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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.

One does not exercise a set-off right willy nilly. Unless one is, mutually, 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, use set-off 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.

Set-off and netting

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] According to the UNIDROIT[2], close-out netting resembles the classical insolvency set-off, but is purportedly wider: general set-off requires mutual debts that are already due, while close-out netting envisages the netting of obligations that are not yet due.[3] Thus, set-off is narrower that close-out netting.
  • 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 upon administration and contractual set-off.

If a master agreement allows set-off, can I net down across master agreements?

So if one of my master agreements has a broad set-off provision (as well as its close-out netting provision), and my netting opinion says the set off (of amounts due under other master agreements) would also be enforceable, can I then treat all my exposures against that counterparty, across all master agreements, as nettable down to a single obligation?

Sorry to be the bearer of the buzzkill, but no. You need a “written, bilateral netting agreement that creates a single legal obligation, covering all included bilateral master agreements and transactions” (a “cross product netting arrangement”), itself supported by a netting opinion. See Rule CRE53.61-9 of the Basel framework[4] This might be, for example, the joint-association-published Cross-Product Master Agreement - and most prime brokerage agreements do this too.

But even if you have got a master netting agreement, also check whether your own firm’s operational systems are capable of recognising cross-product netting arrangements as a practical matter. From personal experience, the JC suspects many aren’t. If the computers can’t do it, your CPMA and your netting opinions are as good as a chocolate starfish.

Set off and subrogation under a guarantee

A debtor cannot set off a subrogated claim against liabilities the guarantor has to that debtor[5]. 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

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 2010 GMSLA 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:

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[6] 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.[7]

Banker’s right to combine accounts

The banker’s right to combine accounts arises where a customer has multiple bank accounts, usually where some are in debit and some in credit. This stands to reason, obviously — unless there are multiple accounts, all overdrawn, but only some of them benefit from a security interest — though see also the rules about bailment. It is sometimes called a Banker’s set-off but, in 1972’s (still leading) case National Westminster Bank Ltd v Halesowen, Lord Buckley noted it isn’t a set off right so much as a function of accounting:

“Nor is it a set-off situation, which postulates mutual but independent obligations between the two parties. It is an accounting situation, in which the existence and amount of one party’s liability to the other can only be ascertained by discovering the ultimate balance of their mutual dealing.”

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.”

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.

Chicken Licken’s Guide™ to things that might defeat 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 forbid parties making assignments by way of security of their rights under a master netting agreement (such as an ISDA Master Agreement or a 2010 GMSLA), for fear of undermining your carefully organised netting opinions?

Generally: No.

  • An assignment by way of security is a preferred claim in the assignor’s insolvency over the realised value of certain rights the assignor holds against its counterparty. It is not a direct transfer of those rights to an assignee: the counterparty is still obliged to the assignor, not the assignee, and any claim the assignee would have against the counterparty would only be by way of subrogation of the assignor’s claim, should the assignor have imploded in the meantime or something.
  • Nemo dat quod non habet”:[8] the unaffected counterparty’s rights cannot be improved (or worsened) 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 the aggregate mark-to-market and applying close-out netting. No one can give what they do not have.[9]
  • The assignee can be in no better position than the assignor and this takes subject to any set-off. The conduct of the debtor vis a vis the assignee is irrelevant, unless it gives rise to an estoppel. See Bibby Factors Northwest Ltd v HFD Ltd (paragraphs 38 and 48).[10]

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 insofar as your netting agreement does not actively do something crazy, like disapplying netting of receivables which have been subject to an assignment and dividing these amounts off as "excluded termination amounts not subject to netting".

I know what you are thinking. "But why on God’s green earth would anyone do that?" This is a question you might pose to the FIA’s crack drafting squad™, who confabulated the FIA’s Professional Client Agreement, which does exactly that.

Collateral and set-off

Could your posting me collateral, or granting me a security interest, upset a set-off arrangement I have elsewhere?

Talk about first world problems. Who ever heard of too much credit mitigation? It seems absurd, but the JC has heard it cited, by a patient attorney as a risk, in this case:

A certain principal has entered transactions with you under collateralised agency master agreement. Say an agent lending agreement, or an agency ISDA Master Agreement. The Agent, for your behalf and those of your fellow principals, is relying on contractual netting to manage the whole exposure across its portfolio with you. If you go bust, the portfolio atomises into groups of transactions with individual principals which net down, but there may be some counter-indemnity or other mechanism whereby the agent may apply any excess collateral resulting from closeout against one such principal against a shortfall arising following close-out against another.

Now what happens if, independently of that agency arrangement, you grant security, or post collateral to that party? Does this defeat netting or set off?

Friends, it is hard to see how. If it is a pledge or security interest, and there is a shortfall on your portfolio, this is extra ballast, should you want it, but it hardly can interfere with the agent’s rights should it want to apply other collateral excesses to your shortfall. And if you have an excess — well, what is there to set off? If it is pledged by title transfer this might (if it applies) adjust the calculation of insolvency set-off, but surely only in a way that leads to your exposure, such as it is, being better covered rather than worse. Again, that should mean your agent has less, not more, need to dip into other pools of excess collateral to net out.

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. “Principles on the operation of close-out netting provisions”
  3. The ISDA Master Agreement achieves this by accelerating them, mind.
  5. A. E. Goodwin Ltd v A. G. Healing Ltd [1999] 1AC 1.
  6. See National Westminster Bank Ltd v Halesowen and in 1995, Stein v Blake
  7. Interestingly, this is not the case under the Swiss Bankruptcy Code.
  8. “A chap cannot give away what he doesn’t own in the first place.” Of course, try telling that to a prime brokerage lawyer, or a counterparty to a 1994 New York law CSA.
  9. Except under New York law — isn’t that right, rehypothecation freaks?
  10. Bibby Factors Northwest Ltd v HFD Ltd [2015] EWCACiv 1908