We first take a look at Articles 368- 372 of the Civil Code which deal with the concept of “Set-off”.

A Set off is defined as the settlement of a debt due to a creditor, against a debt owned by him to his debtor (Article 368)

A Set off may be either (i) mandatory/legal, and takes place by the power of law, or (ii) facultative, carried out by agreement of both parties, or (iii) judicial carried out by decision of the judge (Article 369).

The legal Set off requires that each of the parties be a creditor and debtor for the other, and that both debts be similar in kind, description, maturity, force and weakness, and further provided that applying such offset does not prejudice the rights of third parties regardless of whether the two debts have the same cause or different ones. (Article 370)

A judicial Set-off is one that takes place by order of a judge if the conditions thereof are satisfied, upon either an original or an interlocutory application (Article 371).

A set-off may be made by agreement if any of the conditions for a mandatory/legal Set-off are not satisfied (Article 372)

Background

This dispute before the DIFC Court related to two loan agreements made between the lending banks (Creditor) and a company (Debtor);

The first loan agreement (the “2009 Loan”) was governed by UAE law;

The second loan agreement (the “2010 Loan”) was governed by English law;

2009 Loan was secured by a share pledge agreement between the same parties (“Share Pledge”). The 2010 Loan was secured by an assignment agreement and an account pledge; and

Both the 2009 and the 2010 Loans had clauses that waived the right to claim any Set-off.

The Creditor made an application before the Court of First Instance for immediate judgment against the Debtors for (i) the payment of the outstanding principal and (ii) a declaration that the Creditor was entitled to enforce the Share Pledge to satisfy and collect all amounts determined as outstanding in favour of the Creditor.

The Debtor in defense claimed a Set-off against amount claimed by the Creditor on the ground that the Creditor breached the 2009 and 2010 Loans as well as the Share Pledge.

The Court of First Instance found in favour of the Creditor; the main findings were that the presence of anti-set-off clauses in the 2009 and 2010 Loans operated to exclude all forms of Set-off, thereby entitling the Creditor to immediate judgment on its claim and further, the Debtor could not claim a Set-off as its counterclaim was not quantified and therefore not “indisputable, payable and known.”

The Debtor appealed on the basis that there was a compelling reason why the appeal should be heard, namely, the public interest in clarifying the meaning and extent of the doctrine of mandatory and judicial set-off as set out in Articles 369 to 372 of the UAE Civil Code. The matter was then heard by the Court of Appeal. The Parties made comparative law submissions on the law of set-off with the equivalent provisions in the Civil Codes of Egypt, Iraq, Jordan and Syria to assist the court.

Though there were many issues raised and discussed in the judgment, in this article we are limiting ourselves to a discussion of the Set off provisions of the UAE law.

One of the interesting issues was whether a Set off could be claimed in the defense petition or does it have to filed as a counterclaim or separate petition?

The Debtor had raised the issue of set off in the defense filed by him, rather than in a counterclaim or a separate claim. The Debtor relied on the Rule 17.33 of the rules of the DIFC (the “Rules) which allows set off to be included in the defense.

The Court examined the issue whether the requirement to file a counterclaim was procedural one or a substantive one. The court examined the relevant laws of Egypt and Jordan for a better understanding of the issue and came to the conclusion that the requirement to file a counterclaim was a substantive requirement and not merely a procedural issue. It is a substantive requirement to be fulfilled before permission can be given to an applicant for judicial set off to occur. Therefore the Debtors were required to file a separate claim or interlocutory claim rather than plead a set off in the defense. In the present case Debtors failed to do; even though they had been given ample opportunity to do so. Further, the Debtors claim was unquantified.

The Court relied upon the Dubai Court of Cassation, Petition No. 80/2010 to reach the above conclusion, where it was held that Articles 368, 369 370 and 371 of the Civil Procedures Law stipulated that if a disputed debt exists the clearance should be a judicial one which should be requested through a normal case or a special request.

Conditions for a judicial and legal set-off

Since the Debtor had failed to file a counter claim, the court did not need to consider the requirements of a judicial set off; however the court’s proceeded to discuss for the sake of completeness the conditions for judicial set off to be granted and made insightful observations to elucidate the concept of judicial set off.

The Court considered the comparative law analysis prepared by the Parties and some notable commentaries on Egyptian law to examine the conditions for a judicial set off.

The Court held that the conditions for judicial and mandatory/legal set off are different. The Court relied on the judgment of the Dubai Court of Cassation No 77/2011 and held that in a legal Set-off, the Set-Off claim must be indisputable, payable and known.

The Court came to the conclusion that judicial set off exists when the two conditions of legal set off are absent- i.e. absence of dispute and the pre determination of the value. The correspondence of debts, their maturity for being sues, the probability of attachment and maturity are required in judicial set off as well as a legal Set-off.

The Court observed that save for the fact that the court has a wide discretion in granting judicial Set-Off there is little guidance on how a court can decide on allowing judicial set off once the conditions of legal set off are not fulfilled. The pre-conditions for judicial Set off as described in the Dubai Court of Cassation decision in Petition 129/2009 (Labour)( 07 June 2010) “are likely to be correct”; the conditions being that the two parties should be a creditor and debtor to each other only; there is no requirement for a connection in terms of subject or reason between the two debts; any of the debts may be disputed; any of the debts may have a “non-determined value” as long as it is payable.

The Court further observed that while it was not necessary to discuss legal/mandatory Set off in this matter, the Court would briefly discuss the same. Based on Dubai Case No 77/2011 Commercial Appeal by Cassation; it could be said that for a mandatory set off to occur, the debt needs to be indisputable, payable and known.  The Court also referred to Dubai Court of Cassation on appeal Case No. 129/2009 where the court compared legal and judicial Set-off. While it was not expressly stated in the case that legal set off needed to be quantified, this could be inferred from the judgment which said that in a legal set off the two parties debts should be the same type in terms of description, maturity, force weakness etc, while in a judicial set off the parties should be in creditor and debtor to each other even if the debt is disputed, or non-determined, as it is sufficient it should be payable.

Could parties contract out of the legal Set Off provisions of the Civil Code

The Hon’ble Court reviewed the provisions 257-265 on interpretation of contracts in the Civil Code

The gist of these Articles are that the basic principle in contracts is the consent of the contracting parties and what they have undertaken to do in the contract; there shall be no room for implications in the face of clear words; words should be given effect to rather than ignored, but if it is impossible to give effect to words, they shall be ignored. If the wording of the contract is clear, it may not be deviated from by way of interpretation to ascertain the intention of the parties.

The Court found that the clauses excluding Set-off were clear and unambiguous in both the 2009 and 2010 loan agreements. The intention of the parties was clearly established. The question remained if the parties could by agreement override the provisions of legal set off.

The Court examined the provisions of the Egyptian and Syrian law; where the right to Set- off can only be waived when the right comes into existence and not before. The UAE Civil Code is silent on this point; therefore there is no express prohibition to waive the right of Set off in an agreement.

The court then examined the question whether the restriction on the right of waiver of Set Off could arise from any fundamental principle of UAE law such as the right to justice. The Court did not find any supporting authority presented to it on this subject, further it was not disputed that it was not a question of public order.

Therefore the court found that the waiver of Set off is not prohibited and the clause waiving the right of Set off the 2009 agreement was valid under UAE law

The anti-Set-off Clause in the 2010 agreement governed by English law was held to be valid as it served the legitimate commercial interests of the parties.

Thus it was held that the mandatory Set-off does not override the parties’ freedom to contract under Articles 257, 259 and 265(1) of the Civil Code.

The Appeal Court unanimously allowed the application for immediate judgment against the Debtor and upheld the validity of the anti-Set off clauses in the two loan agreements.