Setting off refers to the legal mechanism that allows one party to offset or deduct a certain amount of money, loss, damage, or expense owed to them by the other party against any amounts owed by the first party. In contracts, a ‘set off’ clause is often included to provide a way of adjusting the overall financial obligations between the parties.
In this guide, our contract lawyer will step you through set-off under contract, as well as equitable set off.
Setting off allows a party to a contract to offset or deduct a certain amount of money, loss, damage, or expense owed to them by the other party against any amounts owed by the first party.
In contracts, a ‘set off’ clause is often included to provide a way of adjusting the overall financial obligations between the parties.
A set-off clause simplifies payments and avoids extra transactions when both parties owe each other money. With this clause, one party only pays the net amount owed after deducting any amounts owed by the other party.
However, the effectiveness and enforceability of this clauses can depend on the specific wording of the clause, which is the reason why it’s important for parties to clearly state the terms in contracts to prevent potential disputes.
Remember – make sure the set off clause doesn’t create an unfair contract term.
Here’s an example set-off clause:
“Party A may set-off and apply against any amounts due to Party B, any amount, claim loss, damage, cost, or expense, that is or may be owed by Party B to Party A. If, after applying the set-off, an amount is still due to Party A, Party A may recover that amount from Party B. Nothing in this clause limits or reduces Party A’s rights at law to recover an amount owed by Party B.”
Below is an example of how setting off operates in practice:
Company A and Company B engage in a business relationship where A supplies raw materials to B, and B manufactures finished goods for A to purchase. They operate under a contractual agreement that includes this clause.
Company A owes $50,000 to Company B for a recent shipment of raw materials. Simultaneously, Company B owes $30,000 to Company A for the manufacturing services. In this scenario, the set-off clause allows Company A to offset its debt of $50,000 against Company B’s debt of $30,000. As a result, Company A pays Company B the net amount of $20,000 ($50,000 – $30,000).
Instead of each company making separate payments, they use the this clause to simplify the process and settle the outstanding amounts more efficiently.
Yes, in certain situations, it may occur even without a specific clause in a contract. Right of set-off in equity is based on fairness and justice and may be applied even in the absence of a contractual provision or a specific set-off clause.
Here’s how the right of set off in equity generally works:
1. Mutual dealings: Equitable set-off often arises when there are mutual dealings between the parties. For example, If Party A has a claim against Party B and Party B has a separate claim against Party A, equitable set-off may be considered.
2. Discretion of the Court: The application of equitable set-off is generally within the discretion of the court. The court will consider factors such as the nature of the claims, the relationship between the parties, and whether it would be equitable and just to allow the off setting.
3. Independent and unconnected claims: Equitable set-off may apply to independent and unconnected claims. This means that the claims involved need not arise from the same transaction or be of the same nature.
4. Application in various contexts: Equitable set-off can be applied in various legal contexts, including contracts, torts, and restitution. It is not limited to a specific type of legal relationship.
5. Preventing unjust enrichment: The underlying principle of equitable set-off is to prevent unjust enrichment. It ensures that a party is not forced to pay the full amount of its debt when the other party also owes it money.
The availability and scope without this clause can vary based on the jurisdiction and the specific facts of the case. It’s important to consult with legal professionals to determine how set off operates in a particular situation.
In Goldsmith v AMP Life Limited, a dispute between a landlord and tenant led to the restatement of some of the relevant principles to be applied when determining whether equitable set-off is available.
The Court found that the claim for compensation under the first lease could be set-off against the unpaid rent under the second lease.
The Court noted that, in substance, both claims arose out of ‘one continuing relationship affected by the [landlord’s] renovation of the shopping centre.
Those principles are:
In this case, a dispute arose regarding the payment of overtime rates to an immigrant employee working at a meat wholesaler. Despite the employee receiving an hourly rate above the minimum set by the Meat Industry Award, the employer attempted to offset these payments against the employee’s entitlements for overtime.
The Federal Court ruled in favor of the employee, emphasizing that the employer’s failure to clearly communicate the intention to fulfill overtime payment obligations through the higher hourly rate led to a violation of the Fair Work Act. As a result, the employer was directed to pay penalties and rectify the underpayment to the employee.
The court’s decision highlighted the importance of transparent communication and explicit agreements in employment contracts. It underscored that employers cannot unilaterally reallocate agreed-upon payments to fulfill different obligations, such as using higher hourly rates to cover overtime entitlements without a clear understanding or agreement with the employee.
This depends on the drafting of the clause. Generally, a set-off clause only applies to debts resulting of a party breaking the agreement. This includes situations where a party violates someone else’s intellectual property rights.
Conversely, a broad set-off clause has a more comprehensive reach, potentially encompassing a larger range of debts, including those arising from defective goods or anticipated costs perceived by the client. Including different debts in a set-off clause can greatly impact the total payment due in a contract.
In employment contracts, a set-off clause can be used to specify the conditions under which an employer can offset certain amounts against the wages or benefits owed to an employee, for example, in an annualised salary arrangement.
The clause will need to clearly define the set-off clause, specify applicable situations, outline notice requirements, clarify the timings of such actions, and outline any limitations to the clause.
Learn more about important clauses for employment contracts in our article.
Yes, as a party entering into a contract, you generally have the right to negotiate and object to specific terms, including the inclusion of this clause.
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