Right of set-off :

The right of set-off is a statutory right which enables a debtor to take into account a debt owed to him by a creditor, before the latter could recover the debt due to him from the debtor. In other words, the mutual claims of debtor and creditor are adjusted together and only the remainder amount is payable by the debtor. A banker, like other debtors, possesses this right of set-off which enables him to combine two accounts in the name of the same customer and to adjust the debit balance in one account with the credit balance in the other. For example, A has taken an overdraft from his banker to the extent of Rs. 5,000 and he has a credit balance of Rs. 2,000 in his savings bank account, the banker can combine both of these accounts and claim the remainder amount of Rs. 3,000 only. This right of set-off can be exercised by the banker if there is no agreement – express or implied – contrary to this right and after a notice is served on the customer intimating the latter about the former’s intention to exercise the right of set-off. To be on the safer side, the banker takes a letter of set-off from the customer authorizing the banker to exercise the right of set-off without giving him any notice. The right of set-off can be exercised subject to the fulfillment of the following conditions:

(i) The accounts must be in the same name and in the same right. The first and the most important condition for the application of the right of set-off is that the accounts with the banker must not only be in the same name but also in the same right. By the words ‘the same right’ meant that the capacity of the accountholder in both or call the accounts must be the same, i.e., the funds available in one account are held by him in the same right or capacity in which a debit balance stands in another account. The underlying principle involved in this rule is that funds belonging to someone else, but standing in the same name of the account – holder, should not be made available to satisfy his personal debts. The following examples, make this point clear:

(a) In case of a sole trader the account in his personal name and that in the firm’s name are deemed to be in the same right and hence the right of set-off can be exercised in case either of the two accounts is having debit balance.

(b) In case the partners of a firm have their individual accounts as well as the account of the firm with the same bank, the latter cannot set-off the debt due from the firm against the personal accounts of the partners. But if the partners have specially undertaken to be jointly and severally liable for the firm’s debt due to the banker, the latter can set-off such amount of debt against the credit balances in the personal accounts of the partners.

(c) An account in the name of a person in his capacity as a guardian for a minor is not be treated in the same right as his own account with the banker.

(d) The funds held in Trust account are deemed to be in different rights. If a customer opens a separate account with definite instructions as regards the purpose of such account, the latter should not be deemed to be in the same right. The case of Barclays Bank Ltd. v. Quistclose Investment Limited may be cited as an illustration. Rolls Rozer Ltd .borrowed an amount from Quistclose Investment Ltd. with the specific purpose of paying the dividend to the shareholders and deposited the same in a separate account ‘Ordinary Dividend No. 4 Account with Barclays Bank Ltd. and the latter was also informed about the purpose of this deposit. The company went into liquidation before the intended dividend could be paid and the banker combined all the accounts of the company, including the above one. Quistclose Investment Ltd., the creditors of the company, claimed the repayment of the balance in the above account which the bank refused. It was finally decided that by opening an account for the specific purpose of paying the dividend a trust arose in favour of the shareholders. If the latter could not get the funds, the benefit was to go to the Quistclose Investment Ltd. and to the bank. The banker was thus not entitled to set-off the debit balance in the company’s account against the credit balance in the above account against the credit balance in the above account. The balance held in the clients’ account of an advocate is not deemed to be held in the same capacity in which the amount is held in his personal account.

(e) In case of a joint account, a debt due from one of the joint account- holders in his individual capacity cannot be set-off against an amount due to him by the bank in the joint account. But the position may appear to be different if the joint account is payable to ‘ former or survivor’. Such an account is deemed to be primarily payable to the former and only after his death to the survivor. Thus the former’s debt can be set-off against the balance in the joint account.

(ii) The right can be exercised in respect of debts due and not in respect of future debts or contingent debts. For example, a banker can set-off a credit balance in the account of customer towards the payment of a bill which is already due but not in respect of a bill which will mature in future. If a loan given to a customer is repayable on demand or at a future date, the debt becomes due only when the banker makes a demand or on the specified date and not earlier.

(iii) The amount of debts must be certain. It is essential that the amount of debts due from both the parties to each other must be certain. If liability of any one of them is not determined exactly, the right of set- off cannot be exercised. For example, if A stands as guarantor for a loan of Rs. 50,000 given by a bank to B, his liability as guarantor will arise only after B defaults in making payment. The banker cannot set- off the credit balance in his account till his liability as a guarantor is determined. For this purpose it is essential that the banker must first demand payment from his debtor. If the latter defaults in making payment of his payment of his debt, only then the liability of the guarantor arises and the banker can exercise his right of set-off against the credit balance in the account of the guarantor. The banker cannot exercise this right as and when he realizes that the amount of debt has becomes sticky, i.e., irrecoverable.

(iv) The right may be exercised in the absence of an agreement to the contrary. If there is agreement – express or implied – inconsistent with the right of set-off, the banker cannot exercise such right. If there is an express contract between the customer and the banker creating a lien on security, it would exclude operation of the statutory general lien under Section 171 of the Indian Contract Act, 1872. In Krishna Kishore Kar v. Untitled Commercial Bank and Another (AIR 1982 Calcutta 62), the UCO Bank, on the request of its customer K.K. Kar, issued guarantee for Rs. 2 lakhs in favour of the suppliers of coal guaranteeing payment for coal supplied to him. The customer executed a counter- guarantee in favour of the Bank and also paid margin money Rs. 1.83 lakhs to the Bank. After fulfilling its obligations under the guarantee, the Bank adjusted Rs. 76,527 due from the customer under different accounts against the margin money deposited by the customer in exercise of its lien (or alternatively the right of set-off). The High Court held that the bank was not entitled to appropriate or adjust its claims under Section 171 of the Contract Act in view of the existence of the counter- guarantee, which constituted a contract contrary to the right of general lien.

(v) The Banker may exercise this right at his discretion. For the purpose of exercising this right of the bank, all branches of a bank constitute one entity and the bank can combine two or more accounts in the name of the same customer at more than one branch. The customer, however, cannot compel or pursue the banker to exercise the right and to pay the credit balance at any other branch.

(vi) The banker has right to exercise this right before the garnishee order is made effective. In case a banker receives a garnishee order in respect of the funds belonging to his customer, he has the right first to exercise his right of set-off and thereafter to surrender only the remainder amount to the judgement creditor.