Ready, set-off, go!
Parties often claim a right of set-off where they have competing claims against each other, but just what it is a right of set-off and when and how does it apply?
What is set-off?
When two parties have monetary debts against each other, a right may arise to “set-off” the debts. A party can look to reduce its liability on one contract by setting off that liability against debts due under another contract (or the same contract). The right of set-off can act as a defence to part or the whole of a claim.
Although the calculations may be simple, it can be difficult to determine if and when the right of set-off arises. There are different types of set-off (such as banking, insolvency and legal set-off) but for the purposes of this article, we are only looking at contractual and equitable set-off.
Parties can agree a contractual right of set-off by including a set-off provision in a contract. A set off-clause will usually provide clarity as to what remedies of set-off are available and when they can be applied before a dispute arises. Parties can also agree to exclude set-off rights from a contract.
In the absence of a contractual right of set-off, there may be an equitable right to set-off. Equitable set-off is more difficult to use in practice than contractual set-off due to the nature of the conditions which must be satisfied.
How and when could an equitable right of set-off arise?
The following test derived from Geldof Mettalconstructie NV v Simon Carves Limited (2010) EWCA Civ 667 can be applied to determine whether a party has a right to equitable set-off:
1) a formal requirement of close connection between the claim and cross-claim; and
2) a functional requirement where it would be unjust to enforce the claim without taking the cross-claim into account.
The above test is not a two-stage test but a test with two elements that cannot be separated from each other. The two elements ensure the test is based on principle and highlights that the basis of the set-off rule is fairness. The test will therefore be applied more on a case-by-case basis.
Equitable set-off is more likely to be available where the cross-claim arises out of the same contract as the claim, than where the claim and cross-claim arise out of different contracts. However, in Geldof, the Defendant relied on a cross-claim for damages for the Claimant’s repudiation of a contract (B) and was held to have established a right to set-off. The Court found that by demanding payment under contract A as a condition for continuing work under contract B, the Claimant had itself linked the two contracts.
Important points to note
Equitable set-off can be used not only as a defence for the claim but also as grounds to withhold payment of a debt.
Set-off is not the same as a counterclaim. The right to set-off can only be used as a defence, protecting the defendant against a claim, whereas a counterclaim is a separate claim entirely.
If you are a party that is expecting payment then it is a real advantage to include in the contract ‘a no right of set-off’ clause. This prevents payment being withheld or held up because of a cross-claim and ensures speedy payment. If there is no right of set-off, the other party will still be able to pursue their counterclaim but will not be able to use it as an excuse to delay payment.
The content of this page is a summary of the law in force at the date of publication and is not exhaustive, nor does it contain definitive advice. Specialist legal advice should be sought in relation to any queries that may arise.
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