Many clauses in a commercial contract can impact the commercial relationship. As a service provider, understanding key clauses is essential to run your business successfully. A set-off clause is one example of a clause that can significantly impact how debts under the agreement are payable. This article will aim to explain what a set-off clause is and its impact on a commercial arrangement.
What is a Set-Off Clause?
A set-off clause is a short clause sometimes included in a commercial contract, often found within the payments clause.
At law, the rights granted under this kind of clause can be quite narrow. However, set-off clauses have the potential to give the client a lot of extra rights they would not otherwise have.
What is the Impact of a Set-Off Clause?
A set-off clause allows a client to deduct money from payments it owes to the service provider, like your business. This deduction is permitted under certain circumstances, such as where:
- the service provider owes a debt to the client; or
- the client has suffered some loss and needs to be compensated.
For example, suppose that you, the service provider, were to breach a third party’s IP rights, resulting in a loss to the client. The set-off clause allows the client to subtract the amount owed by you from their payments. As a result of the subtraction, the client will pay the net amount. This will be the full price listed in the contract, minus the damages resulting from the IP breach).
The above example may be a fair and reasonable deduction. However, other examples can cause headaches for service providers.
Suppose you were working on a new project for a client. Likewise, you have purchased materials, conducted the agreed work, and submitted your first invoice. In response, your invoice comes back with only half the amount paid. When you query it, it appears that a broad set-off clause has allowed the client to deduct money since they claim that some of your initial work was defective, and the cost to rectify the defect was 50% of your invoice price.
Continue reading this article below the formWhat to Do About a Set-Off Clause?
As a service provider, the best way to manage a set-off clause in your contract is to ensure you read it carefully before signing off. Having a lawyer read through the clause will give you an indication of whether the clause is likely to be detrimental to you. This clause may inhibit a provider’s right to claim under their insurance.
However, amending a set-off clause at the contractual level does not eliminate a set-off right. Clients may still maintain this right in the law of equity. A set-off right can be insisted upon in equity when there are two wrongs in different claims (i.e. the client has wronged you, and you have wronged the client) which can set-off against one another to produce a net pay off amount.
It is important to note that the equitable set-off right is not available in every dispute, as the right must be determined and settled by a court. In the scenario where a set-off right is contractually written in a contract, it is more difficult to avoid.
With that in mind, amending a set-off clause at the time of contracting is the best pathway forward. It is quite reasonable to request a client to limit or eliminate the right of their set-off. A limited set-off right ensures a fair arrangement with your clients whilst still protecting your interests as a service provider.
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Key Takeaways
A set-off clause allows your client to set-off or deduct any amounts you may owe them against the amounts they owe you. It can be a hidden right that catches you off guard and affects your ability to claim under your insurance.
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Frequently Asked Questions
Set-off clauses are often included in loan arrangements as protection for instances where a borrower defaults on a loan. They allow a lender to set-off the debt owed by a borrower against the list of assets the clause specifies.
This will depend on the drafting of the clause. A narrow set-off clause may only include debts incurred by the customer following a breach of the agreement, such as a breach of a third party’s IP rights. On the other hand, a broad set-off clause may include any debts, such as those caused by defective goods or any cost the client believes they may incur, which can significantly impact the amount due under the contract.
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