Bermuda: Netting And Set-Off In The Appleby Offshore Jurisdictions

Introduction

Netting, or set-off (the terms are used interchangeable), is the accounting process whereby two parties who have traded together, with each owing the other various sums of money, calculate a "net sum" by adding all sums owed to one party and deducting the sums owed by that party to the other.

Appleby is frequently asked to advise banks whether the netting provisions of contracts with borrowers are enforceable. This article briefly looks at the insolvency set-off provisions in each of the jurisdictions whose laws are practiced by Appleby -- Bermuda, the British Virgin Islands ("BVI"), the Cayman Islands, Jersey and Mauritius, which are comparable (with the exception of the Cayman Islands) to section 323 of the United Kingdom Insolvency Act 1986 ("IA 1986").

General Principles

Generally, the express provisions of a contract providing for netting in determining a single lump-sum payment, and defining a payment due date, would be enforced by a court in each of the offshore jurisdictions discussed where the netting occurs, or is deemed to occur, prior to the insolvent winding-up of the offshore Company. In that event, there should be no opportunity for any mandatory rules of insolvency set-off to apply.

The insolvency rules (with the exception of the Cayman Islands, discussed below) approximately provide that:

• where there have been mutual credits, mutual debts or other mutual dealings between the bankrupt and any creditor of the bankrupt proving or claiming to prove for a bankruptcy debt, an account shall be taken of what is due from each party to the other in respect of the mutual dealings and the sums due from one party shall be set off against the sums due from the other; and
  
  
• in Bermuda and the BVI, sums due from the bankrupt to another party shall not be included in the account to be taken above if that other party had notice at the time they became due that a bankruptcy petition relating to the bankrupt was pending.
  
  

We therefore need to consider how the insolvency rules are interpreted in the Appleby jurisdictions.

Bermuda, Cayman And Mauritius

A Bermuda and Mauritius court will only enforce a netting clause on its terms, without reference to mandatory set-off provisions that become applicable in an insolvent liquidation, if it can be said that there are no "mutual debts" between the parties pursuant to section 37 of the Bankruptcy Act ("insolvency set-off") and Article 1291 of the Mauritian Civil Code, respectively. The position in the Cayman Islands is similar, though the key requirement is that, as a matter of the governing law of the contract, transactions under them are executory or conditional and that the netting clause is not interpreted as itself creating debts between the parties. If these conditions are not met, then the insolvency set-off rules will apply.

The usual rule in an insolvency is that creditors must be treated pari passu, meaning at an equal rate or pace. In Bermuda, however, set-off provisions would be enforceable substantially, but not strictly, in accordance with their terms, but only in so far as Section 235 of the Bermuda Companies Act 1981 materially achieves the same effect. Section 235 imports section 37 of the Bermuda Bankruptcy Act 1989, which has similar wording to section 323 of IA 1986. It is not possible to contract out of Section 235; this provision of the Bermuda Companies Act will override the provisions of any other contract, to the extent of any inconsistency. In Mauritius, the commercial result that is achieved from applying the contractual terms is not substantially affected by an application of the Mauritius insolvency rules.

In the event that this contractual accounting analysis is not applied in the Cayman Islands, then winding-up of a Cayman Counterparty is governed by Part V of the Cayman Islands Companies Law (2007 Revision) ('the Companies Law'). Under the Companies Law, the basic rule is that property of a Cayman Company must, in its winding-up, be applied in satisfaction of its liabilities pari passu and, subject to such application, must be distributed among the members according to their rights and interests in the company. This is qualified by the provisions of sections 112(2) and 136(b) of the Companies Law, which covers involuntary and voluntary winding up, respectively, and which states that 'the collection in and application of the property of the company... shall be subordinated or otherwise deferred to claims of any other creditors and to any rights of set off or netting of claims between the company and any persons...'

BVI And Jersey

The position in the BVI and Jersey is the same as in Bermuda, Cayman and Mauritius, except that the provisions of section 150 of the Insolvency Act, 2003 (as amended) of the BVI and Article 34 of the Bankruptcy (Désastre) (Jersey) Law 1990, respectively, are mandatory. The parties to any contract have no discretion to dispense with these provisions even though the result may be that a creditor may receive full payment of his debt in breach of the usual pari passu principle.

In addition, section 435(1) of the BVI Insolvency Act takes precedence over any legislation or rules or policy that may conflict with it. Under the section, the provisions relating to set-off of the net amounts due under netting agreements, the set-off of money provided by way of security, the enforcement of a guarantee or collateral arrangement, and the set off of the proceeds thereof, as contained within a master netting agreement or a guarantee provided for in such an agreement are legally enforceable against a party to such agreement and, where applicable, against a guarantor or other person providing security. This is also the position in Jersey (Article 2 of the Bankruptcy (Netting, Contractual Subordination and Non-Petition Provisions) (Jersey) Law 2005 ("the 2005 Law")).

Under Article 6 of the 2005 Law, where one party to a security agreement is a branch in Jersey of a body corporate established outside Jersey, the right of set-off is enforceable despite any other enactment or rule of law that may be applicable to the body corporate, including the law of the jurisdiction under which it is established. This could be useful to the many branches of international banks established in Jersey, if it proves necessary to rely on set-off.

Conclusion

While it is usual for contractual rights of set-off to be expressly included in agreements, in an insolvent liquidation, insolvency rules may apply, as in Bermuda, Mauritius and Cayman. However, where the necessary conditions are not met in these jurisdictions, then the rules become mandatory, as in the BVI and Jersey.

Although the commercial results may be substantially the same even upon an application of insolvency set-off rules, it is important to note that a creditor may not be entitled to claim the benefit of any set-off against the debtor where he had, at the time of giving credit to the debtor, notice of an act of bankruptcy committed by the debtor and available against him.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.