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If you intend to engage contractors for a specific project or ongoing service arrangement, managing contracts successfully takes a lot of effort and consistency. As a business hiring a contractor (making you the ‘principal’), it is important that the price you have agreed to pay the contractor in your contractors agreement remains reasonable. This article will discuss your ability as a principal to withhold payments to contractors.
Whether you’re a small business owner or the Chief Financial Officer of an ASX-listed company, one fact remains: your customers need to pay you.
This manual aims to help business owners, financial controllers and credit managers best manage and recover their debt.
Options to Withhold Payments
Your ability to withhold payments will largely depend on the terms of the agreement. Broadly, there are a few common ways to withhold payments to your contractors, including:
- set-off – a right to pay a contractor less because they owe you a certain amount;
- no right to claim payment – arises if the contractor has not properly rendered the works, goods or services. You may be able to claim that they do not have the right to payment because of defective or incomplete works, goods or services; or
- counter-claim – a right to avoid paying the contractor by bringing or foreshadowing a counter or cross-claim against the contractor. For example, you may have a counter-claim to the contractor’s claim for payment if the contractor has breached the agreement. In these circumstances, you may have the right to claim compensation against the contractor.
The following sections explain each of these options in detail.
Right of Set-Off
Including a right-of-set off under your agreement is the easiest way to withhold payments to your contractors. It allows you to set-off (withhold) any amounts owed to you under your agreement or any other agreement. This is ‘set-off’ against amounts payable to the contractor (the amount the contractor is claiming for its services).
Set-off rights are the easiest way to withhold payment. However, it is often the case that a contractor will object to a broad right of set-off in the contract. In particular, the contractor may demand that your right to set-off amounts be limited to those payable to you under the agreement and not under any other agreement.
The Case of Fujifilm
In August 2022, the ACCC reviewed the small business contracts of Fujifilm Australia and found that 38 of their standard terms were unfair. This included their use of a set-off right. The court declared that such a right was void and unenforceable, which meant that it no longer had legal effect and could not be relied upon by Fujifilm.
Accordingly, using a set-off right could pose a significant financial and legal risk to your business. As of the date of this article, the government has a bill in Parliament to enforce financial penalties against businesses that include unfair terms in their commercial contracts. Notably, penalties may extend up to $10,000,000. As such, you might wish to consider other ways of withholding payment, such as those below.Continue reading this article below the form
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Challenging the Contractor’s Right to Payment
Another way of withholding payment to your contractor is to inspect the relevant works, goods or services for defects or incompleteness. If you can prove defectiveness, incompleteness or a failure to render the service according to the agreement, you may be able to withhold payment on the basis that the contractor has no right to payment.
There may be a provision under your agreement that allows you to:
- inspect the works, goods or services for defects; and
- require the contractor to repair any defects before their right to payment arises.
In construction contracts, it is also common to find provisions that allow you to reduce the price payable for defective works.
If you do not have a right to set-off, you may be able to rely on compensation. You may have a right to claim compensation from the contractor if they breach the contract. However, to claim compensation, you may have to bring formal legal proceedings. This is not a direct way of withholding money, but you can sometimes use the threat of court proceedings as a bargaining tool.
Similarly, if the agreement provides for compensation for late work and the contractor is late carrying out the work, you may be able to use this mechanism to withhold payment. Whether you have this right will depend on the contents of the agreement.
There is a range of reasons why you might need to withhold payments to a contractor. Always look to your contractors agreement to see what avenues you have to resolve your situation. Depending on your agreement, you may be able to:
- set-off payment;
- challenge the contractor’s right to payment because of defective or incomplete works; or
- claim compensation in a cross-claim or negotiate a reduced price.
If you have any questions about your ability to withhold payments to contractors, our experienced contract lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.
Frequently Asked Questions
A right to set-off payment allows you to set-off (withhold) any amounts owed to you under your agreement or any other agreement. This is ‘set-off’ against amounts payable to the contractor (the amount the contractor is claiming for its services).
If you can prove defectiveness, incompleteness or a failure to render the service according to the agreement, you may be able to withhold payment on the basis that the contractor has no right to payment.
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