Set-off: Overview, definition and examples
What is set-off?
Set-off is a legal right in contracts that allows one party to offset a debt they owe to the other party with a claim they have against them. Instead of paying the full amount and then separately pursuing their own claim, they can deduct the amount owed from what’s already due. This simplifies the process and reduces the financial burden.
For example, if a supplier owes a client $10,000 for late deliveries, but the client owes the supplier $15,000 for goods received, the client can "set off" the $10,000 against the $15,000. The client would then only pay $5,000.
Why is set-off important?
Set-off is important because it streamlines financial dealings and prevents parties from having to make unnecessary payments when they already have mutual claims. It’s especially useful in business relationships where there are ongoing transactions or disputes.
For businesses, a set-off clause can provide financial protection by allowing them to deduct valid claims from amounts they owe. However, these clauses should be carefully drafted to avoid disputes over when and how set-off can be applied.
Understanding set-off through an example
Imagine a manufacturer delivers machinery to a buyer, but the machinery is faulty, causing the buyer $20,000 in repair costs. The buyer still owes the manufacturer $50,000 for the purchase. Instead of paying the full $50,000 and then suing for the $20,000, the buyer can apply set-off, paying only $30,000 and deducting the repair costs from the payment.
In another scenario, a service provider might claim late fees for overdue payments from a client. If the client has a claim for substandard services worth the same amount, they could use set-off to cancel out their obligation to pay the late fees.
An example of a set-off clause
Here’s how a set-off clause might look in a contract:
“Either party may apply any amounts owed to the other party under this Agreement as a set-off against any amounts due and payable by the other party, provided that the set-off is documented in writing and agreed upon by both parties.”
Conclusion
Set-off allows businesses to deduct what they’re owed from what they owe, simplifying financial transactions and avoiding unnecessary back-and-forth payments. It’s a practical tool for managing mutual claims, especially in contracts involving complex or ongoing dealings.
By including a clear set-off clause in contracts, businesses can define how and when set-off applies, reducing the risk of disputes and ensuring smooth financial operations. It’s a smart way to handle mutual obligations efficiently.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.