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This shows that German law, too, might be confronted with undesirable consequences of ‘officious intermeddling’ which English law tries to brush aside at the earliest possible stage. (See also, Esso Petroleum Co Ltd v Hall Russell & Co Ltd and Shetland Islands Council (‘The Esso Bernicia’) [1989] AC 643). However, if subrogation is denied as a matter of principle, several burning questions must be answered: does the unauthorised payment by a third party discharge the debt? If the debt is discharged then the debtor received an incontrovertible benefit. If, on the other hand, this were denied the question remains whether the creditor has retained his claim, and if so whether the payer can recover the payment from him on the ground that there had been a total failure of consideration or, as a German lawyer would express it, because the payment did not achieve its purpose (condictio causa data, causa non secuta = Kondiktion wegen Zweckverfehlung). In the opinion of Goff and Jones, the plaintiff in Owen v Tate would have succeeded with his action if the bank had expressly assigned its claim against the defendants to the plaintiff. It is therefore strongly arguable that the plaintiff should be subrogated to the creditor who has accepted his suretyship and his payment (Goff and Jones, The Law of Restitution (6th edn, 2002), paras 3-016 and 15-010–15-011 and see also Watts, ‘Guarantees undertaken without the Request of the Debtor’ [1989] LMCLQ 7. Indeed, neither the common law authorities on subrogation nor the statutory adoption of the right in section 5 of the Mercantile Law Amendment Act 1856 was mentioned in the judgments of their Lordships in Owen v Tate; but see also Birks, An Introduction to the Law of Restitution (1989), pp 191–2 who maintained that this is not essentially different from a restitutionary right directly available to the surety against the defendant). There is also something to be said against generalisations from Owen v Tate, the facts of which are exceptional. This is why Ormrod LJ, even though concurring in the result with Scarman LJ, remarked that he would prefer to reserve any opinion about guarantors who enter into guarantees without the request of the principal debtor (at 414). (On the restitutionary analysis of Owen v Tate, see further Burrows, The Law of Restitution, pp 282–6 and the references cited therein.)

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A Blomeyer, ‘Außerprozessuale Aufrechnung und Prozeßaufrechnung’ ZZP 88 (1975) 439; Bötticher, ‘Die ‘Selbstexekution’ im Wege der Aufrechnung und die Sicherungsfunktion des Aufrechnungsrechts’ in Festschrift für Schima (1969) 95; Coester-Waltjen, ‘Die Aufrechnung im Prozess’ Jura 1990, 27; Derham, The Law of Set-off (3rd edn, 2003); Kegel, Probleme der Aufrechnung (1938); Gernhuber, Die Erfüllung und ihre Surrogate (2nd edn, 1994) §§ 12–14; Goode, Legal Problems of Credit and Security (3rd edn, 2003) chapter 7; Goode, Principles of Corporate Insolvency Law (2nd edn, 1997) chapter 8; Lüke and Huppert, ‘Die Aufrechnung’ JuS 1971, 165; McCracken, The Banker’s Remedy of Set-Off (1993); Meagher, Heydon and Leeming, Meagher, Gummow and Lehane’s Equity—Doctrines and Remedies (4th edn, 2002) chapter 37; Musielak, ‘Die Aufrechnung des Beklagten im Zivilprozeß’ JuS 1994, 817; Tiedtke, ‘Zur Aufrechnung mit verjährten Schadensersatzforderungen gegen den Anspruch des Verkäufers auf Zahlung des Kaufpreises’ JZ 1988, 233;

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Wood, English and International Set-Off (1989); Wood, Law and Practice of International Finance: Title Finance, Derivatives, Securitisations, Set-Off and Netting (1995) Part III; Zimmermann, Comparative Foundations of a European Law of Set-Off and Prescription (2002).

(a) Preliminary Observations

As was explained earlier in the text, set-off (Aufrechnung, §§ 387–96) is treated by the BGB as a substitute for performance. Its effect is to extinguish the relevant obligation. It follows that the civil law rules on set-off are of a substantive character. Traditionally, English courts regarded this form of relief as a matter of procedure (see eg, the discussion in Derham, The Law of Set-off (3rd edn, 2003), chapter 1), since the substantive effect—the extinction of both claims—can be produced only by the courts, that is to say by a judgment which allows the set-off and therefore dismisses the plaintiff’s claim. This approach to set-off remains true of the common law rules on the subject: see Stein v Blake [1996] AC 243, 251 (per Lord Hoffmann). More recent developments in equity however have confirmed that certain types of equitable set-off do have a substantive character: see BICC plc v Burndy Corpn [1985] Ch 232 and

Pacific Rim Investments Ltd v Lan Seng Tiong [1995] 3 SLR 1 (see Goode, Legal Problems of Credit and Security (3rd edn, 2003), paras 7-05 and 7-48). The judgment of the House of Lords in Bank of Boston Connecticut v European Grain & Shipping Ltd

[1989] 1 AC 1056 confirmed this position, the area often being known as ‘transaction set-off.’ ‘[T]he party seeking the benefit of [the set-off must] show some equitable ground for being protected against his adversary’s demand’ (Rawson v Samuel (1841) Cr & Ph 161, 178; 41 Eng Rep 451, 458, per Lord Cottenham LC). To show this, there must be a cross-claim ‘flowing out and inseparably connected with the dealings and transactions which also give rise’ to the claim (Bank of Boston Connecticut, 1102–3; cf the discussion in Meagher, Gummow and Lehane’s Equity (cited above), para 37-050, criticising the loose language used by a number of English courts in defining this connecting requirement in equity). Note also that express contractual set-off can operate as a substantive defence under English law: where the parties specify a particular event or act that is to trigger the netting out of mutual obligations, then on the occurrence of that event the contractual set-off takes on a substantive character that can be ranged against claims to the debt due. In civil law systems, the extinction of debts is effected not by the court but by an informal unilateral, extra-judicial declaration by one of the parties or, under certain circumstances, even by operation of law, ie, by the mere fact that the creditor owes his debtor the same amount as he is entitled to claim (ipso iure compensatur; see Article 1290 Code civil which, however contrary to its categorical wording, operates only if one of the parties relies on it).

The key differences between common law and equity when dealing with set-off are as follows: first, equitable set-off allows an equitable claim to be set-off against another equitable claim or against a common law claim. Secondly, the common law requires a liquidated claim to ground a set-off, while equity does not insist on this requirement. Thirdly, equity does not require that there be precise mutuality if set-off is to be available: at common law, the two claims had to be between the same parties, owed in the same capacity and relating to the same right. However, equity does require a sufficient ground be shown for protecting the defendant against the

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claimant’s demand (ie, the defendant’s claim must ‘impeach’ the claimant’s claim in some way: ‘[t]he mere existence of cross-demands is not sufficient’ (Rawson v Samuel (1841) Cr & Ph 161 at p 178–9; 41 Eng Rep 451 at p 458). (See generally, Spry, ‘Equiatble Set-Offs’ (1969) 43 ALJ 265 and the judgment of Woodward J in D Galambos & Son Pty Ltd v McIntyre (1974) 5 ACTR 10.) Note also that in the English case law concerning substantive set-off in equity, it remains an open question whether such a set-off must be asserted by notification to the other party before it can take effect: compare the judgments of Dillon and Ackner LJJ (finding that set-off was self-executing in those circumstances) with that of Kerr LJ (assertion by notification to the other party is required) in BICC plc v Burndy Corp [1985] 1 All ER 417. Goode has supported Kerr LJ’s view as according better with the expectations of the other party, at least where the obligation appears prima facie independent of the obligation claimed to be set-off (Legal Problems of Credit and Security (3rd edn, 2003), para. 7- 52). (See also Re Palmer’s Decoration and Furnishing Co [1904] 2 Ch 743; Stewart v Latec Investments Ltd [1968] 1 NSWR 432 and Stehar Knitting Mills Pty Ltd v Southern Textile Converters Pty Ltd [1980] 2 NSWLR 514, at 518.)

The difference in classification which exists between English law and the continental rules can be of particular importance in disputes containing foreign elements (although insofar as the substantive version of equitable set-off is applicable, the classification difference may be so small as to be insignificant). Hence English courts apply the lex fori, while continental courts apply the proper law of contract in which the debt arose. This difference of classification does not however prevent the application of foreign substantive rules on set-off in an English court if, for instance, the proper law of the contract is German and the defendant’s plea is that the plaintiff’s claim has been extinguished according to the rules governing the contract in which the claim originates. In a case like this, the defendant who pleads a set-off against a German debt in an English court does not ask for a ruling of the court to set one claim off against another (compensatio debiti per iudicem), for his plea is that the plaintiff’s claim has been extinguished under the applicable German law. (For further examples, see Martin Wolff, Private International Law (2nd edn, 1950), pp 233–4 and 456–7. Cf Staudinger-Magnus, Article 32 EGBGB, Rn. 61 et seq.)

In German law, to which we now turn, the set-off is made by declaration to the other party. Such a declaration will be ineffective if it is made subject to any condition or limitation of time (§ 388 BGB). A valid set-off has retrospective effect: insofar as the two claims cover each other, they are deemed to have expired at the moment at which, being suitable for set-off, they are ranged against each other (§ 389 BGB). All the conditions for set-off are laid down in § 387 BGB, which requires careful reading. It states: ‘If two persons mutually owe acts of performance which are of the same kind, either party may set off his claim against the claim of the other party as soon as he can demand the performance due to him and effect the performance due by him.’ The criteria for set-off contained in this provision must now be considered seriatim.

(b) Mutuality of Claims

The creditor of the one claim must be the debtor of the other claim and vice versa, which is also the basic position in English law (both at law and in equity: see eg, Stein v Blake (cited above) and Clark v Cort (1840) Cr & Ph 154; 41 ER 449). As a matter

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of principle therefore third parties may not intervene. For a common lawyer this may not be worth mentioning; but in German law § 267 BGB permits performance by third parties, the approval of the debtor not being necessary. This covers all cases where a debtor need not perform in person, especially money debts. Only in the extremely rare case that both the creditor and the debtor object will performance by a third party not be allowed (§ 267 II BGB). However, the rule against intervention by a third party by way of set-off is subject to exceptions in cases where such third party has a right to substitute performance. Suffice it here to mention only the basic fact situation which is directly in point: if the creditor levies compulsory execution on an object belonging to the debtor, any person who through that execution incurs the danger of losing a right in the object is entitled to satisfy the creditor. This includes satisfaction by set-off (§ 268 BGB; see also §§ 1142 II, 1150 and 1249 BGB concerning analogous cases in the law of mortgages and rights of pledge on movable things).

(c) Claims of the Same Kind

The performances mutually owed must be of the same kind. This refers, in the first place, to money debts, always provided that they are expressed in the same currency; but it is different in the case envisaged in § 244 BGB: in Germany money debts expressed in a foreign currency are payable in German currency, unless payment in the foreign currency is expressly stipulated.

The English common law approach is similar, insisting that the ‘debts . . . [be] either liquidated or in sums capable of ascertainment without valuation or estimation’ (Stein v Blake (cited above) at 251). Thus, a claim to property by the first party will be of the ‘same’ kind where the second party is authorised to dispose of that property and convert it into money. Equally, if such claims are ascertainable only by litigation, then they will not be sufficiently ascertainable to qualify (see Hanak v Green [1958] 2 QB 9, at 14 (per Morris LJ)). In equity, however, the courts have not imposed such strict requirements that the claim must be liquidated: see eg, Lord Cawdor v Lewis (1835) 1 Y & C Ex 427; 160 Eng Rep 174 and Pigott v Williams (1821) 6 Madd 94; 56 Eng Rep 1027.

(d) Validity, Maturity and Enforceability of the Claim Set Off

It goes almost without saying that the claim actively used for set-off (Aktivforderung) must be enforceable, because the party setting off his claim against the claim of the other party thereby forces on this party the fulfilment of an obligation which otherwise could be achieved only with the aid of a court. Since set-off under German law is nothing but a form of self-help, this can only be tolerated if all the conditions, which a court would require, are met when ordering the enforcement of a claim. This is supplemented by § 390 BGB: a claim against which there is a defence (Einrede) may not be set off. This provision has in mind claims, the performance of which is deferred by agreement of the parties (Stundung) or situations where the person bound is temporarily entitled on any other ground to refuse to make performance. (A similar basic position is reached at common law by the insistence that the debt be due and enforceable, and that where ascertainment of the debt is only possible through litigation this would not be sufficient: see the discussion in Hanak v Green and Stein v Blake (cited

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above).) However, in German law there is an important exception to this rule. Prescription (Verjährung) does not exclude set-off if the claim barred by prescription had not prescribed the time at which, being suitable for set-off (see § 389 BGB), it could have been set off against the other claim (§ 215 BGB). For the sake of clarity, it should be added that this does not apply if the claim has already been extinguished because a period of time absolutely limiting the exercise of a right has elapsed (socalled Ausschlußfrist; English law would take the same view, since in such cases a time bar would render the debt unenforceable). In such cases, the BGB does not speak of ‘prescription’ but states categorically that action must be taken within a certain period of time (see, eg, §§ 121, 124, 214 BGB). A good illustration of the present problem is provided by a leading case decided by the Federal Labour Court (BAG NJW 1968, 813).

In that case, an employee wished to set off a claim against a claim of his employer, but when he made this declaration to the employer his claim had already been barred absolutely by a clause contained in the collective agreement (Tarifvertrag) made between the employers’ union and the trade union. The court distinguished this case from the case envisaged in § 215 (previously § 390 sentence 2) BGB and denied the analogous application of that provision to the present fact-situation (contra BGHZ 26, 304, 308–10 which however has since then come round to the view of the Bundesarbeitsgericht; see the cases listed by Palandt-Heinrichs, § 215 Rn. 2).

(e) Existence of the Claim of the Other Party

The existence of the other party’s claim seems to be an obvious requirement of set-off, because otherwise the party who wishes to set off his claim would not be the debtor of the other party. However, this statement should be received with some caution. In German law, gaming or betting creates no obligation; but what has been given by reason of gaming or betting may not be demanded back on the ground that no legally enforceable obligation existed in the first place (§ 762 BGB). The policy behind this rule need not be analysed at this juncture. One thing, however, is clear: the loser of the game or bet, who has paid his ‘debt’ in cash, cannot afterwards rely on a claim for the return of an unjust enrichment. In other words, gaming or betting is a sufficient causa acquirendi or naturalis obligatio (Naturalobligation). The solution can hardly be different if the loser has set off his claim against the ‘claim’ of the winner. The loser’s claim is extinguished thereby and the winner is relieved from a debt. So much then for the ‘basics’ of set-off in German law.

The BGB supplements these rules by some special provisions (§§ 391–6), which need not be explained in detail because their wording is clear beyond all doubt. The policy pursued by the legislator is also easily recognisable. Thus, § 393 BGB forbids any setoff against a claim arising from a delict wilfully committed. Special mention however should be made of §§ 94 et seq of the Bankruptcy Act (Insolvenzordnung) for the effect of set-off. For these provisions put a creditor, who is able to set off his claim against a claim of the debtor, in a privileged position when compared with the other creditors of the insolvent estate. For, unlike the latter (who must content themselves with the dividend, if any, at the end of the bankruptcy proceedings), the former’s claims receive full satisfaction. Similarly, in English law this basic result is achieved by the mandatory operation of rule 4.90 of the Insolvency Rules 1986: see Goode, Legal Problems

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of Credit and Security, para 7-76 ff for discussion of this complex area. Indeed, great care must be taken in the drafting of multilateral netting regimes to ensure that they do not fall foul of mandatory rules of insolvency set-off and pari passu distribution on the liquidation of one of the parties. For an especially tricky example, see British Eagle International Air Lines Ltd v Compagnie Nationale Air France [1975] 1 WLR 758 (where the involvement of the International Air Transport Association (IATA) as a clearing house for payments from and credits to member airlines raised difficult issues of netting payments among different airlines when British Eagle went into liquidation, while still holding a claim against Air France. See Goode (above), para 7-76 ff for discussion and critique).

Finally, BGHZ 24, 97, case no 113, provides an interesting illustration of the complex interplay between the rules of civil procedure, set-off and the right of retention. In this case, a surety sought to rely on a set-off declared by the principal debtor. If the set-off had served to extinguish the debt, the surety would (following the accessory nature of the guarantee: § 767 BGB) likewise have been relieved from liability. Furthermore, § 770 II BGB entitles the surety to a defence if the principal debtor could declare a set-off. However, in the case at hand the set-off was invalid under the rules of civil procedure. This was because the principal debtor had not raised the defence of set-off before the conclusion of the legal proceedings against him (§ 767 II ZPO; see also, BGH NJW 1994, 2769). Thus, the surety could not invoke the set-off either. However, since the principal debtor could in respect of the counterclaim have invoked the general right of retention under § 273 BGB (discussed above, section 2), the surety could rely on this defence (§ 768 I BGB).