Insolvency set-off not available once debtor discharged from Trust Deed

Senior Associate, Andrew Scott, reflects on the recent developments surrounding the case of The Royal Bank of Scotland plc v Alison Donnelly and what this means for insolvency practitioners and their clients. 

12 December 2019

In a decision that will be of interest to anyone with claims for mis-sold PPI insurance, the Inner House of the Court of Session refused an appeal by The Royal Bank of Scotland and in so doing, held that it cannot set off a debtor’s entitlement to compensation against debts that formed part of the debtor’s trust deed.

However, while unsuccessful, it would appear that the bank has not quite given up in its attempt to hold on to the compensation.

This decision will also be of interest to insolvency practitioners who could see a number of previously concluded trust deeds being reopened, if banks think they are able to persuade a court that the relevant acts of the trustee might be reduced as a result of an error as to the extent of the trust estate.

Dooneen Limited v Mond

In previous articles, we looked at the uncertainty caused by the first instance decisions in Donnelly and the case of Dooneen Limited v Mond. Since then, the Sheriff Appeal Court reversed the Sheriff’s decision in Donnelly and both the Inner House and then the Supreme Court upheld the decision of Lord Jones in Dooneen. Many thought that with the Supreme Court decision in Dooneen, the Donnelly appeal would simply fall away. However, while the Dooneen case concerned similar facts, the bank argued that it was not determinative of the issues in Donnelly. In Dooneen, it was a straight question of whether the debtor or the trustee was entitled to the PPI compensation. However in Donnelly, the question was whether the bank could set off the PPI compensation against the sums loaned to Mrs Donnelly but for which she had been discharged under the terms of the trust deed.

In Dooneen, the Supreme Court decided that when a trustee states that a dividend is final, the trust comes to an end and the debtor is discharged of all debt due by them to their creditors. The former trustee has no entitlement to the newly-discovered asset.

Royal Bank of Scotland v Donnelly

Counsel for Mrs Donnelly argued that following the decision in Dooneen, once the trust came to an end the debtor was discharged of all her pre-insolvency debts, including the sums formerly due to the bank. The debt to the bank was extinguished and could not form the basis of any set-off claim.

In response, the bank argued that the discharge given to Mrs Donnelly was not absolute. In particular, it did not prevent the exercise of insolvency set-off. The bank’s debt was not extinguished in the way that a debt is extinguished by prescription. It argued that while the bank was prevented from commencing proceedings against Mrs Donnelly, it was not prevented from exercising a right of set-off which would give it an absolute defence to Mrs Donnelly’s claims for compensation. In other words, while the sword of direct action against Mrs Donnelly was gone, the bank was still able to make use of the shield of insolvency set-off.

The Inner House disagreed. For the bank’s plea of set-off to succeed, it had to demonstrate that there was a debt owing to it by Mrs Donnelly at the time when it put forward its pleas of set-off and the bank was unable to do that. It was unable to do so because Mrs Donnelly’s debts to the bank were discharged on termination of the trust, which was before Mrs Donnelly brought her claim against the bank and the bank sought to advance the plea of set-off. In short, she no longer owed any debt to the bank which could made the subject of that set-off.

The court rejected the suggestion that the discharge was not absolute. The trust deed takes effect as a contract between the debtor and the acceding creditors. The ordinary meaning of the word “discharge” meant that the debts due to creditors are extinguished upon payment by the trustee of the final dividend. Like the Supreme Court in Dooneen, the Inner House felt that any other interpretation would lead to a state of uncertainty, which was to be avoided.


It was noted that much of the bank’s submissions were focused on broad principles of insolvency law, with “its emphasis on achieving an equitable solution and the subordination of rigid logic to practical common sense”. This is perhaps unsurprising given the Supreme Court’s description of its interpretation of the trust deed as “scarcely a satisfactory outcome”. From the bank’s perspective it did not seem fair that it was having to pay money to Mrs Donnelly while it was still out of pocket from the earlier loans.

However, the court pointed out that they were not concerned with a claim to set-off in the insolvency because the insolvency process came to an end when the final distribution was made in the trust deed. Unless it was re-opened, it would not be possible for the bank to rely on insolvency set-off in respect of its claims.

And there is the sting in the tail. In its penultimate paragraph, the court noted that while there had been no claim to set aside the actings of the trustee so as to re-open the trust proceedings, it had been advised that there was such an action “on foot at the instance of the bank” should the appeal be unsuccessful. Therefore, for Mrs Donnelly and others who find themselves in the same position, the wait for compensation continues.

Shepherd and Wedderburn has one of the largest and most established corporate, restructuring and recovery teams in Scotland. Please contact Andrew Scott in our Restructuring and Business Advisory team for further information and advice.