The Concepts of Lien and Set-Off - Term Paper Example

Introduction The concepts of lien and setoff are very old. This Paper explains the concepts of lien and set-off and then proceeds to compare the two concepts and finally stated the restrictions on the applicability of setoff. What is A Lien? The principle of Lien is based on the common law principle that if a man has an article delivered to him, on the improvement of which he has to bestow trouble and expense, he has a right to detain it, until his demand is paid.1 In this primary sense, Lien is bestowed by law and not by contract.2 Under English law, lien, is in the simple sense, a legal right to keep possession of property until a claim has been met. It has been intended that lien cover a number of analogous rights. Liens are now described as legal, non-possessory, equitable, general, particular, statutory, contractual, judicial and subrogatory lien.3 English law has made distinctions between a general lien and particular lien, and made them applicable as two different categories. General lien is, in the ordinary course of nature, discouraged as it hinders an equitable disbursement of assets in the case of dissolution or liquidation4. Particular lien is more acceptable and practiced. The broad general categories of lien are as follows: 1) Legal, 2) Non possessory, 3) Equitable, 4) Statutory, 5) Contractual and 6) Subrogatory. Under American law, lien is defined in a very broad sense, as a claim for a charge on property as security for the payment of a debt or the fulfilment of some obligation.5 The original, common law understanding of the term lien, which used to signify the right which certain mechanics and artisans had to retain the chattel on which they had performed some labour, or had bestowed some care, at the request of the owner directly or impliedly, until they had been paid for the labour performed. However, this position appears to have changed in the light of more recent cases. Lien was held to be the right to detain the possession of personal property until some debt due on, or secured by, such property is paid or satisfied.6 It has been held, that under American law the concept of lien is an all-encompassing one, unlike the restricted one under Indian law. Lien, under American law, is taken to be a very wide concept under which mortgage, pledge and hypothecation fall as special cases. Set-off – Principles and Practice In every developed legal system, cross-claims existing reciprocally between two parties may be set-off against each other through unilateral declaration, judicial order or ex lege effect.7 The origins of the law of set-off can be traced back to ancient Roman law. A set-off is a counterdemand which a defendant holds against a plaintiff, arising out of a transaction extrinsic of plaintiff’s cause of action.8 It is the right which exists between two parties, each of whom under an independent contract owes an ascertained amount to the other, to set-off their respective debts by way of mutual deduction, so that in any action brought for the larger debt the residue only, after deduction, may be recovered.9 The right of set-off is a common-law right, which belongs to every creditor, to apply unappropriated monies of his debtor, in his hands, in extinguishment of debts due to him.10 It allows parties that owe mutual debts to each other to assert amounts owed, subtract one from the other, and pay only the balance.11 Statutory law and jurisprudence recognize three kinds of set-off, or compensation: legal, which is effected by operation of law;12 contractual, which is effected by the will of the parties;13 and judicial, which is effected by the courts.14 Set-off Under Common Law The equitable character of set-off was the starting point for the development of set-off in common law. The plea of set-off was first granted as ‘equitable set-off’ of claims flowing out of the same or closely related transactions by the courts of equity,15while the common law courts adhered to the concept of abatement16 or recoupment.17 Later, set-off was allowed at law in England under Statutes of Set-off enacted in 1729 and 1735.18 Today, the distinction between equitable set-off and set-off at law is said to be blurred.19 The ‘independent’ set-off at law under the Statutes just mentioned is available only for mutual debts, which are capable of being liquidated or ascertained with precision, including liquidated damages, e.g. those arising out of a liquidated damages clause.20 This type of set-off does not require any relation between the transactions out of which the claims arise.21 Set-off at law is a purely procedural defence, i.e. a procedure for taking an account of the balance due between the parties.22 There is thus no set-off at law without legal proceedings.23 Even when invoked by the respondent during the proceedings, claim and cross-claim as two separate and distinct debts remain in existence until there is a judgment for a set-off. Consequently, set-off at law cannot be invoked unilaterally by one of the parties outside judicial or arbitral proceedings.24 Equitable or ‘transaction’25 set-off, on the other hand, operates as a true, substantive defence against the respondents liability to pay a debt otherwise due. It may be invoked independently of any order of a court or arbitral tribunal.26 Also, the cross-claim, whether contractual or tortious, need not arise out of the same contract as the claim, provided that ‘it is inseparably connected with the transaction giving rise to the claim so that the title of the plaintiff at law to prosecute his demand is impeached’.27 Lien and Setoff – Comparison and Contrast The common-law concept of set-off is a right, not a lien.28 The roots of both these concepts lie in Equity. Both primarily aim at ensuring that the claims of both the parties to a dispute are settled. Both legal and equitable liens and set-offs, in their true sense arise by the operation of law or equity. They are both equitable interests and not mere equities, both are governed by reasonably strict requirements of from and liable to be dismissed under the limitation rules. There always exists a commercial transaction which forms the basis of the applicability of either of these concepts. Generally, If the transaction is providing services then there would almost certainly exist a right of lien, whereas when the transaction is of trading or supply of goods over a period of time, then set-off would be attracted. The similarities between the two concepts are however, limited and restricted; while, the differences, many. The first and primary difference between Lien and Setoff comes in their very natures and what they imply. While Lien is a substantive provision, bestowing rights and liabilities on a party, allowing a party to base a claim on it, the provision which gives rise to the cause of action in a particular case. A setoff is essentially a procedural right permitting a party to settle existing debts from monies to be paid with the primary purpose and intention of reducing litigation and multiplicity of payments. Both can however be used as defenses or as obstructions to the payment of monies in the form that another party may claim a pre-existing superior lien to be operating over that particular property which the party seeks to call upon towards payments of monies due; or the party can claim that the same is not possible as the preexisting debt upon which the claiming party seeks to base its claim, has been, or, is to be, setoff against another pre-existing debt with that party itself or another party connected to the responding party who transfers or assigns the debt to the respondent party. Thus, while the principle of Lien is essentially an empowering provision of substantive law, giving rights and liabilities to a party and creating a cause of action; Setoff is a procedural right exercisable at ones option for more efficiently dealing with cross-debts owed on other independent causes of action. In lien there need not be a cross debt or claim, it is merely a right to hold on to a property until dues are paid. Furthermore, owing to this very nature of the right to Lien, the right is ordinarily not transferable and only the entities concerned may exercise the right to lien. The rationale for that is that lien is primarily dependent on possession and link with the property, even equitable lien, though not directly dependent on possession, is dependent on a court order for enforcement and therefore indirectly dependent on possession and hence is not in practice, assignable. Setoff on the other hand, is a procedural right for the easier settlement of debts; and as both debts and actionable claims are transferable, so too is the right to setoff, in effect and practice, transferable on a limited basis and can be assigned. This is especially relevant when considering the payment of monies from one entity in a group of companies to another entity or banks, considering that debts owed to another entity in the same group may be used to setoff the monies owed by the first entity. Lien is a substantive right awarded by law or even in equity to retain certain properties for the enforcement of other claims. A set-off is available to a defendant only when the rules of procedure of the court in which the plaintiff brings action permits a set-off to be pleaded, and the mode in which such a plea may be raised is also determined by those rules.29 The defendant may request the court to adjust the plaintiff’s claim with his cross claim and the nature of the total claim would accordingly vary. Further, a defendant is not obliged to plead a set-off; he can, is he wishes, enforce his claim by an independent action. Both the rights accruing as a lien and those benefits that can be claimed under setoff are both governed by all the requirements of form and subject to the statutes of limitation and other procedural limitations as are applicable. Development of the law relating to Setoff; its current position and limitations under law Prior to the enactment of the first Statute of Set-off in 172930 there was no general right of set-off available to the Defendant in a common law action when he was being sued by a solvent plaintiff as opposed to the assignees of a bankrupt.31 This denial of a set-off was consistent with the adoption of strict rules of pleading and of forms of action, which were designed to reduce the question to be decided by the courts, as far as possible, to a single well defined issue.32 Although there were certain discrete situations in which rights akin to set-off were recognized and permitted by the common law courts,33 it was not permtted as a general practice. With the enactment of the Statute of Set-offs in 1729 and 1735, this was permitted. The title of the first statute, ‘An Act for the relief of Debtors with respect to the Imprisonment of their Persons’ suggests that the primary purpose of the Act was to assist debtors who were liable to be sent to prison for non-payment of debts, although the courts, not so long after their enactment considered that the Act was designed to avoid the circuity of action and multiplicity of suits.34 The first statute was a temporary provision intended to last for five years and the right of set-off conferred by the first statute was made permanent by the second enactment of 1935.35 The Statutes were repealed in England in 1879 by Section 2 of the Civil Procedure Acts Repeal Act in so far as they applied to the newly founded Supreme Court of Judicature, though it was expressly provided that the repeal was not to effect any ‘jurisdiction or principle or rule of law or equity established or confirmed, or right or privilege acquired.’36 This has been interpreted as preserving the right of set-off originally conferred by the statutes,37 though the procedure for giving effect to the same has been set out in the rules.38 Prior to the Judicature Acts the courts applied the principle that a set-off under the Statutes could only be pleaded in a bar to the Plaintiff’s action only if it was available at the commencement of the action. In other words, at the date of the commencement of the action, there had to be a presently existing and payable debt owed by the plaintiff to the defendant.39 After the Judicature Acts however, the Supreme Court Rules40 permitted a defendant to rely on a ground of defense which arose after the action was commenced.41 While this has not been reproduced in the new Civil Procedure Rules 1998, there is nothing to suggest that the principle itself will not be continued. On the other hand, if a defendant wishes to amend his defence after it has been served, the Civil Procedure Rules now require the defendant to obtain the written consent of all the parties or the permission of the court.42 For set-off to be available there must be a debt on both sides; that is to say, there must be monies owed on each side of the account. Because of this requirement of ‘debts’, a claim for the return of goods,43 or an entitlement to statutory benefits which does not create a debt enforceable by action,44 is not susceptible to a defense of set-off under the law. Furthermore, a set-off under the statutes is only available in respect of cross-debts that are due and payable.45 Debts that are merely payable in futuro,46 or which is merely contingent,47 cannot be employed in a set-off. Similarly, under US law, a claim for set-off is an independent action which may be raised as a counterclaim.48 It is a claim for affirmative relief, rather than a defense.49 Generally, set-off must rest on a claim enforceable in its own right,50 and a party cannot avail itself of the right to set-off unless it has a legally subsisting cause of action51 in its favor on which it could maintain an independent action.52 In this regard, a defendant who pleads a set-off occupies substantially the position of a plaintiff.53 Set-off must be applied in the forum in which the conflicting claims are heard, and the fact that another action is pending upon a claim will not prevent the same claim from being used as a set-off in a subsequent action. The claim must be such that at the date of the commencement of plaintiffs suit, the defendant could maintain an action against the plaintiff.54 The right of set-off is based on principles of right, justice, and benevolence. The doctrine of set-off, whether legal or equitable, is essentially one of equity, and is denied in situations where it would be inequitable to allow it. The right to set-off exists independently of statute and rests upon the inherent power of a court to do justice to the parties before it. The defense of set-off requires mutual obligations whereby each obligor owes an equally liquidated and demandable debt to the other. In order for judgments to be qualified for offset, the demands must be mutual and subsisting between the same parties, and due in the same capacity or right.55 A contingent or unmatured obligation which is not presently enforceable cannot be the subject of set-off.56 Where there is no mutual debt there is no possibility of legal set-off.57 As general rule, mutual debts are not automatically set-off by operation of law.58 The right of set-off is an exercisable right, and not a fixed or natural right conclusively established by the mere fact that each of the parties has a claim against the other.59 The right to set-off is an equitable remedy which arises only when the intent to set-off is asserted.60 Generally, to effectuate the right of set-off, a party must take following three steps: (1) make a decision to effectuate a set-off, (2) take some action accomplishing the set-off, and (3) record the set-off.61 One who claims set-off or compensation necessarily admits the debt sued upon.62 Thus, in spite of its few limitations, the right of set-off minimizes litigation and makes settlement of claims easier. Bibliography BOOKS & ARTICLES Halsbury’s Laws of England, Volume 28, Butterworths, Fourth edition. Loyd, The Development of the Set-off, (1916) 64 University of Pennsylvania Law Review, 541, 544. Tiger, Automation Extinction of Cross-Demands: Compensatio From Rome to California, (1965) 53 California Law Review 224. Set-off Law and Practice – An International Handbook (William Johnston & Thomas Werlen eds., Oxford University Press, New York, 2006). Derham, S R, The Law of Set-off 9 (3rd edn, Oxford University Press, New York) Chitty on Contracts (1994, 27th ed.) James and Hazard, Civil Procedure (1977, 2nd ed.) Waterman, Set-off, Recoupment and Counter-claim (1872, 2nd ed.) Clark and Surbeck, ‘The Pleading of Counter-claims’ in (1928) 37 Yale LJ 300 ICC Award No. 5971 in (1995) 13 ASA Bulletin at p. 728 Zimmermann, The Law of Obligations, Roman Foundations of the Civilian Tradition (1990) STATUTES Sale of Goods Act, 1979. Supreme Court of Judicature Act, 1873. Read More