I wrote previously about the Supreme Court of British Columbia decision in Coffee (Estate) v. Coffey, 2014 BCSC 110 that a woman who had defrauded her mother of about $1.6 was entitled to a gift in her mother’s will despite the fraud.
Chief Justice Hinkson was also asked to decide the following question:
Whether the balance owing by Josephine Frances Coffey to the estate of Elizabeth Margaret Annie Featonby Coffey pursuant to a Restitution Order of the Provincial Court of British Columbia dated May 22, 2007 should be deducted from or set-off against any bequest or legacy owing to Josephine Frances Coffey by the estate of Elizabeth Margaret Annie Featonby Coffey….
This question is significant because Josephine Coffee had declared bankruptcy. If she received the gift under her mother’s will, then it would go to her trustee-in-bankruptcy, and would be available to all of her creditors. Although her mother’s estate might get some of the funds payable to Josephine Coffee back as a creditor, the estate would not receive all of the funds back to apply to Josephine Coffee’s debt to her mother. But if Josephine Coffee’s debt could be set-off against her entitlement as a beneficiary, then the Elizabeth Coffee estate administrators would only have to pay out any amount owing after setting-off the full amount of Josephine Coffee’s debt.
The Chief Justice considered section 97(3) of the Bankruptcy and Insolvency Act which says that:
The law of set-off or compensation applies to all claims made against the estate of the bankrupt and also to all actions instituted by the trustee for the recovery of debts due to the bankrupt in the same manner and to the same extent as if the bankrupt were plaintiff or defendant, as the case may be, except in so far as any claim for set-off or compensation is affected by the provisions of this Act respecting frauds or fraudulent preferences.
The effect of this provision is that when it applies it gives certain creditors, those who are indebted to the debtor, a priority over other creditors. In a decision cited by Chief Justice Hinkson, Husky OilOperations Ltd. v. Minister of National Revenue,  3 S.C.R. 453, 128 D.L.R. (4th) 1, the Supreme Court of Canada had considered the argument that this priority was unfair. Mr. Justice Gonthier wrote:
57 In the bankruptcy context, a right to set-off necessarily has the effect of securing the claim of the party claiming set-off against assets of the bankrupt's estate. This was recently recognized in unambiguous terms by Lord Hoffman in his speech for the unanimous House of Lords in Stein v. Blake,  2 All E.R. 961. His Lordship stated at p. 964:
Bankruptcy set-off ... affects the substantive rights of the parties by enabling the bankrupt's creditor to use his indebtedness to the bankrupt as a form of security. Instead of having to prove with other creditors for the whole of his debt in the bankruptcy, he can set off pound for pound what he owes the bankrupt and prove for or pay only the balance.…
59 Indeed, as a result of creating a type of security interest in the estate, the operation of set-off in bankruptcy has been the subject of academic criticism: see Palmer, supra, at pp. 204-7; Judge and Grottenthaler, supra, at p. 117; John C. McCoid, “Setoff: Why Bankruptcy Priority?”(1989), 75
Va.L. Rev. 15, and for counterpoint, Philip T. Lacy, “Setoff and the Principle of Creditor Equality” (1992), 43 S. Cal. L. Rev. 951. The central criticism has been that while outside of bankruptcy set-off strikes a fair balance between two parties with mutual obligations, in bankruptcy the material inquiry should be the rights of the estate's creditors inter se. An inquiry which considers the rights of creditors inter se must necessarily consider a broader range of interests than an inquiry limited to ensuring fairness between only two parties (McCoid, supra, at p. 43). Thus, allowing set-off in bankruptcy has been considered as unfairly limiting the class of relevant interests. The concern has also been voiced that allowing set-off in bankruptcy (Judge and Grottenthaler, supra, at p. 117):
... is disruptive of a complex and sophisticated system developed for establishing priorities amongst creditors of various types, particularly where registration of a secured interest is required.This second concern is thus to the effect that allowing set-off gives a claimant the benefit of a security interest without imposing the important concomitant obligation of registering that interest.
60 While this academic debate is undoubtedly interesting, the fact remains that our Parliament has recognized in s. 97(3) of the Bankruptcy Act that the “law of set-off applies to all claims made against the estate of the bankrupt”. As a result, in the bankruptcy context, the law of set-off allows a debtor of a bankrupt who is also a creditor of the bankrupt to refrain from paying the full debt owing to the estate, since it may be that the estate will only fulfil a portion, if that, of the bankrupt's debt. Consequently, in this limited sense the party claiming set-off has Parliament's blessing for the “reordering” of his priority in bankruptcy by virtue of the operation of the law of set-off.
Chief Justice Hinkson held that section 97(3) applied to allow the administrators of Elizabeth Coffee’s estate to set-off the amount Josephine Coffee owed to the estate from her share of the estate. He wrote:
 I am satisfied that the requirements for legal set-off have been made out, and therefore answer the second of the questions framed by the petitioners in the affirmative and direct that the petitioners’ are entitled to the set off the amount owing to Ms. Coffey under the Testatrix’ will against the amount still owed to her estate pursuant to the restitution order. While this may have the effect of elevating the claim of the Testatrix’ estate to that of a secured creditor, to the detriment of others, the Supreme Court of Canada made clear in Husky Oil that this reordering of priorities is what was intended by Parliament under s. 97(3) of the Bankruptcy and Insolvency Act.