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Set-Off Clause Guide by Lawyers Online

Reading time: 8 mins

Setting off refer 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. This clause is often included in contracts to provide a mechanism for 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. Hence, it is important for parties to clearly state the terms in contracts to prevent potential disputes.

In this guide, our contract lawyer will step you through set-off under contract, as well as equitable set off.

What is an example of a set-off clause?

Here’s an example:

“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.”

What is an example of setting off?

Below is an example of setting off:

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.

Set off clause

Can you set off without a set-off clause?

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. Hence, it may be applied even in the absence of a contractual provision or a specific set-off clause.

Here’s how 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 is important to consult with legal professionals to determine how set off operates in a particular situation.

Case Law Examples

Goldsmith v AMP Life Limited

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:-

  • there must be a sufficient connection between the two claims
  • to be sufficiently connected, one claim must be said to ‘impeach’ or ‘go to the root of’ the other claim, such that it would be unfair for one claim to be allowed without accounting for the other
  • a set-off can arise where the claims are based on different legal instruments between the same parties
Set off clause

Australasian Meat Industry Employees Union v Dick Stone Pty Ltd [2022] FCA 512

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.

Key Takeaways

  • Setting off is a legal way for parties to cancel out debts, making payments easier and avoiding extra transactions.
  • A set-off clause’s effectiveness and enforceability rely on the contract’s wording. Clear terms are crucial to avoid disagreements and ensure smooth implementation.
  • Equitable set-off can occur fairly and justly even without a specific clause. Consider mutual dealings, court discretion, and avoid unfair enrichment to achieve this.
  • Talking to legal experts is important to understand how set-off works in different situations. Availability and rules can change depending on the location and details of the case.

Frequently Asked Questions

What kind of debts will benefit from a this clause?

This depends on the drafting of the clause. A set-off clause, also called a narrow provision, applies only to debts resulting from the customer breaking the agreement. This includes situations where the customer violates someone else’s intellectual property rights.

Conversely, a broad set-off clause has a more comprehensive reach, potentially encompassing a broad spectrum 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.

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.

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.

About the Author

Farrah Motley
Director of Prosper Law. Farrah founded Prosper online law firm in 2021. She wanted to create a better way of doing legal work and a better experience for customers of legal services.

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