Bills of Exchange: are there set-off defences to a call on the bill?

Mary Gibbons

This article was first published in the May 2011 edition of Butterworths Journal of International Banking and Financial Law.

It considers whether set-off is an effective defence against a call on a bill of exchange between remote parties where there has been a total or partial failure of consideration.

• This question was considered in the recent case of GMAC Commercial Finance Limited v Mint Apparel Limited [2010] EWHC 2452 (Comm).
• In this case Teare J was unable to say that MINT had a real prospect of success in defending the GMAC claim in respect of the alleged set-offs because there was insufficient authority before him.
• The real difficulty in relation to an allegation of partial failure of consideration arises when what are termed ‘remote parties’ are involved.

In the current economic climate, the expeditious recovery of a straightforward debt due and owing is of paramount importance to a commercial claimant. On the other side, in the absence of a defence and/or counterclaim with a reasonable prospect of success, delay, a reduction of the judgment sum awarded and the avoidance of further liabilities will be the objective of the defendant and his legal advisors. One area which recently has been explored in the courts concerns the extent to which set-off defences are available to a party in bills of exchange transactions.

Bills of exchange have existed since the Middle Ages. They were devised by the Florentines in the 12th century and adopted by the Venetians in the 13th century to facilitate their local and international trading activities.[1] These Italian merchants, together with their bankers and foreign exchange dealers, developed them into a major financial tool to significant effect in foreign trade. Bills of exchange were transformed in part into a form of paper money. They operated as a mechanism for a merchant’s acquisition of international goods through the issuance of a standard document which could be used by the merchant to meet a payment obligation and thus avoid the need to transport bulky precious metals to effect purchase. As a side effect, depending upon its terms, the bill of exchange also provided short-term credit.[2]

There is some dispute as to when they first were the subject of mercantile usage in England.[3] However, there is no doubt that from the late 17th century onwards they became commonplace. Today, as in the past, bills of exchange remain significant short-term credit instruments for international traders. They perform the same dual functions of giving credit to the debtor until the bill matures and of giving the creditor immediate funds by means of a discount as they did historically – and all via a simple document. In line with its commercial purpose, a bill of exchange, just as a promissory note, is to be treated as ‘cash’ unless there is some good reason to the contrary.[4] As a financial instrument in documentary form, it is characterised by negotiability. Being a negotiable instrument, a bill is also a document of title, the possession of which may confer rights. The extent of those rights and the defences which can be raised to a claim to enforce those rights has been the subject of a recent case in the Commercial Court, GMAC Commercial Finance Limited v Mint Apparel Limited [2010] EWHC 2452 (Commercial).

In this case Teare J considered an application for summary judgment brought by GMAC Commercial Finance Limited (‘GMAC’) in relation to two unpaid bills of exchange accepted by Mint Apparel Limited (‘MINT’). GMAC had provided a $20m invoice discount facility (‘the IDA’) to China Export Finance Limited (‘CEF’). CEF provided finance to Chinese exporters by drawing bills of exchange for 100 per cent of the invoice value of goods to be sold internationally, which, when accepted by the importers, MINT, were presented to GMAC. GMAC discounted them under the IDA and paid CEF 85 per cent or in certain circumstances 80 per cent of the value of the bill. CEF in turn paid these funds over to the exporter. Upon maturity of the bills GMAC would present them to the importers for collection, receive funds equal to 100 per cent of their face value and remit the unpaid balance of 15 per cent or 20 per cent (less its fees) to CEF. Following the liquidation of the bills, funds were then available for further advances to exporters – GMAC in effect providing a revolving credit facility to CEF under which funds were drawn down and repaid in the normal cycle of export financing. In this case when GMAC presented the two bills at maturity, one for $671,826.21 and the other for $87,374.28, in early 2010 they were not paid. Thereafter CEF went into administration. Using its power of attorney as provided by the IDA, GMAC indorsed the bills on behalf of CEF to itself and demanded payment from MINT.

GMAC acknowledged that it was not a holder in due course. Thus they accepted that they could not bring their claim as a bona fide purchaser for value without notice, taking free of any defects of title and any equities of prior parties which might have attached to the bills.[5] In its Defence and Counterclaim, MINT argued that it was entitled to challenge the quantum sought as a result. It pleaded that the sums claimed included irrecoverable amounts to which GMAC were not entitled and in addition alleged that there were three other amounts which it was entitled to set off by way of counterclaim. The irrecoverable sum alleged was $143,018.19, being the discount which had never been paid over to the exporter on the two bills; the three other sums which MINT claimed to be entitled to set off against the debt were liquidated and consisted of £204,346.36 which represented the 20 per cent discount from three earlier and paid bills (less the fee) which CEF had failed to pay over to the exporters and which the exporters were claiming from MINT, $27,500 claimed by an exporter against MINT for late payment of a bill and $34,415 claimed by MINT against CEF as CEF had failed to pay an exporter who in turn failed to deliver contractual goods because of the non-payment.

It is the entitlement of MINT to set off the three liquidated sums against GMAC’s claim for payment on the two bills which has raised the question of what set-off defences, if any, does the acceptor of a bill have against a holder for value. The rights of a holder for value are not defined in the Bills of Exchange Act 1882. As the rights and protections of a holder in due course are expressly identified in the Bills of Exchange Act 1882[6] and those of both a mere holder or a holder for value are not, it would appear that the rights of a holder for value are limited to suing on the bill in his own name.[7]

The question then arises as to what defences can be raised against him. As a holder for value, GMAC in this case, lacked the protections afforded to a holder in due course and therefore defects in title brought about by fraud, for example, would have defeated an action on the bill much in the same way as fraud would defeat a claim under a performance bond. They did not arise on the facts. But what about a total or partial failure of consideration?

In the case of a failure of consideration between the original contracting parties where the defendant to a claim on the bill alleges the total absence of consideration, the answer, relying upon older authority,[8] would appear to be that the holder in due course has provided consideration. Therefore any absence of consideration between prior parties to the bill does not constitute an effective defence to a claim. Chitty on Contracts[9] argues for this approach. The learned authors of Byles on Bills of Exchange and Cheques argue that there is no reason why a total failure of consideration could not constitute an effective defence.[10]

Matters are further complicated when the issue concerns a partial failure of consideration as occurred in this case. There appears to be no difference of opinion between textbook writers that a partial failure of consideration between immediate parties can in defined circumstances operate as a defence. Immediate parties are those who have a direct relationship with one another, in addition to the privity created by the bill such as a seller as drawer of the bill and a buyer as acceptor. A partial failure of consideration between such parties can operate as a set-off in these circumstances as long as the sum is ascertained and liquidated. As an example, a seller’s failure to supply the contractual quantity of goods could result in a diminution of the sum recoverable from the buyer under the bill; however, while a buyer’s allegation of unsatisfactory quality of the goods could found a claim for damages, it could not provide a defence to the seller’s action on the bill after its presentation. In those circumstances the claim is neither ascertained nor liquidated.

The real difficulty in relation to an allegation of partial failure of consideration arises when what are termed ‘remote parties’ are involved – the facts in this case. In this case, GMAC was the remote party. It became a holder for value solely as a result of the indorsement on the bill. Both Chitty[11] and Chalmers and Guest on Bills of Exchange, Cheques and Promissory Notes[12] suggest that given these circumstances there is no set-off available to a defendant such as MINT against GMAC’s call on the bill so long as consideration had been paid for the bill (which it was). Byles disagrees.

In this case Teare J was unable to say that MINT had a real prospect of success in defending the GMAC claim in respect of the alleged set-off s because there was insuffi cient authority before him. In the absence of such material, MINT was forced to rely upon an argument that a trust had come into existence in respect of the three sums it sought to set-off against the claim. This argument did not succeed and summary judgment was awarded in favour of GMAC.

CONCLUSION

This case highlights the need for clarity in this area of the law. However, as is apparent, the case has not advanced matters. The basic question: is a set-off an effective defence against a call on a bill of exchange between remote parties where there has been a total or partial failure of consideration remains. But that is not surprising. The difficulty here is that the case law upon which the various learned authors and editors rely is old, sparse and therefore limited in its application. And unfortunately, as matters stand, it does not appear likely that the law will be developed in the short term. Th e reason for this is simply that a well-advised claimant with a bona fi de claim on a defaulted bill will seek summary judgment under CPR Pt 24. Even if a defendant were to persuade the court that there was a real as opposed to fanciful prospect of success in defending the claim, it is highly likely that leave to defend would require a payment into court of the full amount owing. With that prospect, it seems doubtful that a defendant will expend further funds on litigation. And this question will remain unanswered.

Mary Gibbons focuses on commercial work, principally in the areas of banking, insurance, fraud and regulatory matters. Her practice extends into the related fields of professional negligence and insolvency which often require consideration in parallel. She brings an unusual hands-on commercial background to her practice. She worked in a senior management capacity for J P Morgan in New York and London before moving to Hong Kong to run her own corporate financial advisory firm, working with European companies, Hong Kong-based businesses, and Austral-Asian entities and their boards advising them on Far Eastern entry and exit strategies.

[1] Goodwin v Robarts and Others (1874-75) L. R.10 Ex 337 per Cockburn CJ at 346-347.

[2] Concurrently they fostered the development of foreign exchange markets: bills of exchange could be and were denominated in various currencies and often were on-sold to foreign exchange dealers for bills in the required currency.

[3] See Goodwin at 347-348.

[4] Fielding & Platt v Njjjar [1969] 357 at 361 per Lord Denning MR.

[5] Bills of Exchange Act 1882, s 38(2).

[6] Sections 12,20(2), 21(2), 29(2), 38(2), 54(2), 55(2) and 64(2).

[7] Section 38(1).

[8] For example, Forman v Wright (1851) 11 CB 481.

[9] 30th edition, Volume II at paras 34-097 and 34-099.

[10] 28th edition at para 19-046.

[11] Archer v Bamford (1822) 3 Stark 175.

[12] 17th edition at paras 4-009 and 4-027.