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The Jolly Contrarian’s Glossary

The snippy guide to financial services lingo.™
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Net-net, there are three concepts to bear in mind: close-out netting, settlement netting, and set-off. Related, but different things.

  • If you are an ISDA ingénue you may have come to the set-off page by accident. Chances are, you're really interested in close-out netting.
  • If you are an ISDA ninja, you’ll know the difference, so welcome.

Don't forget the specific article about Set-off in Section 6(f) of the 2002 ISDA

Easy, tiger.

Don't exercise a set-off right willy nilly. Unless you are settlement netting (where on a given day I owe you a sum, you owe me a sum, and we agree to settle by one of us paying the other the difference) set-off is a drastic remedy which will be seen as enemy action. You would not do it, without agreement, to any client you expected to keep. So, generally, as a remedy it only arises following an event of default. See, for example, Set-off in the 2002 ISDA under Section 6(f). So you don’t just do it for the hell of it.

General terms

That said, at its simplest, a right of set-off exists where there are cross-claims for money between a creditor and a debtor. The effect of a set-off is that both claims are discharged to the extent that they are of an equal amount, and the balance becomes owing to the party who was owed the larger amount.

The difference between close-out netting and set-off

  • Close-out netting, in the learned words of Allen & Overy, is a contractual process comprising early termination, valuation and determination of a net balance. This last step may involve a contractual set-off but, saucily, the considered view of ISDA’s counsel for England and Wales is that the net effect of the agreement is to arrive a a net balance without the good offices of contractual set-off[1]
  • Set-off is a legal principle permitting (or requiring) a debtor to discharge its debt by setting off a cross-claim owed to the debtor against the debt. There are various legal bases for set-off, including, under English law, equitable set-off, set-off in judicial proceedings under the Civil Procedure Rules, statutory set-off under the Insolvency Rules 1986 upon a winding upor administration and contractual set-off.

Set off and subrogation under a guarantee

A debtor cannot set off a subrogated claim against liabilities the guarantor has to that debtor[2]. Would the converse situation apply? Could a debtor set off a subrogated claim by the guarantor against another liability owed to the debtor by the beneficiary of the guarantee? On one hand the set-off should have been applied before the guarantee has been called upon. On the other hand, what if the guarantee is expressed to be payable regardless of any set-off (as usually it would be).

The varieties and mysteries of set-off

Cross-affiliate set-off

Seems like a cool idea, but don't bet the farm on it, especially where your counterparty is bankrupt — which is the one time you’re really going to want to rely on it.

In a recent decision issued in the Lehman Brothers Inc. SIPA proceeding the court held that a contractual right to effect a cross-affiliate setoff is unenforceable in bankruptcy.

The court found that mutuality is a requirement for both common law and contractual setoff under Section 553 of the Bankruptcy Code, and that the contract did not create mutuality for purposes of Section 553. The court further held that the safe harbor provisions for swaps and other derivatives contracts in the Bankruptcy Code do not permit a party to exercise a contractual right to setoff where there is no mutuality.

More here.

Contractual set-off

Where each party to a transaction owes the other they may agree that, instead of making separate payments, the party due to make the larger payment should simply pay the difference. Set off provisions in the ISDA Master Agreement and Global Master Securities Lending Agreement tend to go a lot wider, and allow (on default) a non-defaulting party to offset amounts owing against any liabilities of any kind owed by the defaulting party. This is clearly a drastic step and ordinarily would only be exercised as an utter last resort. See:

Equitable set-off

This is a self-help remedy available to a debtor whose cross-claim arises from the same transaction (or a closely related transaction) as the original debt. Under this device a debtor simply deducts its claim from the debt it owes and tenders any balance to the creditor. The sums in question must be due or, if representing unliquidated damages, a good faith and reasonable assessment of the loss. (Contrast with set off at law, which requires the claims to be determined by judgment of the courts).

In Geldof Metaalconstructie v Carves [2010] EWCA Civ 667 the leading judgment confirmed the equitable test as being “whether the cross-claim is ... so closely connected with the claimant’s demand that it would be manifestly unjust to allow it to enforce payment without taking into account the cross-claim.”

Banker’s set-off (a.k.a combination of accounts

This arises where a customer has multiple bank accounts some of which are in debit and some in credit. It is also known as the combination of accounts. It is arguably available in any situation where one party has multiple accounts with another.

Discussed in some detail in Fearns v Anglo-Dutch Paint and Chemical Company Limited [2010] EWHC 2366 (Let me Google that for you).

The question arises as to whether it is available across multiple currencies.

Insolvency set-off

You can’t contract out of insolvency set-off under English law.

It has been treated as an authoritative statement of English law since 1972[3] that you cannot contract out of insolvency set-off. The insolvency set-off rules (currently made (British) flesh by the Insolvency Act 1986) operate automatically and are mandatory upon the commencement of winding-up.

The administrator must take account of all dealings between the creditor and the bankrupt (including future and contingent obligations and unliquidated sums owing). Sums due from one must be set off against the sums due from the other, except that sums due from the bankrupt cannot be included if, when the bankrupt debtor incurred them, the creditor knew of existing formal bankruptcy steps against that debtor:

  • a resolution or petition to wind-up (if a company);
  • an application for an administration order or of notice of intention to appoint an administrator (if a company); or
  • a pending bankruptcy petition (if a natural person).

Therefore a bank cannot agree not to exercise the right to combine accounts.[4]

Assignment and set-off

Assignment and its effect on Netting and Set-off

Could a right to assign by way of security upset close-out netting such that one should, prohibit any assignment by way of security of any rights under a master netting agreement (such as an ISDA Master Agreement or a Global Master Securities Lending Agreement)?

Generally: No.

  • An assignment by way of security is a preferred claim in the assignor’s insolvency over the realised value of certain rights. It is not a direct transfer of those rights to an assignee: the assignor is still obliged to the counterparty, not the assignee, and any claim the assignee would have against the counterparty would be by way of subrogation of the assignor’s claim.
  • Nemo dat quod non habet”: the counterparty’s rights cannot be improved by assignment, and it being a single agreement on termination of the agreement the assignee’s claim is to the termination amount determined under the Agreement, which involves terminating all transactions and determining he aggregate mark-to-market and applying netting. No one can give what they do not have.[5]

At the point of closeout, the assignee’s right is to any termination payment payable to the Counterparty. Therefore any assignment of rights is logically subject to the netting, as opposed to potentially destructive of it.

But: This is only true unless your netting agreement actually disapplies netting of receivables which have been subject to an assignment. If it does something crazy, like dividing these amounts off as "excluded termination amounts not subject to netting".

But why on God’s green earth would anyone do that? A question you might want to ask to the drafters of the FIA's Professional Client Agreement, which does exactly that.

Netting between legal entities established in England and Wales

In November 1993 — not long after the publication of the 1992 ISDA, the Financial Law Panel (these days the Financial Markets Law Committee) published a Statement of the Law relating to Netting which, more or less, confirmed that not only is netting permissible between English entities on an insolvency; it’s compulsory, whether or not you have an ISDA Master Agreement. Therefore one doesn’t need a netting opinion for domestic English swap agreement. Hurrah.

See also


  1. Sigh - except where there are unpaid amounts payable under Section 2(a)(i). You knew there’d be some kind of qualification though, didn’t you.
  2. A. E. Goodwin Ltd v A. G. Healing Ltd [1999] 1AC 1 (Let me Google that for you).
  3. See National Westminster Bank Ltd v Halesowen and in 1995, Stein v Blake
  4. Interestingly, this is not the case under the Swiss Bankruptcy Code.
  5. Except under New York law — isn't that right, rehypothecation freaks?