Set off clause: deducting what the other side owes

Sample clause

a freight services agreement between Marlow Logistics and a wholesale nursery whose stock is sometimes damaged in transit

12. Set off 12.1 The Customer may set off against any amount payable to Marlow Logistics an amount that Marlow Logistics owes the Customer under clause 9 for loss of or damage to Goods, provided the amount has been agreed in writing or determined under clause 16. 12.2 The Customer must give Marlow Logistics written notice at least five (5) business days before making a deduction under clause 12.1, stating the invoice affected, the amount and the basis of the claim. 12.3 Marlow Logistics must not set off any amount against a sum it owes the Customer without the Customer's written consent. 12.4 A deduction made under clause 12.1 does not limit either party's other rights, and is not an admission by Marlow Logistics that the amount claimed is owed. 12.5 This clause does not apply to an amount the Customer claims but which Marlow Logistics disputes in writing within five (5) business days of the notice under clause 12.2.

Sample wording, not legal advice.

Variants

What to negotiate

• Certain debts or claimed amounts

  The whole negotiation sits here. A right to deduct anything the customer claims turns every quality complaint into a payment reduction. A right limited to amounts agreed or determined protects the supplier's cash flow. Most commercial contracts land on agreed or determined, with a short notice period before any deduction is made.

• Whether the right runs both ways

  Customers usually propose a one way clause in their own favour and suppliers ask for the mirror. Since a supplier rarely owes the customer money outside a claim, mutual wording costs the customer little and reads far better. Refusing symmetry is often what prompts the supplier to ask for a no set off clause instead.

• Group companies

  Customers sometimes ask to set off amounts owed by or to their related entities. That widens the exposure a long way, because a supplier then funds a dispute it had with a different company. The usual answer limits set off to amounts arising under this agreement between these two parties.

The risk of leaving it out

Silence does not remove set off. Equitable set off can still be available where the cross claim is closely connected to the amount claimed, so a customer may deduct anyway and argue about it later. A no set off clause is the only way to take that away, and a supplier who assumed silence was enough often learns otherwise on a large invoice.

What happens in insolvency

Set off changes character once a party goes into liquidation. The Corporations Act 2001 provides for mutual credits and debts between a company in liquidation and a creditor to be set off against each other, with only the balance provable or payable. That statutory set off operates on the state of accounts and is not something a contract can simply exclude, so a no set off clause that works perfectly during normal trading may not survive the counterparty's collapse. Both sides should price that in rather than rely on the clause alone.

Common mistakes

The clause allows deduction of any amount the customer considers owing, which is a discretion dressed as a right. It requires no notice, so the supplier discovers the deduction from a short payment and starts a reconciliation exercise. It sits in the same paragraph as the payment terms, so the payment obligation reads as conditional. And in construction contracts, wording that limits deduction rights has to be checked against security of payment legislation, which has its own rules about withholding.

Where it sits in a generated document

Set off belongs in the payment section, immediately after the obligation to pay, because it qualifies that obligation. Generated agreements number the clauses, so a set off sub clause can cross reference the liability clause that produces the deductible amount and the dispute clause that determines it. That cross referencing only works if the numbering is stable, which is why this kind of document is generated as numbered content rather than as running prose.

Documents that carry this clause

Master services agreementA data consultancy and an insurer sign this once and then buy work under it for three years. It is the rare contract whose whole purpose is to make the next twenty contracts short.Subcontractor agreement template that flows the head contract downA subcontract exists to pass the head contract's obligations down one level and move the money back up on time. This one names the scope by drawing, sets the progress claim dates against the security of payment rules, holds retention and states the insurances, so the trade knows exactly when it is paid and for what.Loan agreement templateA Tasmanian foundry is borrowing $180,000 from a private investment company to buy a used induction furnace. The lender is not a bank, so everything a bank would take for granted has to be written down: what has to happen before the money moves, what is registered over what, and how long the borrower gets to fix a default.

Questions people ask