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Problems with no set-off clauses: prevention is better than cure

Philip Carstairs

In TMF Trustee v Fire Navigation, the court held that a no set-off clause did not stop borrowers from relying on the “prevention principle” namely that the alleged breach was caused by the lenders.

Set-off is a common law right that a debtor has to net obligations it owes to a creditor off against obligations the creditor owes to it and only to pay the balance. The rules governing what can be set-off against what are complex. It is generally possible to exclude a party’s right to set-off by including clear contractual provisions to this effect.

Here, lenders had lent USD 69m and taken mortgages over two ships to secure the debt. A notice was served under a clause requiring the borrowers to provide additional security if the value of the ships fell below a set level. However, this notice overstated the amount required to remedy the shortfall in value of the vessels. The borrowers did not provide the additional security demanded. The facility agent served an acceleration notice on the borrowers requiring them to repay the whole loan and arrested one ship in Los Angeles and subsequently sold it.

The lenders then sought summary judgment for the outstanding balance of the loan, default interest and various  declarations. By the time of the hearing the facility agent had arrested the other ship in Singapore.

The borrowers argued that they were not in breach of the loan because they had been prevented from performing their obligations by the facility agent’s prior breaches (the wrongful arrest of the first ship had scuppered their attempts to sell the vessels). This “prevention principle” is well-established: a party can use it to defend itself from claims that it has breached the contract when the alleged breach is caused by the other party’s actions.

The hearing focussed on whether the no set-off provision in the loan agreement which required the borrowers to pay “all amounts due from the Borrowers … without any form of set-off, cross-claim or condition …” prohibited the borrowers from relying on the prevention principle to avoid repaying the principal.

The borrowers argument was that they had not exercised the right of set-off but that the prevention principle meant that the debt under the loan had not become due at all because of the lenders’ breach: the lenders could not rely on the fact that the loan remained unpaid despite the acceleration notice and the final maturity date passing as they had engineered this situation by making it impossible for the borrowers to repay. No set-off clauses like this one only applied to debts that were due, the borrowers were claiming that their obligation was not due.

The court found on the facts that the borrowers’ defence had a real prospect of success and that the lenders were not entitled to summary judgment.