The Defence of Set-Off and Limitation Periods

Imagine the following scenario. John and Edward open a shop together in 2009. While running the shop, John steals $1,000 out of the register. Edward finds out and confronts John who apologizes and promises not to do it again. Three years pass, the partnership breaks up and in anger Edward steals pens from the business worth $1,000. John sues Edward for the theft of merchandise. What are Edward’s options?

Can Edward sue John for his theft of $1,000 from the cash register? The answer is no because the limitation period has expired.

Section 4 of the Limitations Act¹ provides that “Unless this Act provides otherwise, a proceeding shall not be commenced in respect of a claim after the second anniversary of the day on which the claim was discovered.” Essentially, sections 4 and 5 of the Limitations Act bar a claimant from pursuing a claim more than two years after the time that the claimant knew or ought to have known the necessary details to make their claim. But that does not mean that their claim has no legal value.

Going back to the above scenario, let’s say that it is now 2013, more than three years after Edward learned of John’s theft of the $1,000 from the register. Despite the expiry of the limitation period for Edward to commence an action to recover that money, the claim may still be used in response to defeat John’s claim for the merchandise using a defence of equitable set-off.

At this point we should take a moment to define some terms. There is a difference between legal set-off and equitable set-off, which will impact on our discussion.

In Green v. Mirtech,² Justice Belobaba of the Ontario Superior Court of Justice explained the difference between the two.

“Analysis

Legal Set-Off

11     Section 111 of the Courts of Justice Act provides the statutory framework for legal set-off. Subsections (1) and (2) provide as follows:

(1) In an action for payment of a debt, the defendant may, by way of defence, claim the right to set off against the plaintiff’s claim a debt owed by the plaintiff to the defendant.

(2) Mutual debts may be set off against each other even if they are of a different nature.

12     The case law is clear that set-off at law requires at least two things: one, that both obligations be liquidated debts or money demands which can be ascertained with certainty; and two, that both debts constitute mutual cross-obligations (as between the parties).1 Set-off at law is not available in response to a claim which sounds in damages.

Equitable Set-Off

15     Unlike legal set-off, the defence of equitable set-off does not require that the claims between the parties be debts or money demands that can be ascertained with certainty. Nor is there a need for strict mutuality.

16     Although the requirement of mutuality is relaxed for equitable set-off, there must still be a close connection between the claims. The connection must be sufficiently close to warrant an exercise of the equitable jurisdiction of the court. And, the remedy must not result in any form of inequity.

17     Equitable set-off arises where there is a relationship between the respective claims such that the claim of the defendant has been brought about by, or is otherwise closely bound up with, the rights that are relied upon by the plaintiff. It is said that the opposing claims must flow from the same transaction or relationship between the parties. If such is the case, there is the final requirement that it would be unconscionable to allow the plaintiff to proceed without permitting a set-off.

18     The Court of Appeal for Ontario recently endorsed a test that was first enunciated by Lord Denning and later cited with approval by Madam Justice Wilson in Telford v. Holt:

We have to ask ourselves: what should we do now as to ensure fair dealing between the parties? … This question must be asked in each case as it arises for decision; and then, from case to case, we shall build up a series of precedents to guide those who come after us. But one thing is quite clear: it is not every cross-claim which can be deducted. It is only cross-claims that arise out of the same transaction or are closely connected with it. And it is only cross-claims which go directly to impeach the plaintiff’s demands, that is, so closely connected with his demands that it would be manifestly unjust to allow him to enforce payment without taking into account the cross-claim.6 [Emphasis added by Court of Appeal.]

So now let’s discuss Edward’s options.   Can he use what otherwise might have been a valid cause of action that is now statute barred as a sword to defend his own theft of merchandise? Can he claim legal or equitable set-off based on John’s theft of the pens?

In Pierce v. Canada Trustco Mortgage Co,³ the Court of Appeal for Ontario held that although limitation periods apply to the statute-based legal set-off, they do not apply to equitable set-off.⁴ The court adopted English jurisprudence which distinguished between “a matter which is in the nature of a defence and one which is in the nature of a cross-claim”. As such, equitable set-off, as a “true substantive defence” is not subject to a limitation period.⁵

Therefore, despite the fact that three years have passed since Edward discovered John’s theft, Edward may not be barred from claiming the defence of equitable set-off to in effect, defeat John’s claim against him if he can satisfy the above test. ⁶