The legally enforceable right of set-off

Learning objectives

• Explain why a right of set-off that is contingent on a future event does not meet the criterion.L2
• Analyse whether a right of set-off is enforceable in the normal course of business, in the event of default and in the event of insolvency.L3

Normative references

• IAS 32 §AG38AA right of set-off may be currently available or contingent on a future event (for example, triggered or exercisable only on the default, insolvency or bankruptcy of a counterparty); even if it is not contingent, it may be legally enforceable only in certain circumstances (normal course of business, default, insolvency or bankruptcy of one or all of the counterparties). The paragraph describes these situations; the requirement itself is set out in para. AG38B.
• IAS 32 §AG38BTo meet the criterion in para. 42(a), the right of set-off must both not be contingent on a future event and be legally enforceable in all of the following circumstances: the normal course of business, and the event of default, insolvency or bankruptcy of the entity and all of the counterparties.
• IAS 32 §AG38CThe nature and extent of the right of set-off, including any conditions attached to its exercise and whether it would remain in the event of default, insolvency or bankruptcy, vary between jurisdictions; it therefore cannot be assumed to be available outside the normal course of business, since bankruptcy laws may prohibit or restrict it.
• IAS 32 §AG38DTo determine whether the right of set-off is enforceable in the normal course of business, in the event of default and in the event of insolvency or bankruptcy of the entity and all of the counterparties, the laws applicable to the relationships between the parties must be considered: the contractual terms, the laws governing the contract, and the default, insolvency or bankruptcy laws applicable to the parties.

Original summaries of the paragraphs (reference register), never a quotation of the standard.

2 questions

• Jade SA holds a deposit of 500,000 with the bank Terra and a loan of 480,000 from the same bank. The agreement between Jade and Terra gives Jade the right to set off these amounts only in the event of default by Terra or Jade (case facts). Jade intends to settle on a net basis. Is the criterion of a legally enforceable right of set-off met?L2
• A working paper analyses the criterion of a legally enforceable right of set-off. Which of its conclusions is wrong?L3