Set-Off Rights

It is not uncommon for developers or clients to generally work with the same supply chain project to project or even, in certain circumstances, have more than one contract with a supplier but on the same project. As a client, you would need to recover sums due from the contractor or subcontractor, and you may be able to use a set off provision where you set off the amount owed from an amount due on another contract.

However, depending on how you draft the contracts and the terms and conditions included will dictate what form of action you should take and how robust your case is for the recovery of monies owed.

There are three types of set-off available which are, 1) Contractual, 2) Equitable, and 3) Statutory Insolvency. However, there is also the option of abatement, which, whilst like set-off provisions, is not for the recovery of cross contract claims.

Contractual

Most standard forms of contract do not contain a set-off clause, presumably as the logic is the terms and conditions are such that the intent is for them to deliver works on a single project. It will be at the client’s discretion if they choose to link in other contracts or at least provide the right to link in other contracts through set-off rights as they see fit.

Generally, contractors do not like including set-off rights as additional clauses in their contracts for apparent reasons, i.e., they wish to limit their liability to confines of that individual contract, and by agreeing to the provision of set-off clauses, they are increasing their risk profile such that potential losses incurred on one contract can impact another non-loss-making contract.

If set off clauses are included, a good practice is to describe how they will work, consisting of what and who can trigger the clause, e.g., is it at the client’s discretion or should it be mutually agreed? And by activating an agreement as to why it should be used, should you also limit when it cannot? If the clause is included, but there are no limitations, this will favour the client, whereas the contractor will want to be more specific and limiting to assert a right to veto the clause.

The debts incurred that are consequently sought to be set-off do not need to be connected, they do not need to be for the same work type, but both contracts need to contain the right to set off. Also, remember that if you choose this course of action, you should still serve payments notices accordingly, and similarly, you should serve pay less notices according to the construction act. Suppose you fail to notify your intent clearly according to the contract, including citing the relevant clauses. In that case, you run the risk of invalidating your payment notice and this being overturned at adjudication if launched.

Equitable

Similar in principle to the contractual rights of set-off but without an express clause upon which to act, equitable set-off arises where two contracts are in place on the same project between the same parties.

As there is no clause to use for set-off, the parameters to meet are far narrower for a claim to be successful. The case of Geldof Metaalconstructie NV v Simon Carves Ltd (2010) progressed through the TCC and the Court of Appeal where it was decided that to allow equitable set-off to be used, the claim must be “so closely connected with demands that it would be manifestly unjust to allow them.”

If the contracts were for different projects and there were no specific clauses concerning set-off rights, it would be difficult to make a case to deduct an amount that was lawfully due, especially when considering that section 110(1A) of the Construction Act indicates that payments to parties cannot be conditional on the obligations outside of the contract. If the contracts included a separate and pre-agreed set-off clause, you would argue the parties have mutually overridden this obligation. Still, you can see the case that if there are no express provisions set down in the contract, then how can you make a lawful payment by deducting a debt incurred on another seemingly unrelated contract.

However, note that in the 2011 amendments to the Construction Act, if you issue a valid withholding notice according to the contract, you can set off, albeit you need to consider if you are to do so on a contractual or equitable basis.

Abatement

Not strictly a set-off provision but still a means by which to reduce payment. The principle is that goods and services are not provided in accordance with the contract and that, as a result, the payment due is reduced in whole or in part accordingly.

This differs from equitable or contractual set-off because you are not seeking to issue a counterclaim for the recovery of a debt through the provisions of a pre-determined set-off clause or a case for equitable set-off. You are reducing the value of the works due to a defect plus the associated cost.

You will still need to issue a pay less notice under the Construction Act and determine how the value of the works should be reduced because of the defect. Also, with abatement, it can only apply to payments regarding labour and materials, and therefore it does not apply to professional service contracts. The logic here presumably is that if you need to claim defective work on a professional service contract, you would raise a claim against their professional indemnity insurance.

Statutory Insolvency Set-Off

Through the Insolvency Act, if a party becomes insolvent, you can apply statutory set-off through the Insolvency Rules. The general principle being that if a subcontractor or contractor was to enter insolvency during the work, they might have completed works that an administrator dealing with the insolvency will later claim they need to be paid for. However, if you need to make the site safe or incur other losses in dealing with this insolvency, you can recover these costs from the amount owed.

The logic here is that if you were to make payment and then once all debts had been settled and if there were anything left, you would only receive an equitable share along with all other creditors as opposed to being able to recover your costs. Therefore, you should evaluate the position on a mutual debts and mutual credits basis before making payment of the balance to the administrator. However, the final position is often that the contractor or client is left facing a shortfall in most cases.

Dispute Resolution Decision

This is an interesting point: Can an adjudicator’s decision involve the instruction on the recovery of funds from the other party if there is no specific set-off clause? Suppose the adjudicator can only consider the dispute within the confines of the contract in which they are operating. In that case, they do not have express permission or authority to alter or change those terms. Therefore, in their final determination, they cannot impose that one party should be able to set-off such sums from the other unless there is an express provision in the contract to do so, save for the rights of statutory insolvency, which is unlikely to be in adjudication, or the case of equitable set-off.

Relevant Case Law

In terms of equitable set-off, the most prominent case appears to be Geldof Metaalconstructie NV v Simon Carves Ltd (2010). Simon Carves was the main contractor on a project constructing a bioethanol plant, and they contracted to Geldof for two separate contracts. The first being for the supply of pressure vessels, the second for the installation of storage tanks. Both were subject to a different tender process.

The relationship deteriorated, and Geldof, who downed tools on the installation contract, refused to work unless outstanding payment was made across both contracts, but principally on the supply contract. Simon Carves then terminated the installation contract, and the parties ended up in litigation to resolve the dispute. Geldof claimed monies owed on the supply contract, but to counter this Simon Carves claimed unliquidated damages due to the default and breach of contract on the installation contract.

The first ruling was there was no connection such that Simon Carves had the right of set-off, and so they went to appeal against this decision. In the appeal, it was decided that the law needed to be clarified on this point. The results were that to avoid a situation being manifestly unjust by enforcing payment, and it must also take into account the closeness of the connection between the payment and the cross-claim.

This allowed the previous ruling to be re-evaluated, and as such, it was determined that by Geldof stopping works on one contract to leverage payment on another, they had created this closeness of the relationship between the two contracts that would otherwise not have been there. As a result, the decision was made that it would be manifestly unjust not to consider this relationship when determining payment, and the right to set-off was established on an equitable basis.

M J Gleeson Group Plc v Devonshire Green Holding Ltd (2004) involves a smash and grab adjudication made by Gleesons where Devonshire had not issued a notice of withholding or payment assessment in response to Gleeson’s application for payment. Therefore, once referred to adjudication, it was determined the full value claimed was payable.

Devonshire objected to this, and one of the reasons was they counterclaimed, stating they were owed liquidated damages, which were more than the amount payable in the adjudicators determination. Therefore the decision was not binding as they had not considered all the facts at hand in making such a determination. Devonshire effectively sought a right of set-off through the application by the application of delay damages.

The court considered that as Devonshire had not issued a notice of non-completion under the contract in a timely manner, i.e., upon adjudication, they calculated that liquidated damages were due despite the non-completion occurring one year before. Notwithstanding this, the adjudicator was not privy to the information of a non-completion notice. Therefore, how could they have considered this, or even as Devonshire had not provided the adjudicator with a calculation of delay damages, how could they have factored this into their determination? The ruling was that even if the events in question related to events prior to the decision by the adjudicator if they had not acted on them, they cannot be considered.

Conclusion

Using set-off provisions is less than straight forward unless you have pre-agreed clauses that are included in your contract. For this reason alone, if you intend to utilise the same contractor or sub-contractor on the same project or a range of projects, ensure that you have made clear contractual provisions such that, should you need it, you have the right of set off and that it is clear how it operates, as most are favoured in line with the client, providing early sight to the supply chain is preferential for timely agreement.

Feature Photo by John Towner on Unsplash

About Dean Suttling

A member of the Royal Institution of Chartered Surveyors, Dean has twenty years of experience in commercial management and quantity surveying, undertaking roles for contractors, clients, and consultants.