Fearns (t/a "Autopaint International") v Anglo-Dutch Paint & Chemical Company Ltd & Ors

In my judgment given on 2 July 2010 on the enquiry held in this case, I left over for further argument the question of the date at which the damages payable (in sterling) to the Claimant, Mr Gary Fearns, and the debt payable (in euros) by Mr Fearns to the First Defendant (“De Beer”) should be converted into a common currency and set off against each other to derive a net liability. I found that question difficult as well as being one on which, perhaps surprisingly, there appears to be little direct authority.

I heard argument on this question, and on other matters consequential on my judgment, on 28 July 2010. On that date I made an order determining the net sum due on the enquiry but indicated that I would give my reasons for my decision on the set-off point in writing later. In this judgment I give those reasons and also the reasons for my decision on a further question of set-off (between damages and costs) which I was asked to deal with after the hearing on 28 July on the basis of written submissions.

In accordance with my earlier judgment I assessed the damages payable to Mr Fearns as compensation for the Defendants’ infringement of his Autopaint trade mark and passing off in the principal sum of £438,569. This sum comprises £162,679 in respect of profits lost in the period up to the end of June 2005 as a result of unlicensed sales made by the Second Defendant (“Anglo Dutch”) to franchisees and £275,890 in respect of profits lost in the period from the end of June to the end of December 2005 as a result of the loss of the Autopaint franchisee network.

I assessed the debt owed by Mr Fearns to De Beer in the principal sum of €594,696. This sum represents €627,229 due in respect of goods sold to Mr Fearns in the UK (after giving credit for licensed sales made to franchisees) less €26,521 due to Mr Fearns under the Australia agreement and €6,012 due under the Malta agreement.

It was common ground between the parties that the damages awarded to Mr Fearns and his debt to De Beer should be set off against each other and judgment given for a single net sum. There was a dispute, however, as to the date at which the amounts of the claim and counterclaim should be converted into a common currency. Counsel for Mr Fearns contended that part of his claim should be converted at the rate applicable in 2005, when the claim arose. The Defendants contended that the relevant date was the date of judgment, i.e. 28 July 2010.

The date matters because the rate of exchange between sterling and the euro has altered significantly over the relevant period. In 2005, the rate of exchange was around £1: €1.45. Converted at that rate, the damages of £438,569 payable to Mr Fearns would be equivalent to €635,925 (that is, €41,229 more than the principal sum which he owed to De Beer). However, at the time of the hearing on 28 July 2010 the rate of exchange was around £1: €1.2. Converted at this rate, the damages would be equivalent to €526,283 (that is, €68,413 less than the principal sum owed to De Beer).

The primary argument advanced by Mr Wilson QC on behalf of Mr Fearns was that all the damages arising up to the end of June 2005 should be converted into euros and deducted from Mr Fearns’ debt to De Beer at the rate which prevailed at that time. Mr Wilson was not able to cite any case which establishes that this is the correct approach, but he argued that it follows from the fact that the two claims were subject to an equitable set-off. Mr Wilson submitted that the effect of an equitable set-off is to reduce pro tanto the amount owing to the other party. His primary submission, as I understood him, was that this effect is automatic, so that as and when Mr Fearns’ right to damages arose his liability to De Beer was reduced by the amount of the damages. Alternatively, Mr Wilson contended that the set-off took effect when it was pleaded as a defence to the Defendants’ counterclaim at the end of October 2005. In practical terms it would make no difference which of these dates was chosen as the exchange rate was around £1: €1.45 throughout 2005. In support of his argument (in its alternative formulation) Mr Wilson relied on a passage in Wood on Setoff and Netting, Derivatives and Clearing Systems (2007) at §3-040, which states: “Self-help multicurrency set-off is available if a market rate can be easily determined: the courts should allow a conversion at the time of the exercise of the set-off”.

On behalf of the Defendants, Mr Moody-Stuart did not dispute that there was an equitable set-off but denied that either the existence or the exercise of the set-off had the effect of extinguishing or reducing either party’s liability to the other. He submitted that the correct approach is to calculate the total amount of each liability, including interest at a rate appropriate to the currency of the liability, at the date on which the court gives judgment; and then to convert the lesser sum into the currency of the greater at the exchange rate prevailing on that date and deduct it from the greater sum, giving judgment for the balance. In support of this contention, Mr Moody-Stuart relied on a line of Admiralty cases involving cross-claims arising out of collisions between ships where both were to blame, in which such an approach has been adopted.

Mr Wilson responded that these cases reflect a rule particular to Admiralty proceedings and are also difficult to reconcile with Smit v Selco [1988] 2 Lloyd’s Rep 398, another Admiralty case which he argued supports his position.

I will come to the Admiralty cases, which are the only cases that counsel were able to find in which the appropriate date of conversion of cross-claims in different currencies has been discussed. But before doing so, I will address the question as a matter of principle by identifying the different types of set-off recognised in English law and considering the nature of equitable set-off, as Mr Wilson urged me to do.

The term “set-off” as it is used in English law has no uniform meaning and is therefore a ready source of confusion. In one sense it refers to a process by which one sum is netted off against another so as to leave only a single liability for the balance. But the term is also used to refer to rights which do not have this effect but which prevent a person in certain circumstances from enforcing a claim where there is a cross-claim against him while leaving both liabilities intact. Such rights, as I will indicate, can themselves differ in their nature.

Leaving aside rights of set-off which are created by contract and the mandatory set-off which occurs on bankruptcy or the winding-up of a company, there are two main types of set-off in English law. These are generally referred to, respectively, as ‘legal set-off’ and ‘equitable set-off’.

Legal set-off is a creation of statute. It originated in the Insolvent Debtors Relief Acts 1729 and 1735 which provided that where there were “mutual debts between the plaintiff and the defendant ... one debt may be set against the other”. The rights conferred by those statutes have been continued in subsequent statutes and are now enshrined in section 49(2) of the Senior Courts Act 1981 and CPR r.16.6: see Re Kaupthing Singer & Friedlander [2009] 2 Lloyd’s Rep 154, 156.

In Stein v Blake [1996] AC 243, 251C-D, Lord Hoffman said:

“Legal set-off does not affect the substantive rights of the parties against each other, at any rate until both causes of action have been merged in a judgment of the court. It addresses questions of procedure and cash-flow. As a matter of procedure, it enables a defendant to require his cross-claim (even if based upon a wholly different subject matter) to be tried together with the plaintiff's claim instead of having to be the subject of a separate action. In this way it ensures that judgment will be given simultaneously on claim and cross-claim and thereby relieves the defendant from having to find the cash to satisfy a judgment in favour of the plaintiff (or, in the 18th century, go to a debtor's prison) before his cross-claim has been determined.”

The characterisation of legal set-off as procedural rather than substantive has at least three aspects. First, such a set-off can only be asserted in legal proceedings and not in any other context. Second, it only arises when pleaded as a defence. Third, it is clear that the assertion of a legal set-off does not extinguish either liability but leaves separate and distinct claims in existence until a judgment is given in which the claims are merged.

For a right of legal set-off to exist the claim and cross-claim need not be for debts strictly so-called, but they must be for sums which are due and which are either liquidated or capable of ascertainment without valuation or estimation at the time of pleading: see Axel Johnson AB v Mineral Group [1992] 1 WLR 270; Stein v Blake, supra, at 251F-G. In the present case neither the claim nor the counterclaim satisfied this test, and it was not suggested that the principle of legal set-off was applicable.

The limitation of legal set-off to circumstances where both claims are for ascertained or readily ascertainable amounts severely diminishes its utility. Historically, two doctrines were developed by the courts which mitigated this position.

One was the doctrine of abatement which was developed by the courts of common law. In essence, this allows a party to a contract for the purchase of goods or services to obtain a reduction in the price payable to the extent that the value of the goods or services has been diminished by reason of a breach of contract by the seller: see Mondel v Steel (1841) 8 M & W 858. Again, it is not suggested that this principle is applicable in the present case.

The second doctrine was that of equitable set-off. The definitive account of the evolution of this doctrine is contained in the judgment of Morris LJ in Hanak v Green [1958] 2 QB 9, described as “masterly” by Lord Diplock in Gilbert-Ash (Northern) Ltd v Modern Engineering (Bristol) Ltd [1974] AC 689 at 717. As explained in that judgment, before the passing of the Judicature Acts there were circumstances in which a court of equity would restrain someone who had brought an action at law from proceeding with the trial of the action or from levying execution of a judgment obtained in the action until further order. Such circumstances included the existence of a cross-claim which the court regarded as entitling the defendant to be protected against the plaintiff’s claim, even though no legal set-off was available. After the Judicature Acts were passed, it was no longer necessary (or permissible) to obtain an injunction to restrain a pending action but in those circumstances in which a court of equity would formerly have granted such an injunction a defence to the claim was available. The basis for such a defence of set-off is thus that “a court of equity would say that neither of these claims ought to be insisted upon without taking the other into account” (per Morris LJ at 26).

The correct test for equitable set-off has been further considered in later cases, most recently by the Court of Appeal in Geldof Metallconstructie NV v Simon Carves Ltd [2010] EWCA Civ 667. In Geldof, at para 43(vi), the Court of Appeal has endorsed as the best statement of the test, and the one most frequently referred to and applied, that formulated by Lord Denning in Federal Commerce & Navigation Co Ltd v Molena Alpha Inc (The “Nanfri”) [1978] 2 QB 927 at 975, namely that equitable set-off is available where a cross-claim is “so closely connected with [the claim] that it would be manifestly unjust to allow [the claimant] to enforce payment without taking into account the cross-claim”.

As the doctrine of equitable set-off has developed, it has ceased to be regarded simply as a procedural defence, in the way that legal set-off undoubtedly is, and has come be seen as affecting substantive rights. In particular, it is now generally accepted that an equitable set-off can be relied on outside the context of legal proceedings and that, where such a set-off is properly asserted, it can prevent a person from exercising contractual or other legal rights which taht person would otherwise have.

The case which most clearly establishes this point is The Nanfri, supra, which concerned a dispute about the payment of hire under three time charters. The terms of the charters required hire to be paid twice monthly in advance; in default of payment the owners had the right to withdraw the vessel. The charterers made various deductions from hire, some of which were disputed by the owners. One of the questions on which the court was asked to rule (on a special case stated by arbitrators) was whether the charterers were entitled to deduct from hire without the consent of the owners valid claims which constituted an equitable set-off. A majority of the Court of Appeal (Lord Denning MR and Goff LJ, Cumming-Bruce LJ dissenting on this point) held that they were.

The importance of this decision is that it establishes that an equitable set-off can be relied on outside the context of proceedings as an immediate answer to a liability to pay money otherwise due and to the exercise of rights, such as a right to terminate a contract, which are contingent on such non-payment.

The critical question for present purposes is precisely how such a set-off operates and in particular whether its effect is to extinguish the claim and cross-claim except in so far as one exceeds the other. This was the position for which Mr Wilson QC contended on behalf of Mr Fearns. As pointed out by Mr Wilson, it is the view taken by Professor Wood in his massive work on the law of set-off; and see also Goode onLegal Problems of Credit and Security (4^th Edn, 2008) at paras 7-06, 7-54–7-55; contrast Derham onThe Law of Set-off (3^rd Edn, 2003) at paras 4-30–4-32. Dicta can be found in some cases which support this view. For example, in Hanak v Green, supra, Sellars LJ said (at 29) that “[i]f there is a set-off at all each claim goes against the other and either extinguishes it or reduces it”. Similar statements can be found, for example, in Lockley v National Blood Transfusion Service [1992] 1 WLR 492 at 495D-E.

Notwithstanding these dicta and the views of some commentators, I do not think it is right to regard either the existence or the exercise of a right of equitable set-off as having the effect of extinguishing or reducing the liability of either party to the other. Three lines of authority lead me to this conclusion.

First, I have referred at paragraphs 19 and 20 above to the authorities which establish the correct test for equitable set-off. From the authoritative statements of the test which I have quoted, I understand the nature of an equitable set-off as being not to extinguish or reduce either claim but only to prevent each party from enforcing or relying on its claim to the extent of the other claim where the connection between the claims would make this manifestly unjust. Accordingly if, after such a set-off has been validly asserted, one of the claims is later satisfied from another source, or withdrawn, the other claim remains in existence and can thereafter be enforced (in full).

The second line of authority starts with The Nanfri, supra. As I have indicated, the majority of the Court of Appeal decided in that case that the charterers were entitled to deduct from hire without the consent of the owners valid claims which constituted an equitable set-off. Because of the way in which the question was formulated – referring as it did to “valid claims” – it was unnecessary to decide what the position would be if (1) the charterers made a deduction from hire which was disputed, (2) the owners withdrew the vessel, and (3) it was subsequently determined in arbitration or court proceedings that the deduction was (partly or wholly) invalid. However, in the course of their judgments Lord Denning MR and Goff LJ addressed this point obiter and expressed conflicting views on it. Lord Denning said (at 975E-F):

“If the charterer quantifies his loss by a reasonable assessment made in good faith - and deducts the sum quantified - then he is not in default. The shipowner cannot withdraw his vessel on account of non-payment of hire nor hold him guilty at that point of any breach of contract. If it subsequently turns out that he has deducted too much, the shipowner can of course recover the balance. But that is all.”

[my emphasis]

By contrast, Goff LJ said (at 982A-B):

“…this defence [of equitable set-off] by its nature is such that it must be open to the charterer to set it up before ascertainment, not merely as a means of preventing the owner obtaining judgment or, at any rate, execution, but also as an immediate answer to his liability to pay hire otherwise due. Of course he acts at his peril and, if he is wrong, he will enable the owner to determine the charterparty if he is willing for his part to act at his peril the other way.” [my emphasis]

The question which gave rise to this difference of opinion arose for decision in Santiren Shipping Ltd v Unimarine SA (The “Chrysovalandou Dyo”) [1981] 1 Lloyd’s Rep 159, where charterers made a deduction from hire which they assessed reasonably and in good faith but which was subsequently held at trial to be excessive. Mocatta J therefore had to decide between the view expressed by Lord Denning and that expressed by Goff LJ in The Nanfri. He preferred the view of Lord Denning as being “in accord with what commercial considerations demand” (see 164).

Robert Goff J took the same view of the effect of an equitable set-off in SL Sethia Liners Ltd v Naviagro Maritime Corp (The “Kostas Mellas”) [1981] 1 Lloyd’s Rep 18, 26. He emphasised that:

“…although a right of set-off is a defence, with all the legal consequences which follow from it, in practice the exercise of a right of deduction or set-off is essentially a provisional act. It decides nothing finally. Its exercise simply operates as a temporary retention of an economic asset by the party exercising the right, and the temporary deprivation of the other party of that asset. For the exercise of the right does not prevent either party from subsequently proving his claim or cross-claim, and so does not affect the final resolution of the fundamental dispute. … Even so bearing in mind the characteristics of the right, it is in my judgment implicit in its very nature that it should only be exercised in good faith on reasonable grounds,”

This line of cases shows that in order for an equitable set-off to arise it is not necessary that the claim which is relied on as a set-off should be valid (on a true analysis of the law and the facts) but only that the claim should be asserted reasonably and in good faith. This being so, it cannot be the case that the exercise of a right of equitable set-off has the effect of extinguishing or reducing the other party’s claim; otherwise a liability could be extinguished by a cross-claim which, although asserted reasonably and in good faith, turned out to be invalid.

The third authority, to which attention is drawn in Derham on The Law of Set-off at paras 4-31–4-32, is Aries Tanker Corp v Total Transport Ltd [1975] 1 WLR 185. In that case charterers had deducted from the payment of freight under a voyage charter a sum claimed as damages for short delivery of their cargo. The owners later sued for the amount which had been deducted. The charterers sought to rely as a defence on their claim for damages. The case is best known for the affirmation by the House of Lords of the special rule of shipping law that a claim for damages cannot be set off against freight. However, the primary ground of the decision was that no set-off was possible because the contract incorporated Article III rule 6 of the Hague Rules. This provides that the ship will be discharged from all liability in respect of loss and damage unless suit is brought within one year after delivery of the goods. Lord Wilberforce, who gave the leading speech with which Viscount Dilhorne and Lords Simon and Edmund-Davies agreed, emphasised that the effect of this time bar is not merely to bar the claimant’s remedy but is to extinguish the claim. Lord Wilberforce held that, because no suit had been brought before expiry of the time limit, the claim had ceased to exist, with the result that the charterers could not rely on it in the subsequent proceedings for any purpose – “whether by defence or (if this is different) as a means of reducing the [owners'] claim, or as a set-off, or in any way whatsoever” (see 188F). This was so even though the charterers had asserted a set-off within the limitation period by deducting the amount of their claim from the freight. Lord Wilberforce said (at 188H-189A):

“The deduction of $30,000, unaccepted by the [owners], conferred no legal rights, and could not alter the legal position. After it, as before, the [charterers] had a disputed – and unquantified – claim against the [owners]: after it, as before, if they wished to pursue and to quantify this claim, they had to bring a suit for damages, or to refer the matter to arbitration. By failing to commence a suit before May 1974, a necessary condition to the survival of their claim, they contractually agreed to discharge it.”

It was thus decided by the House of Lords that the exercise of a right of equitable set-off does not have the effect of extinguishing or reducing the cross-liabilities. Had this been its effect, the charterers would have been able to maintain that the owners’ claim had already been reduced by the amount of the charterers’ cross-claim before the time limit expired. They would therefore have had a potential defence to the owners’ claim to the extent of the deduction made despite the fact that no suit was brought with the limitation period; nor for that matter would the charterers have had any surviving claim after the deduction had been made on which they could have sued or on which Article III rule 6 could bite.

From these different lines of authority I therefore conclude that, where A has a claim against B which A is entitled in equity to set off against a claim made by B against A, neither the existence nor the exercise by A of this right of equitable set-off has the effect of extinguishing or reducing either claim.

This conclusion also seems to me to be in accordance with both policy and principle. If the mere existence of a right of set-off, even if not exercised, had the effect of extinguishing or reducing the cross-liabilities, this would produce great uncertainty and injustice. For example, it would allow a party who failed to make payments under a contract and offered no excuse for the default, whereupon the other party terminated the contract, to argue subsequently that the termination was wrongful because of a set-off of which no mention had been made (and of which both parties might even have been unaware) at the time. It would be equally damaging to commercial certainty if it were the law that the assertion of a set-off has the effect of retrospectively reducing or extinguishing the cross-claims.

A rule that the assertion of an equitable set-off has the effect of extinguishing the cross-claims, whether retrospectively or prospectively, would be contrary to principle. In principle, a tender of payment is only effective to extinguish a liability if the recipient agrees to accept it in discharge of the liability. There must, in the old language of pleading, be accord and satisfaction. Thus, if a debtor tenders payment of the debt but the tender is rejected, the debt is not discharged (though if the creditor subsequently sues, the debtor may have a defence of tender before claim). This applies whatever the form of payment tendered, including therefore where what is offered as satisfaction is discharge of a cross-claim. I accordingly do not see how asserting a cross-claim, however closely connected, in set-off of a liability can have the effect of discharging the liability in the absence of agreement.

As well as by agreement, cross-liabilities can be netted off (and thus extinguished to the extent of the other) pursuant to a judgment of the court. Before such a set-off can be effected it is of course necessary that the existence and amount of each liability has been established by agreement or judgment.

CPR r.40.13 applies where the court gives judgment for specified amounts both for the claimant on his claim and against the claimant on a counterclaim: in such circumstances the court may order the party whose judgment is for the lesser amount to pay the balance. More generally, it has long been the practice of the courts as part of their inherent jurisdiction over their own proceedings to allow cross-judgments given in the same action, or in different actions, to be set off against each other: see Edwards v Hope (1885) 14 QBD 922; Reid v Cupper [1915] 2 KB 147; In re a Debtor, No 21 of 1950 (No 2) [1951] 1 Ch 612. As these cases show, this jurisdiction encompasses judgments for damages and also orders for costs. Unlike legal or equitable set-off, such a ‘set-off’ involves treating the judgment in favour of one party as satisfying pro tanto the judgment in favour of the other. There is accordingly an extinction of liabilities.

It is clear from the authorities mentioned, and from the word “may” in CPR r.40.13(2), that the power of the court to order such a set-off is discretionary. In Edwards v Hope, supra, Brett MR (at 926) and Bowen LJ (at 927) described the power as “an equitable jurisdiction”. By this they plainly did not mean a jurisdiction exercised by courts of equity (as they were referring to the practice of the common law courts) but a jurisdiction to order a set-off where the court considers it just and equitable to do so.

Ordinarily the date at which a set-off ordered by the court will be effected will be the date of the order. No doubt the court has power to order the set-off to be effected at an earlier or later date. I cannot, however, see justification for back-dating the set-off to any earlier date than the earliest date at which a set-off would have been possible, that is when the existence and amount of the two liabilities was finally determined by judgment or agreement. Equally, if the amount of one or both liabilities has not yet been finally determined at the date when the order is made, the date of the set-off should be the date on which that determination takes place.

The conclusions that I have reached as to the correct approach in principle where there are cross-claims which are subject to an equitable set-off is consistent with the Admiralty cases which were cited by counsel.

In The Despina R [1978] 1 QB 396 at 414-415, at first instance, Brandon J considered (obiter) the situation where ships A and B collide and both are to blame, so that the owners of ship A are liable for a proportion of the damage to ship B, and the owners of ship B are liable for a proportion of the damage to ship A. Brandon J observed that it was decided by the House of Lords in The Khedive (1882) 7 App Cas 795 that in this situation there is only one judgment of the court, namely, a judgment for the difference between the amounts of the two liabilities after set-off against the ship which has the greater liability of the two. He continued:

“If one of the two liabilities is in one currency and the other is in another currency (whether both foreign or one foreign and the other sterling) two questions will arise. First, to what common currency should the amounts of the two liabilities be reduced in order to effect set-off? Secondly, at what date should such reduction to a common currency, and the set-off which follows it, take place? My provisional view on these questions, without having had the benefit of argument upon them, is that the currency of the lesser liability should be converted into the currency of the greater liability, and the set-off then effected at the date on which the amounts of the two liabilities are established by agreement or decision. Judgment should then be given for the amount by which the greater liability exceeds the lesser liability in the currency of the greater liability or its sterling equivalent at the date of payment.”

The same view was reached, after hearing argument, by Sheen J in The Transoceanica Francesca and Nicos V [1987] 2 Lloyds Rep 155 and by Clarke J in The Botany Triad and Lu Shan [1993] 2 Lloyd’s Rep 259. In The Transoceanica Francesca Sheen J regarded The Khedive as authority for the proposition that where there is a claim and counterclaim arising out of a collision neither party is liable to pay until a balance has been struck (see p.161). In The Botany Triad and Lu Shan (at 262) Clarke J said that even without the benefit of the earlier cases he would have reached the same conclusion that the correct course is to strike a balance at the date of assessment or agreement. He also held that in principle interest should be added to each claim before the balance is struck.

It is true that these cases were based on Admiralty practice and did not involve consideration of the principle of equitable set-off. But, as Mr Moody-Stuart observed, it would be irrational if the position were different in a case involving a collision between two ships from that which applies in, say, a case involving a collision between two cars in which each driver is at fault and claims against the other. In each case it seems to me that an equitable set-off would plainly arise and would prevent either party from insisting on payment of its claim except in so far as it exceeds the other party’s claim. Equally in each case it is likely to be just and convenient when the parties’ respective liabilities have been established for the court to strike a balance between the two claims and give a single judgment for the net sum.

An authority which may at first sight be thought to support an earlier date is Smit v Selco [1988] 2 Lloyd’s Rep 398. The facts were that the parties had co-operated in the salvaging of a number of ships. In some cases (Class A cases) Selco had contracted with the owners of the ship and Smit was its sub-contractor; in the other cases (Class B cases) Smit was the contractor and Selco the sub-contractor. In the Class A cases Smit, as sub-contractor, was entitled to be paid a share of the remuneration received by Lloyd’s on behalf of Selco from the owners, which was mainly payable in US dollars; and in the Class B cases Selco was entitled to be paid a share of the remuneration received by Lloyd’s on behalf of Smit, which was mainly payable in Dutch guilders. It was common ground (1) that liquidated sums payable by one party as contractor to the other as its sub-contractor could be set off against any sums payable the other way, and (2) that the contractor had a right to effect such a set-off as at the date when Lloyd’s received a payment on its behalf which the contractor had become absolutely entitled to receive.

As a result of orders made in certain proceedings brought by banks to whom Selco’s rights had been assigned, Lloyd’s was prevented from paying over to Smit monies received on its behalf. In these circumstances counsel for Selco argued that it was only when the court made an order for the release of the monies by Lloyd’s that Smit became absolutely entitled to receive these monies so that they matured into a debt payable to Selco which could be set off against sums due to Smit. Accordingly the currency conversion should take place at that date.

Warner J did not accept these arguments. He said (at p.405):

“Those are at first sight powerful arguments, but I do not think that they ought to prevail. In the absence of authority - and Counsel have been unable to find any directly in point - the question must be decided on principle and, to my mind, the relevant principle is that people's rights are not in general changed by litigation about them; the effect of such litigation is only to ascertain and enforce those rights. Accordingly, if but for the interpleader proceedings, the right of Selco or its assigns to receive Selco's share of each payment of Class B remuneration would have arisen when that payment was received by Lloyd's on behalf of Smit, so that Smit would have become entitled to give effect to its right of set-off at the same time, and that is not challenged, Smit's right to calculate the set-off on that basis cannot, in my view, be altered by the existence of those proceedings. The true view is, in my opinion, that Smit's debt to Selco, and Smit's right of set-off, arose when the relevant moneys were received by Lloyd's, and that the interpleader proceedings merely delayed the parties' ability effectively to enforce those rights.”

I would make three comments on this case. First, as I read the judgment, all that Warner J actually decided was that, on a correct analysis of the facts, Smit should be regarded as having become absolutely entitled to be paid sums received by Lloyd’s when Lloyd’s received those sums, notwithstanding the existence of orders made in proceedings which prevented Lloyd’s from releasing the moneys. This decision has no application to the facts of the present case.

Second, although it was common ground that the currency conversion should be calculated at the date when Smit’s “right of set-off” arose, it is not clear from the judgment why this was accepted, nor what type of set-off was being discussed. The approach would, however, have been justified if the set-off was contractual and the parties had expressly or impliedly agreed that there should be a running account between them whereby a share of remuneration payable by either party to the other as its sub-contractor should be brought into account at the date when the contractor received payment of the remuneration.

The third comment that I would make relates to the general principle identified by Warner J that “people's rights are not in general changed by litigation about them” and that “the effect of such litigation is only to ascertain and enforce those rights”. The conclusions which I have reached about the effect of both legal and equitable set-off do not seem to me to conflict with this principle.

I can summarise my conclusions on the relevant law as follows:

Applying these principles to the present case has the consequence that the date at which the damages payable to Mr Fearns and the sum which he owed to De Beer fell to be converted into a common currency and netted off against each other was the date on which the amounts of those liabilities were finally determined.

It might be said that, if the above conclusions are correct, there is a defect in the law which can be illustrated by the following example. Suppose that A exercises a right to set off (either by way of legal or equitable set-off) a claim for damages against a debt owed to B and that the two liabilities are in different currencies. Suppose further that at the time when the right of set-off arises and is asserted the exchange rate is such that B’s liability, correctly calculated, exceeds the amount of A’s debt. However, the claim is disputed, and by the time its amount has been determined by the court, the exchange rate has fluctuated so that, when converted into the same currency, A’s claim is now worth significantly less than the amount of the debt. It may be said that it is unfair if the conversion is made at the exchange rate current at the date of judgment so that A has to bear a liability which has only arisen because of the time taken to resolve the dispute. Moreover, these facts are, in essence, the facts of the present case.

I do not think that the law is defective in this regard because I do not think that it is necessarily the case that on these facts A will have to bear the liability resulting from the movement in the exchange rate. The reason is that the movement in the exchange rate may result in a corresponding increase in the amount of A’s claim. Just as a party may in principle recover damages for a currency exchange loss caused by late payment of a debt (see e.g. President of India v Lips Maritime [1988] AC 395), so too may such a loss form part of the damage caused by the other party’s tort or breach of contract.

The basic object of an award of damages in contract or tort is of course to put the injured party in the same financial position as he would have been in if the breach of contract or tortious act had not occurred. Thus, if A would but for the existence of the claim on which he relied by way of set-off have paid the debt, he can in principle (subject to considerations of remoteness etc.) add the loss flowing from the movement in the exchange rate to the amount of his claim. If on the other hand he would not have paid the debt anyway – for example, because he disputed the debt on other, invalid grounds and relied on set-off only as an alternative basis for non-payment – then I can see no injustice in A bearing the loss resulting from the fall in the value of the currency of his claim.

Accordingly, in the present case the fact that the date of currency conversion is the date of the court’s order does not mean that Mr Fearns must necessarily bear the loss caused by the fall of sterling against the euro since 2005. If on the facts Mr Fearns would have used the profits of which he was deprived by the Defendants’ wrongful acts of trade mark infringement and passing off to pay off part of his debt to De Beer, he could in principle have claimed the additional loss which he has suffered because sterling has depreciated before the damages were paid as a further head of damages.

It was clear on the evidence, however, that Mr Fearns would not have applied such profits to reduce his debt to De Beer. Under the arrangements which the parties had made, the only source of funds from which his debt was being reduced was the sales which De Beer / Anglo Dutch were authorised to make to the franchisees. If Mr Fearns had made more sales himself, he may well have used the profits to buy more products from De Beer; but there was no prospect of his using the money to pay down his outstanding debt.

On the facts of this case, therefore, Mr Fearns could not, and did not, claim that the loss which he suffered because of the fall in the value of sterling against the euro between the time when his claim arose and the date of judgment was caused by any wrongdoing of the Defendants. In these circumstances it is not in my view a loss for which the Defendants can or should be held responsible.

Mr Wilson QC advanced an alternative argument on behalf of Mr Fearns that, even if the existence or exercise of a right of equitable set-off did not reduce the amount owed by Mr Fearns to De Beer in 2005, the way in which the Defendants calculated that amount at the time should be treated as having had such an effect.

There were, as I understood it, two limbs of this argument. First, Mr Wilson relied on the fact that, in their contemporaneous calculations of the amount owed by Mr Fearns, the Defendants overstated the credit due to Mr Fearns for licensed sales. As at the end of June 2005, the total amount credited by the Defendants was €133,323. As it turned out, this was over-generous as I have held that the amount of credit actually due to Mr Fearns for licensed sales was €101,094 (see paragraph 37 of my earlier Judgment). However, Mr Wilson submitted that, in circumstances where credit for a higher amount was given in the Defendants’ books in euros at the then current exchange rate of €1.45 to £1, it would be wrong to undo the accounting now by re-evaluating the credit made at the time. He accordingly argued that the sum of €32,229 (€133,323 less €101,094) which was wrongly credited by the Defendants should be converted at the June 2005 exchange rate.

The second limb of Mr Wilson’s argument involved an analysis of how the Defendants’ figure of €133,323 was calculated. There were two major errors in the Defendants’ contemporaneous credit calculations, which had opposite effects. One error was to treat some sales made to franchisees (in particular, sales of Octoral and De Beer products and some sales of ancillaries) as licensed which were in fact unauthorised. Mr Wilson sought to reconstruct the effect of this error and calculated that it resulted in credits of €59,995 being wrongly given to Mr Fearns. The Defendants’ second major error was to fail to give credit for some licensed sales. On Mr Wilson’s reconstruction, this resulted in a sum of €27,766 being wrongly left out of account. As mentioned, these two errors counteracted each other but their net effect was to overstate the credits due to Mr Fearns by €32,229. Mr Wilson argued that it was appropriate to look behind this end result and also to convert the figure of €27,766 at the June 2005 exchange rate on the ground that the Defendants should have given credit for this further amount.

The second limb of Mr Wilson’s argument seemed to me to be an attempt to have his cake and eat it. On the one hand, he contended that Mr Fearns should get the benefit of the Defendants’ miscalculation of the credit due to him (the first limb of the argument). This contention depends on not looking at the true credit position and treating Mr Fearns’ debt as having been reduced by the amount which the Defendants calculated at the time (albeit erroneously). Yet at the same time Mr Wilson also contended that one should look at the true credit position and give Mr Fearns the benefit in assessing the balance due from him at the end of June 2005 of an amount which the Defendants’ calculations wrongly omitted. The two contentions appear to me to be mutually inconsistent.

In fact, both limbs of the argument are in my view misconceived. The fact that in their contemporaneous calculations the Defendants miscalculated the credits due to Mr Fearns for licensed sales does not provide a reason to assess the amount payable on an incorrect basis. It was not suggested that Mr Fearns agreed the Defendants’ figures nor that he relied on them in any way. In particular, it was not suggested that if the Defendants had calculated the credit due to him accurately he would have made any payment to De Beer to reduce his debt which he did not in fact make. On any view, Mr Fearns’ debt to De Beer in June 2005 was very substantial – the true amount, as I have assessed it, being €627,229 – and it is perfectly clear that the fact that the Defendants mistakenly recorded it in their books at the time as €32,229 less than it actually was made no difference to anything that Mr Fearns did. There is in these circumstances no justification for treating Mr Fearns’ debt to De Beer as having been reduced as at June 2005 by anything other than the credits which were in fact due to him at that time. To calculate those credits it is necessary to include sums which the Defendants at the time mistakenly omitted (as per the second limb of Mr Wilson’s argument) but also to exclude sums which the Defendants wrongly included. I can see no principled basis, and none was identified by Mr Wilson, for correcting only the error which was unfavourable to Mr Fearns and ignoring the error made in his favour.

For these reasons, I rejected both limbs of the alternative case.

In the result, following the approach described in paragraph 50(5) above, I directed that a balance should be struck on 28 July 2010 at the exchange rate of £1: €1.2 current at that date between the principal amounts referred to at the start of this judgment after adding interest on each amount up to the date of the order. I awarded interest on the claim at a rate of 5% above the Bank of England base rate and on the counterclaim at 1½% above the European Central Bank rate. The unusually high premium above the base rate awarded on the damages payable to Mr Fearns was based on evidence adduced of the high cost of borrowing for a person in his parlous financial circumstances.

In the event, although the exchange rate was less favourable to Mr Fearns when judgment was given than it had been in 2005, the interest accrued on the damages payable to him was substantially more than the interest on the euro debt which he owed to De Beer. There were two reasons for this: first, the fact that sterling interest rates during the intervening period were generally higher than the rates available for borrowing in euros; and second, the higher premium over the applicable base rate which I have mentioned.

When the claim and counterclaim were netted off, the result was a balance due to Mr Fearns of £36,832.72.

Although there was thus, in the end result, a balance in favour of Mr Fearns, I took the view that the Defendants were in substance the successful party when the case is looked at as a whole. In particular, the issue at the heart of the case, and which caused it to be fought out for so long at what must have been very considerable expense on each side, was Mr Fearns’ contention that the Defendants had caused him to lose a valuable business. I rejected that contention. Furthermore, the fact that there was in the final calculation a net sum payable to Mr Fearns did not in my view make him the “winner”, given the relative insignificance of this sum in comparison with the size of his claim and the fact that the direction in which the balance turned out to fall depended upon the adventitious effects of interest rates and exchange rate movements over the period of the litigation. Having regard to all the circumstances, including an offer made by the Defendants without prejudice save as to costs at an early stage of the proceedings, I ordered Mr Fearns to pay 70% of the Defendants’ costs of the claim and enquiry. I also made an order under CPR r.44.3(8) for an amount of £300,000 to be paid by Mr Fearns as an interim payment on account of the Defendants’ costs.

At the hearing on 28 July 2010 the further question arose whether the interim payment on account of costs should be set off against the Defendants’ net liability in damages to Mr Fearns, thereby extinguishing the latter liability and resulting in a sum of £263,127.28 payable to the Defendants. As counsel were not in a position to address me on the relevant law at the hearing, it was agreed that I should decide it on the basis of written submissions which were duly sent to me when the order was being drawn up, and that I should give my reasons later.

In ordinary circumstances whether such a set-off was ordered would be of little or no practical consequence. However, Mr Fearns is insolvent and his affairs are subject to a voluntary arrangement under Part VIII of the Insolvency Act 1986. Under the arrangement, the benefit of any damages recovered in these proceedings will go mainly to his creditors (other than De Beer). On the other hand, any liability for costs will lie with Mr Fearns, who has no ability to meet it. In practice, therefore, if no set-off were ordered, the Defendants would have to pay out the sum of £36,832.72 while at the same time recovering nothing in respect of the costs awarded to them.

On behalf of Mr Fearns, Mr Wilson QC submitted that the question of setting off costs against damages is one of law and not one of discretion, and turns on the same principles as govern the set-off of claims generally. He further submitted that, applying the test for equitable set-off, there would be nothing inequitable in treating the damages and costs as falling, so to speak, in separate compartments and that it would be right for Mr Fearns’ creditors to get their share of the damages awarded to him independently of the Defendants’ remedies in relation to their costs.

On behalf of the Defendants, Mr Moody-Stuart submitted that whether there should be a set-off of costs against damages is a matter of discretion and that the only just course was to order a set-off, as it would be manifestly inequitable for Mr Fearns to be able to take the benefit of the damages award and yet avoid the liability in costs by reason of his bankruptcy.

Both sides referred in their written submissions to the case of Lockley v National Blood Transfusion Service [1992] 1 WLR 492, in which the jurisdiction to order a set-off of costs against costs or damages was considered by the Court of Appeal. In his judgment in that case Scott LJ stated five propositions (at 496-7). Three of these are concerned with the particular position of legally aided parties and are not relevant in the present case. But the third and fourth propositions are potentially of general application. They are as follows:

“(3)

The broad criterion for the application of set-off is that the plaintiff's claim and the defendant's claim are so closely connected that it would be inequitable to allow the plaintiff's claim without taking into account the defendant's claim. As it has sometimes been put, the defendant's claim must, in equity, impeach the plaintiff's claim.

(4)

Set-off of costs or damages to which one party is entitled against costs or damages to which another party is entitled depends upon the application of the equitable criterion I have endeavoured to express. It was treated by May J. in Currie & Co v The Law Society [1977] QB 990, 1000, as a ‘question for the court's discretion.’ It is possible to regard all questions regarding costs as being subject to the statutory discretion conferred on the court by section 51 of the Supreme Court Act 1981. But I would not have thought that a set-off of damages against damages could properly be described as a discretionary matter, nor that a set-off of costs against damages could be so described.”

Mr Moody-Stuart also referred to the later case of R (Burkett) v Hammersmith & Fulham [2004] EWCA 1342, in which the Court of Appeal (at paras 41-42 and 44-46) endorsed the view that, as with all other questions of costs, whether to order a set-off between two sums of costs is subject to the statutory discretion conferred by section 51 of the Senior Courts Act 1981. However, the present case involves a set-off between costs and damages and, like Scott LJ in Lockley, I cannot see how this can be said to fall within the discretion conferred by section 51 – at any rate where, as here, the application is to set off an order for costs against damages rather than vice-versa.

In Lockley, in the propositions quoted above, Scott LJ expressed the view that, as it does not fall within the discretion as to costs conferred by section 51, a set-off of damages against damages or of costs against damages is not properly described as a discretionary matter at all, and depends upon whether the test for an equitable set-off is satisfied. He also expressed the opinion (at 497E) that, while a set-off of costs against other costs incurred in the same action “seems so natural and equitable as not to need any special justification”, it is “less obvious that a set-off of costs against damages would always be justified”.

Not only, however, were these statements obiter but (as pointed out in Brookes v Harris [1995] 1 WLR 918 at 925D-F) the Court of Appeal in Lockley does not appear to have been referred to the earlier authorities that I have mentioned at paragraph 37 above which make it clear that the court has a discretionary jurisdiction to order a set-off between different liabilities in respect of damages or costs for which judgment has been given in the same case, or in different cases, in accordance with its view of what is just in the particular circumstances. While therefore it seems to me that it must be right to order a set-off if the principle of equitable set-off applies, in accordance with these authorities I consider that there is also broader discretion to order a set-off if the court thinks it just to do so.

In the present case it does not in fact make any practical difference in my view which approach is adopted. Applying the test for equitable set-off or exercising the court’s discretion, the connection between the two sums is such that justice plainly requires that they be set off. If one looks simply at the position of Mr Fearns and leaves aside the effect of the order on his creditors, I cannot see how it could be right for him to receive a payment of damages without giving credit against the payment for the liability in costs which he has incurred in pursuing the claim to recover those damages. The justice of the matter seems to me equally clear if one considers the effect on Mr Fearns’ creditors, for whose benefit the litigation has in large part been maintained. It would in my view be manifestly unjust that they should receive a share of the damages free of the liability to make a payment on account of the Defendants’ costs which was part of the cost of obtaining the damages award.

For these reasons, I ordered that the sum due from Mr Fearns by way of interim payment on account of the Defendants’ costs should be set off against the Defendants’ liability in damages to him.