Right of Set off under the UAE Civil Transaction Law No. 5 of 1985 and the view from the DIFC

In a 2018 judgment the DIFC, discussed
and decided upon the concept of set-off
under the UAE Civil Transaction Law No. 5 of 1985 (the “Civil Code”).

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.

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