Whist there are various kinds of set-off (for example, legal, insolvency and banker’s set-off), in the context of commercial contracts, the most relevant types are contractual set-off and equitable set off.
Law of set-off
Set-off is a common law right allowing parties (each of which being both a creditor and a debtor) that have debts owing to each other to set them off. Where the right of set-off is applicable, the parties can net their payment obligations, and, as a result, will be liable to pay the remaining balance only.
It is important to note that, for the right of set-off to arise, the debts to be set-off must be monetary and must be mutual (in other words, a debtor is not entitled to use another person’s debt to satisfy its own liability).
Set-off can be (and is often) used as a defence to a claim by netting the amount claimed.
Contractual set-off
The common law right of set-off just described is often referred to as ‘legal set-off’. The range of situations where it can be applied is relatively restricted (it is applicable only in particular circumstances where the relevant preconditions are met) and so its usefulness to parties to commercial contracts is limited.
To avoid the uncertainty and restricted applicability associated with common law set-off, parties may wish to include a contractual provision specifying, amongst others, the following aspects:
i. that set-off is to apply;
ii. the mechanism of application; and
iii. situations where the right of set-off would be triggered.
Where the parties to a contract have a long-standing contractual relationship, where the sums mutually owed may already have accrued before the contract was concluded, it is particularly beneficial to include an express provision dealing with set-off rights.
The sort of widely drafted set-off clause often encountered might read as follows:
‘Purchaser, without waiver or limitation of any rights or remedies of Purchaser or Owner, shall be entitled from time to time to set off against the Purchase Order Price any amounts lawfully due from the Supplier to the Purchaser whether under this Purchase Order or otherwise’
Clauses such as this can be used to significantly widen the situations in which the right of set-off can apply. Conversely, parties can also elect to exclude the right of set-off by a contractual provision to this effect.
Equitable set-off
Another means of circumventing the restrictions associated with legal set-off is equitable set-off. Equitable set-off is a self-help remedy which becomes relevant where a contract does not contain any express set-off provisions either allowing or prohibiting the same.
The leading case confirming principles and conditions that equitable set-off requires in order to be recognised by law is set out in Geldof Metaalconstructie NV- v- Simon Carves Ltd. The following test established equitable set-off:
i. the requirement for a ‘close connection’ between the claim and the counterclaim; and
ii. the requirement that it needs to be unjust to enforce the claim without taking into account the counterclaim.
The test is based on legal principal and leaves little discretion to the court.
In practice, it is a lot less challenging to contest if the claim and counterclaim arise under the same contract – in that case both (i) and (ii) of the test are likely to be satisfied. When multiple contracts are concerned, the outcome would very much depend on the facts in dispute.
Geldof Metaalconstructie NV -v- Simon Carves Ltd [2010] EWCA Civ 667.
For further information, please contact:
Olga Newman, Hill Dickinson
olga.newman@hilldickinson.com
