J. Set-off and Account Combination

• Author: M.H. Ogilvie
• Profession: LSM, B.A., LL.B., M.A., D.Phil., D.D., F.R.S.C. Of the Bars of Ontario and Nova Scotia Chancellor's Professor and Professor of Law, Carleton University
• Pages: 247-250

Page 247

The rule in Clayton’s Case applies only to appropriations within a single account. But customers typically have several accounts with a bank, as well as accounts at several branches of the same bank. Where a customer creates an overdraft in an account or draws a cheque that can be paid only by combining funds in more than one account, the question is raised of whether a bank may combine or consolidate funds or accounts to discharge the overdraft loan or honour the payment instruction. In the case of an overdraft, the bank wishes to set off other funds to discharge an indebtedness to it, that is, for its own purposes, but where it wishes to do so to comply with a customer’s mandate, it is doing so for the customer’s purposes, that is, to discharge the customer’s indebtedness to a third party. Banks are expected to honour a customer’s mandates generally both by contract and to protect the customer’s reputation.¹²⁶

Bank and customer agreements typically provide that banks may exercise a right of set-off to discharge an indebtedness to the bank without notice to the customer, but they are less likely to make provision for setoff to ensure payment of any payment instruction from the customer. The exercise of set-off, then, requires consideration of the common law against which account agreements operate. Most of the case law is concerned with the situation where a bank combines accounts in its own interest, and this situation will be considered first.

A bank’s right to combine accounts in order to discharge an overdraft is based on the fundamental bank and customer contractual relationship entered into when the first account is opened. In Re European Bank, Agra Bank Claims,¹²⁷the customer bank maintained three accounts at another bank, but both banks failed. The indebtedness in two accounts was covered, but the question arose of whether securities originally given to cover acceptances of bills of exchange in relation to one of these accounts could be applied to discharge the indebtedness in the third account or were to be given to the liquidator. The English Court of Appeal found that the securities could be applied to the indebtedness in the third account on the ground that there was essentially one account(ing) between the bank and customer, although there may have been several accounts.¹²⁸

Although it is arguable that each account opened between bank and customer is a separate contractual agreement, Re European Bank has become widely accepted in

Page 248

banking law¹²⁹and enshrined in most bank and customer contracts in widespread use today.

The last time a final appellate court considered this issue was in 1972 in the House of Lords in National Westminster Bank Ltd. v. Hale-sowen Presswork & Assemblies Ltd.,¹³⁰which clarified the distinction between set-off and the exercise of a banker’s lien. In that case, it was agreed that a customer whose company accounts were in substantial overdraft would open another account as a working account and that the corporate accounts would be consolidated and frozen until the company’s affairs improved. The customer subsequently resolved to wind down voluntarily, and the bank took the view that this decision constituted a material change of circumstances and set-off the balance in the working account against the overdraft in the frozen account. The House of Lords upheld the bank’s right to do so.

The law lords used the terms "set-off," "combination" and "consolidation of accounts" interchangeably, thereby indicating that these are different ways of referring to the same concept. However, they also distinguished "combination" and "lien." Account combination or set-off cannot be an exercise of a right of lien because the funds set-off belong to the bank by virtue of the bank and customer contract as a debt owed to the customer, whereas a lien does not confer legal title. A person cannot have a lien over that person’s own property, especially when it is in that person’s possession. In Halesowen, the law lords also rejected...