account or other matter whatsoever, combine or consolidate all or any of the undersigned's then existing accounts (of any nature or description whatsoever and whether subject to notice or not), and set-off or transfer any sum standing to the credit of any one or more such accounts wheresoever situate in or towards satisfaction of any liabilities to you of the undersigned under this Guarantee or on any other account, or in any other respect whatsoever, whether such liabilities be present or future actual or contingent, primary or collateral, and several or joint and where such combination, set-off or transfer requires the conversion of one currency into another, such conversion shall be calculated at your spot buying rate of exchange (as conclusively determined by you) for the currency for which the undersigned is liable against the existing currency so converted.

21. As a separate and independent stipulation (but without increasing the before-mentioned total amount recoverable hereon) the undersigned agrees that all sums of money which may not be recoverable from the undersigned on the footing of a guarantee whether by reason of any legal limitation disability or incapacity on or of the Principal or any other fact or circumstance and whether known to you or not shall nevertheless be recoverable from the undersigned as sole or principal debtor(s) in respect thereof and shall be repaid by the undersigned on demand in writing made by you or on your behalf."

8. It is the 1st Plaintiff's case that, relying on M.S.Fashions, the 1st Plaintiff was a primary obligor (a person who, it was not in dispute, is no different from a principal debtor), that no demand was necessary to trigger his liability (again it is not in dispute that no demand in writing or otherwise has been made) and that his liability is and always has been immediate.

In M.S. Fashions, Hoffmann L.J. said at page 229:

"Mr. Thomas said that with the possible exception of the M.S. Fashions case, in which a demand in writing was made in November 1991, B.C.C.I. had no claims against the directors, whether now or at the date of the winding up. The liability of the directors was contingent upon the making of a demand and none had been made. Since the liability of the directors was merely contingent, it could not form the subject of set-off. No doubt they would be entitled to plead set-off if B.C.C.I. decided to make a demand and sue them on their guarantees, but this may never happen. In particular, it will not happen if B.C.C.I. can recover the advances from the companies themselves.

At page 230, the Lord Justice continued:

"If the relationship between B.C.C.I. and the directors was governed only by the standard form guarantees I think that there would be no answer to the submission that the liability of the directors remains contingent. All the guarantees in the B.C.C.I. standard form require a demand in writing before any liability arises on the part of the guarantor. It is well established that in such a case, no cause of action arises until the demand is made: see Bradford Old Bank Ltd v. Sutcliffe [1918] 2 K.B. 833. It would follow that (apart from the M.S. Fashions case) there is nothing due from the directors to B.C.C.I. and no basis for set-off against what is owed to them on the deposit accounts.

In fact, however, the directors are also liable to B.C.C.I. under the various instruments I have described and which deems them to be principal debtors. This liability is in my judgment not contingent at all. It is either a joint and several liability with the companies or at any rate a several liability for the same debt. In the M.S. Fashions case and the Impexbond case the letters of charge made no mention of the need for any demand. In the case of the mortgage deed in the M.S. Fashions case and the charge on the deposit in the High Street Fashions case the obligation was to pay on demand in writing: However, in the case of primary obligations as opposed to secondary ones like guarantees, a provision for demand in writing is not regarded as creating a contingency: see In re J. Brown's Estate; Brown v. Brown [1893] 2 Ch. 300. Thus in the case of a promissory note payable" on demand, "the debt arises immediately the note is given and is not contingent upon demand.

In my judgment the "principal debtor" clauses have the effect of creating primary liability for the purposes of the rule that the debt is not contingent upon demand. This was the provisional view of Walton J. in Esso Petroleum Co. Ltd. v. Alstonbridge Properties Ltd. [1975] 1 W.L.R 1474, 1483, and I think it was correct."

And at page 231, he said:

"One therefore has on the one hand a liability of B.C.C.I. to the individual director against a several liability of the director to pay the same debt as that for which the company is liable. Such liabilities may be set off against each other."

On Appeal, Dillon L.J., with whom Nolan and Steyn L.J.J. agreed, said at page 237:

"It is accepted by B.C.C.I. that the liabilities of the principal debtors, the various companies, to B.C.C.I. were at all times presently enforceable by B.C.C.I. without any need for a demand before the issue of a writ even if the indebtedness was described in the relevant documents as "repayable on demand." That is in accordance with many authorities and it is sufficient to take the statement by Bayley J. in Rowe v. Young (1820) 2 Bli. 391, 465, where he said:

"the rules which the law has laid down as to cases in which a demand is or is not necessary, must be considered. One of these rules I take to be this, that where a man engages to pay upon demand what is to be considered his own debt, he is liable to be sued upon that engagement, without any previous demand; ......"

But Bayley J. went on to say:

"but ... if he engage to pay upon demand what was not his debt. What he is under no obligation to pay, what but for such engagement he would never be liable to pay any one, a demand is essential, and part of the plaintiff's title."

Consequently it has been held in various contexts that to enforce liability against a mere surety there must be a demand before action brought: see the decision of Chitty J. in In re J. Brown's Estate; Brown v. Brown [1893] 2 Ch. 300 and the decision of his court in Bradford Old Bank Ltd. v. Sutcliffe [1918] 2 K.B. 833.

Essentially, however, the question is one of the construction of the contract: see Joachimson v. Swiss Bank Corporation [1921] 3 K.B. 110, 129, where Atkin L.J. said:

"The question appears to me to be in every case, did the parties in fact intend to make the demand a term of the contract? If they did, effect will be given to their contract, whether it be a direct promise to pay or a collateral promise, though in seeking to ascertain their intention the nature of the contract may be material."

In the present case in the letters of charge signed by Mr. Amir in respect of Impexbond Ltd. and Tucan Ltd. he has expressly agreed that his liabilities thereunder - namely the companies' liabilities charged on his deposits - shall be as that of a principal debtor.

Similarly in the forms setting out the cash deposit security terms which Mr. Ahmed signed in respect of High Street Services Ltd. and its associated companies he accepted that the liabilities of those companies should be recoverable from him as principal debtor and they were thus within the definition of his indebtedness; he also authorised the appropriation of the deposited moneys in satisfaction of his indebtedness without further notice to him.

The effect of that must be to dispense with any need for a demand in the case of Mr. Amir since he has made the companies' debts to B.C.C. I. his own debts and thus immediately payable out of the deposit without demand. In the case of Mr. Ahmed there must be immediate liability even though the word "demand" was used, because he accepted liability as a principal debtor and his deposit can be appropriated without further notice." "

9. At first blush, the 1st Plaintiff's case seems unassailable. For the Defendant, however, Mr. John Griffiths, Q.C. mounted a strong attack, an attack which he had already made, at least in part, in Yeu Yui Fong v. Band of Credit and Commerce Hong Kong Ltd. (In Compulsory Liquidation), 1993 No. A1637 and which was rejected by Jones J. on 7th June, 1993. The documents in that case were different from those before me so, general principles apart, I am unable to derive much assistance from that decision.

Mr. Griffiths' attack fell into two parts. First, that the Court of Appeal did not consider the particular effect of the words "in writing" attached to "demand", and insofar as they decided that those words added nothing they were wrong. Second, that on the true construction of the continuing guarantee:

(a) The 1st Plaintiff was not primary obligor to the conventional part of the guarantee, as opposed to the special and separate provision contained in clause 21, and

(b) The "demand in writing" was a term which the parties intended should have effect.

10. As a starting point, Mr. Griffiths was not prepared to accept the concession made in M.S. Fashions at page 237 to the effect that no demand was necessary of the principal debtors notwithstanding the provision "repayable on demand". He reserved his position on the point. I can only respectfully suggest that he reserves the point indefinitely because the weight of authority is against him.

11. Turning to the first limb of his argument, Mr. Griffiths said that Hoffmann L.J. was wrong when he relied upon In re J. Brown's Estate (1893) 2 Ch. 300 for the proposition that, in the case of primary obligations, a provision for demand in writing does not create a contingency. He said (and a reading of the report confirms) that that case involved only the words "on demand". The Court of Appeal, in the passage from M.S. Fashions at page 238 already set out, correctly dealt with that case. Mr. Griffiths complained, however, that having also correctly stated the question to be one of construction the Court of Appeal went on to construe the contracts in question on the basis of "demand" simpliciter, no doubt because of the concession made, and did not focus upon and give effect to the additional words "in writing".

12. Mr. Griffiths referred to two passages in Joachimson v. Swiss Bank Corporation (1921) 3 K.B. 110. At 116, Bankes L.J. said:

"... it is helpful to bear in mind what the general law is with reference to payments to be made "on demand." In Walton v. Mascall (1844) 13 M. & W. 452, 458 Parke B. states the law thus: "Now it is clear that a request for the payment of a debt is quite immaterial, unless the parties to the contract have stipulated that it shall be made; if they have not, the law requires no notice or request; but the debtor is bound to find out the creditor and pay him the debt when due." And again in Norton v. Ellam 2 M. & W. 464 the same learned judge says: "It is the same as the case of money lent payable upon request with interest, where no demand is necessary before bringing the action. There is no obligation in law to give any notice at all; if you choose to make it part of the contract that notice shall be given, you may do so. The debt which constitutes the cause of action arises instantly on the loan." In every case, therefore, where this question arises the test must be whether the parties have, or have not, agreed that an actual demand shall be a condition precedent to the existence of a present enforceable debt."

13. Mr. Griffiths said that that passage states the general law that a request for payment is immaterial unless stipulated and that the parties may, if they choose, agree that a request be necessary.

14. At page 128, Atkin L.J. said:

"The contention of the plaintiffs appears to me to ignore the fact that the contract between banker and customer contains special terms, and cannot in its entirety be expressed in the phrasing of an ordinary indebitatus count. A simple promise to pay upon an executed consideration creates a debt, and the creditor may sue without notice. "It is clear that a request for the payment of a debt is quite immaterial, unless the parties to the contract have stipulated that it shall be made; if they have not, the law requires no notice or request; but the debtor is bound to find out the creditor and pay him the debt when due": per Parke B. in Walton v. Mascall. 13 M. & W. 458. The question is in every case whether the parties have stipulated that a request shall be made. In the case of a note made payable on demand it is clear that the words "payable on demand" do not make a demand a term of the contract: see Norton v. Ellam 2 M. & W 461, a decision that on a note payable with interest on demand the Statute of Limitations ran from the date of the note."

15. According to Mr. Griffiths, three propositions emerge from that passage:

(1) The essential question is whether the parties have stipulated a requirement for payment should be made, that is, it is a question of construction.

(2) It is authority for the concession made by B.C.C.I. in M.S. Fashions, and

(3) Where a request or demand is not required, the Statute of Limitations runs from the date of the loan.

16. For the Plaintiffs, Mr. Barlow contended that the mechanics of how a demand is to be made, for example, in writing, do not add anything. The only issue, he said, is whether a demand of any kind is necessary. The authorities of long standing relied on in M.S. Fashions establish that no demand is necessary of a primary obligor for him to be liable. He said it would be a dangerous step to go against the authorities and create uncertainty in the commercial world.

17. For my part, I am reluctant to accept that "in writing" adds nothing. It seems to me arguable that "pay on demand" or similar words have come to constitute a term of art understood and accepted as creating an immediate liability. Where, however, parties to an agreement qualify or modify that phrase, they are not qualifying or modifying 'demand' alone but rather conditioning the word "pay", and creating a new concept.

18. In any event, as the Court of Appeal recognized by citing Joachimson, each contract falls to be considered on its own. That being so I find it difficult to understand how it can be argued that "demand in writing" cannot be construed other than as giving rise to immediate liability. The decision of the Court of Appeal must surely be limited to the construction of the documents with which they had to deal. There was no discussion of any other particular terms of the documents, such as that contained in clause 5 of the continuing guarantee. In the circumstances, I do not regard M.S. Fashions as authority for the proposition that the words "demand in writing" necessarily create an immediate liability.

19. So I turn to construction of the continuing guarantee. In relation to clause' 1, Mr. Griffiths said the words "in writing" were added to supply certainty as to when the loan was repayable, a matter of importance in the commercial world where matters such as cash flow are crucial. That of course is true, but I observe that if Mr. Barlow is correct the Defendant or any other commercial institution can be equally certain of when it can obtain repayment, that is, immediately it wants it.

20. In relation to clause 3, Mr. Griffiths argued that it is important for the Defendant to know whether or not the guarantee will die after 6 years, as would be the case if the 1st Plaintiff was immediately liable. He said "in writing" has the effect of making it clear that limitation runs from the date of demand and not from the date of the document, or the making of the loan or overdraft. Again I accept that. But again I observe that the Defendant can be equally certain of its position if time begins to run from the date of the guarantee or loan, and take such steps as it might consider prudent if the arrangements subsist after 6 years.

21. As to clause 5, Mr. Griffiths described this as the agreed machinery for the giving of notice and said it serves to crystallize the time from which limitation shall run. He submitted that the parties clearly addressed their minds to the need for a demand. I find this submission more compelling. It is difficult to see why the parties included this clause if there was no intention to require a demand as provided in clause 1. Indeed, it seems to me to be irresistible that that was the intention. In the circumstances, on the true construction of the guarantee, I find a demand in writing was a condition precedent to liability on the part of the 1st Plaintiff

22. It follows that I do not have to deal with the other limb of Mr. Griffiths' argument, namely that the 1st Plaintiff was not principal obligor under the conventional part of the guarantee. He said liability as principal obligor arose only under clause 21 which constitutes a separate contract to provide for the situation where the conventional guarantee is for some reason unenforceable. He argued that clause 1 is descriptive only. By a consideration of the entire contract, he said, it is plain that the 1st Plaintiff is to be regarded as principal obligor under clause 21 alone once the conventional guarantee has been shown to be unenforceable and notice in writing has been given.

23. Unlike Jones J. in Yeu Yui Fong, who had to construe a somewhat similar clause, I do not regard clause 21 as a "sweeping up provision". It is a separate agreement. Like Jones J. however, who also had to consider wording similar to that contained in clause 1, I have no difficulty in finding that the 1st Plaintiff was principal obligor under the conventional part of the guarantee. Clause 1 is plain and unambiguous and does not need recourse to a consideration of the entire agreement in order to discern its meaning and intention. Had it been necessary, I would have rejected Mr. Griffiths' argument.

24. I come to the security over deposit. Mr. Griffiths submitted that the 1st Plaintiff incurred no personal liability under this document because it created only a charge on the deposit and contained no personal covenant on the part of the 1st Plaintiff. Mr. Barlow, I think, accepted this because he said that this document has to be read in conjunction with the continuing guarantee which does give rise to personal liability on the 1st Plaintiff's part. In view of my finding in relation to the continuing guarantee, it is not necessary to deal with these arguments. For the sake of completeness, however, I shall do so shortly.

25. The relevant clauses of the security document are:

"1.01 In consideration of your granting or continuing to make available credit facilities or other financial accommodation, at the request of the undersigned, ........................................... ("the Depositor"), for so long as you may think fit to ...............................("the customer"), the Depositor has deposited with you the sum of CAD915,391.41*** ("the Deposit",.......) free from any lien, charge or encumbrance of any kind, and, as beneficial owner, hereby charges to you, by way of first fixed charge, all the right, title and interest of the Depositor whatsoever, present and future, in and to the Deposit as a continuing security for the punctual payment to you on the respective due dates of all moneys which are now or may at any time hereafter be or become from time to time due or owing to you by the Customer anywhere, or in respect of which the Customer may be or become liable to you whether on any current, deposit, loan or other account or otherwise in any matter whatsoever (in all cases whether alone or jointly with any other person, and in whatever style, name or form, and whether as principal or surety), in each case at the time, in the place and in the manner required of the Customer ..........

2. The Depositor, as beneficial owner, hereby charges by way of fixed first charge to you all the Deposit and all right, title and interest of the Depositor whatsoever, present and future, thereto and therein, together with any certificate(s) or other instrument(s) relating thereto, as a continuing security for the payment and settlement of the moneys and liabilities referred to in Clause 1.01 or otherwise hereby secured.

3.01 If the Customer has failed to pay any moneys hereby secured when due or if the Depositor is in default under any of the terms hereof or if the Customer or the Depositor is unable or admits inability to pay debts as they become due or in the event of any proceedings in or analogous to the bankruptcy, insolvency, winding-up or liquidation or composition of the Customer or of the Depositor or if legal process is levied or enforced against any assets of the Customer or the Depositor, you may, without demand, notice, legal process or any other action with respect to the Depositor, retain, apply or realise the Deposit or any part thereof, for your own benefit, at any time and in any way which you may deem expedient, free from and discharged from all trusts, claims, rights of redemption and equities of the Depositor in or towards payment and settlement of the moneys and liabilities referred to in Clause 1.01.

6.01 The Depositor hereby agrees that you may, at any time without notice, notwithstanding any settlement of account or other matter whatsoever, combine or consolidate all or any of the Depositor's then existing accounts (of any nature or description whatsoever and whether subject to notice or not) including the Deposit and set-off or transfer any sum standing to the credit thereof in or towards satisfaction of any liabilities of the Depositor referred to in Clause 1.01 or otherwise hereby secured, whether such liabilities be present or future, actual or contingent, primary or collateral, and several or joint ........."

26. Mr. Barlow said that the debts of the customer to be secured by clause 1.01 include the customer's joint and several liabilities. By virtue of the continuing guarantee, the 1st Plaintiff is liable jointly and severally with the customer, therefore clause 6.01 creates a contingent personal liability.

27. Mr. Griffiths submitted that, even if the 1st Plaintiff is liable under the guarantee, there was no mutuality between the Defendant and the 1st Plaintiff as required by section 35, because the deposit was made over for a special or specific transaction. He relied on a line of authority reviewed in National Westminster Bank Ltd. v. Halesowen Presswork and Assemblies Ltd. (1972) AC 785, where at page 808, Lord Simon of Glaisdale said:

"But before I venture to indicate my own view on whether section 31 may be excluded by agreement, there is one subsidiary matter on that section with which I should like to deal. The section concerns the right or duty of set off "where there have been mutual credits, mutual debts or other mutual dealings, ..." It was common ground that "mutual dealings" would not cover a transaction in which property is made over for a "special (or specific) purpose": see In re Pollitt, Ex parte Minor [1893] 1 Q.B. 175; [1893] 1 Q.B. 455; In re Mid-Kent Fruit Factory [1896] 1 Ch. 567 and In re City Equitable Fire Insurance Co. Ltd. [1930] 2 Ch. 293. But I regret that I cannot agree with the view of the majority of the Court of Appeal on what meaning should be attached to this concept of "special (or specific) purpose." I prefer the view of Buckley L.J., and I agree with all that my noble and learned friend, Viscount Dilhorne, has said on this matter. Every payment of money, every contractual provision, is for a special or specific purpose in the ordinary sense of those words: something more is required to take the transaction out of the concept of "mutual dealings." It was suggested on behalf of the appellants that the situation only arises when the transaction given rise to a payment on which a quasi-trust is imposed. My only quarrel with this way of putting it is that quasi-any-thing gives uncertain guidance in the law. I would prefer to say that money is paid for a special (or specific) purpose so as to exclude mutuality of dealing within section 31 if the money is paid in such circumstances that it would be a misappropriation to use it for any other purpose than that for which it is paid. I think that all the cases cited on this point are explicable on this basis; but I cannot see anything in the instant case which amounts to such a special purpose so as to negative mutuality of dealing."

28. I agree with Mr. Barlow that such lack of mutuality occurs in situations such as those of trust or agency and not, as in the National Westminster case, the ordinary commercial dealings between bank and customer. I reject this argument.

29. Mr. Griffiths next argued that while the deposit remained subject to the charge, no debt was owed by the Defendant to the 1st Plaintiff. Therefore, the 1st Plaintiff could not demand payment and could not prove in the liquidation. I reject this proposition. The debtor/creditor relationship plainly existed subject only to the Defendant's right to resort to the deposit and so extinguish and defeat the debt if circumstances so dictated.

30. Third, Mr. Griffiths submitted that set-off would destroy the 1st Plaintiff's equity of redemption. He relied on a passage in English and International Set-off by Philip R. Wood at paragraph 5-147:

"Prior to a default by the customer there would be no set-off mutuality between the charged deposit and a debt owed by the customer to the bank. A set-off by the bank would destroy the customer's equity of redemption - the bank has only a defeasible proprietary interest. A set-off by the customer would destroy the bank's security ........... If the bank is insolvent the customer loses the set-off because of lack of mutuality."

31. The argument based on this passage was not developed by reference to any authorities. It should, however, be read in conjunction with Mr. Griffiths' fourth point, namely, that liquidation set-off has no application to a bona fide security, for which proposition he relied upon Ex parte Caldicott (1884) 25 Ch. Division 716. At page 721 Earl of Selborne L.C. said:

"I am of opinion that the decision is right, and upon this simple ground, that sect. 39 has no application to a bona fide security; and we all agree in thinking that this arrangement was a bona fide one for the purpose of giving the bank a security.

It is admitted that, if the money did remain a security, the bank were not obliged to deduct its value before proving their debt against the estate of the firm, because the rule in bankruptcy is, that a valuation or giving up of a security is only necessary when, in the case of a proof by joint creditors, it is a security on the joint estate. Well, this is not a security on the joint estate, and, being in substance, as it is in terms, a security, the principles which are applicable to securities, and not those which apply to mutual credits, appears to me to govern the case."

32. The other members of the Court of Appeal agreed.

33. Mr. Griffiths said, therefore, that the law in relation to securities is governed by its own special principles and is not in part materia with that relating to set-off. He said that the Canadian dollar deposit was plainly made a security on a bona fide basis. Therefore, liquidation set-off does not apply to it.

34. Mr. Barlow said that it is difficult to understand why there should be no set-off if the Defendant is insolvent. He pointed out that the money has already been applied for the benefit of the bank, that is, the general body of its creditors as contemplated by clause 3.01 of the document. He said that the same point was considered by the Court of Appeal in M.S. Fashions in the passage from the judgment of Dillon L.J. at page 236 to which I have already referred. He submitted that Caldicott is no longer good law.

35. The authority on this topic seems to be sparse. The apparently conflicting statements of principle are not, as far as I can tell, supported by any close analyses. In Ex parte Barnett upon which Dillon L.J. relied, Lord Selborne was equally as brusque as the Earl of Selborne in Caldicott. After referring to the equivalent section in the Bankruptcy Act 1869, Lord Selborne simply said:

"As debt can co-exist with security, and often does, the fact that nothing is said about security or lien one way or the other in the section, seems to me only to show that the existence of security is not to affect its operation."

36. Somewhat tentatively, I come to the conclusion that Mr. Barlow is right. A bona fide security held by an insolvent bank is susceptible to liquidation set-off. The security when realized will necessarily constitute funds in the liquidator's hands against which there should be a set-off. Further, I am by no means convinced that there are separate and special principles applicable to securities. The important word in section 35 is, in my judgment, "mutuality". It seems to me that one must have regard to the principle illustrated in National Westminster Bank. One has to look at the security transaction to see whether some specific purpose is attached to it. If so, then it is not susceptible of set-off. If on the other hand, it is part and parcel of the mutual dealings between the parties, then liquidation set-off will arise.

37. In this case, I have already found that there was no separate and specific purpose in relation to the security over the deposit. Accordingly, I would reject this argument.

38. The third document is the letter of set-off which gave the Defendant a wide discretion to combine the 1st Plaintiff's accounts for the purpose of set-off. I agree with Mr. Griffiths that this document, upon the Defendant being wound up, has been overtaken by the provisions of section 35.

39. As a fallback, Mr. Barlow suggested that liquidation set-off applies even to contingent claims. He referred to a passage in the judgment of Hoffmann L.J. in M.S. Fashions at page 230, where he said:

"The problem of contingent claims can often be solved by the hindsight principle. MacFarlane's Claim was a case in which a subsequent event enabled the court for the purposes of proof to quantify a claim against the insolvent company which had been contingent at the date of the winding up. The same would apply to quantification for the purposes of set-off. In re Daintrey; Ex parte Mant [1900] 1 Q.B. 546 shows the hindsight principle applied to a contingent claim in favour of the insolvent. An extended discussion of this and similar cases can be found in In re Charge Card Services Ltd. [1987] Ch. 150 and it would be superfluous to cover the same ground. Sometimes, however, the insolvent estate needs to be wound up before it is known either that the contingency has occurred or that it will not occur The court must then put some value on the contingent claim and it will do this for the purposes of ordinary proof or the taking of an account under rule 4.90. There is no similar mechanism for valuing claims by the insolvent, but I am not sure that this is a real problem. Until the contingency occurs, the liquidator or trustee will not be able to use the claim as either a cause of action or a set-off. If the other party has a cross-claim, he will be able to prove for the full amount. I suppose it may happen that the contingency occurs long after the winding up has been completed and the company is then restored to the register and brings an action. The defendant may have proved for his cross-claim and received a small dividend. Can he still rely on the full claim as a set- off, giving credit for the dividend? For my part, I do not see why not."

40. In Re Charge Card Services Ltd. (1987) 1 Ch. 150, Millett J. said at page 177:

"It does not, of course, follow that an attempt to create an express mortgage or charge of a debt in favour of the debtor would be ineffective to create a security. Equity looks to the substance, not the form; and while in my judgment this would not create a mortgage or charge, it would no doubt give a right of set off which would be effective against the creditor's liquidator or trustee in bankruptcy, provided that it did not purport to go beyond what is permitted by section 31 of Bankruptcy Act 1914. This brings me to the last question, whether debts or liabilities which result from mutual dealings but are still only contingent at the relevant date are available to be set off under section 31."

41. The judge proceeded to review the authorities.

42. Finally, at page 187, he concluded:

"By 1956 there was thus a long and consistent line of authority that all provable debts which resulted from mutual dealings were capable of set off; that these included debts whose existence and amount were alike contingent at the date of the receiving order, as well as liability for breaches occurring on or after the receiving order of contracts existing at that date, which by force of the statute were converted into provable debts; and that the essential requirements were, first that the liability must be one which would mature, if it matured at all, into a quantified money claim in the natural course of events, that is to say without any fresh agreement but solely by virtue of a contract already existing at the date of the receiving order; and, secondly, that it had in fact done so by the time the claim to set off was made."

43. It seems plain to me that what both Hoffmann L.J. and Millett J. were saying was that a contingent claim, provided that it arises out of a contract which existed at the date of winding up, is provable and that, upon the contingency being fulfilled, liquidation set-off can and must take place. It is clear that a claim, while still contingent, cannot be subject of set-off.

44. In support of his argument, Mr. Barlow said that the liquidator is under a quasi-judicial duty to seek out and identify the Defendant's true creditors and cannot be allowed to exploit the liquidation process in favour of the general body of creditors at the expense of an individual. He said that liquidation set-off is a notional process and it is, therefore, necessary to concentrate on what would be done in the normal course of events. If the liquidator benefits one set of creditors in an unreal sense, that should not be permitted as a correct exercise of his function. That the 1st Plaintiff has no accrued cause of action is due to the way in which the liquiditor has conducted this liquidation and should be ignored.

45. That argument may give rise to a claim for an alternative form of relief against the liquidator. I should very much doubt, however, whether in the circumstances of this liquidation as outlined to me the liquidator's decision could be impeached. In any event, the argument is not germane to these proceedings where the 1st Plaintiff's liability remains contingent and not subject to liquidation set-off until it crystallizes.

46. For the reasons which I have given, I refuse the declarations sought. I make an order nisi that the Defendant should have the costs of the application.