Do not set me off on contractual set-offs

Set-off clauses in construction contracts are common. A party’s rights to set-off can be grounded in contract, equity or be legislative in nature.

However, unlike set-off principles applied at law, contractual set-off is only limited to the extent the parties to a contract agree for it to be. In these days of attempted “take it or leave it” contracting models, it can be difficult for Contractors to restrict the extensive use of set-off clauses in their construction contracts.

But resist they should.

This article will provide a basic guide so that contractors and subcontractors can minimise their exposure to set-offs and back charging and use their limited ability to re-negotiate contractual terms with Principals wisely.

Typically, Principals seek to apply set-off provisions in contracts for alleged defective work; costs and expenses relating to delay and disruption claimed to be the fault of the Contractor; and for liquidated damages. We will deal with the latter scenario and the issue of recourse to security, in a future article and instead focus in this one on limiting the application of set-off clauses for instances other than liquidated damages for delay.

Golden Rule – No Set-Offs for Claims

The Australian Standard contract suite generally only provides for the contractual right to set-off in instances where a debt amount is due and owing by a Contractor to a Principal. Clause 42.10 of AS2124 (in part) provides:

“The Principal may deduct from moneys due to the Contractor any money due from the Contractor to the Principal otherwise than under the Contract…”

Similarly, clause 37.6 of AS 4000 and AS 4902 both state:

“The Principal may elect that moneys due and owing otherwise than in connection with the subject matter of the Contract also be due to the Principal pursuant to the Contract.”

Despite giving a Principal a contractual right to set-off monies owing to it by the Contractor independent of, or outside of, the contract at hand (which is not ideal), these unamended provisions establish a reasonable construction contract principle that set-offs should only be available for an amount established as a debt due and owing by the Contractor to the Principal.

Instead, we are regularly confronted in the construction sector with amended Australian Standard or bespoke contracts which attempt to pass-off as unremarkable set-off clauses that allow for Principals to apply a back charge for a mere claim by them that a Contractor is said to owe them money.

The below clause in a recent contract I reviewed is one such example:

                “The Principal may elect to deduct from any moneys otherwise due to the Contractor:

(a) any debt or other moneys due from the Contractor to the Principal; and
(b) any claim to money which the Principal may have against the Contractor whether for damages (liquidated or unliquidated) or otherwise…”

This clause does not just establish a set-off right for a Principal for a debt or amount due to it from the Contractor, but it goes further by providing the Principal with the right to offset against the Contractor for any “claim” to money it may have against the Contractor. This considerably opens-up the field for the Principal to claim any expense, cost, loss or liability it is says it has incurred as a result of the Contractor, to be set-off.

But, it gets worse.

Taken to its fullest meaning, the clause also allows for the Principal to set-off against an amount otherwise payable to a Contractor, any amount it claims that at some future point in time the Contractor will owe it money. That’s right, a Contractor’s hard-earned cash-flow could be subject to the whim and an estimate of a Principal.

It is a nonsense. Contractual set-off rights for a “claim” by a Principal, like the one outlined in paragraph (b) above, should be deleted from proposed contract terms by an astute Contractor.

…it can be difficult for Contractors to restrict the extensive use of set-off clauses in their construction contracts. But resist they should.

 Fall-back Position

So you have tried to push-back on the Principal’s contractual right to set-off for a claim and you have been told “no” or “it will not be accepted” by the Principal. (Actually, you are usually informed by the Principal’s pin-striped suited lawyer, you know the one from the marble reception area law firm who has not been near a site shed other than passing one on his mid-morning walk for a latte).

Well, there is a fall-back position you should adopt.

Have the contract amended on the basis that you will accept the Principal’s right to set-off for a claim, however the Principal’s right to do so is only for “bona fide” claims it is said to have against the Contractor.

“What is a bona fide claim?”, you ask, “and what is the difference of one from a bare claim?”

The term “bona fide” is Latin for “in good faith”. If a person or party is acting on a bona fide basis, it means that they are acting in good faith and with an honest intention.

An example set-off clause including the term might be the following:

“…the Principal may deduct from any moneys due to the Contractor any sum which is bona fide claimed as being payable by the Contractor to the Principal…”

This amendment does not get completely away from a Contractor’s concern about a Principal having a right to set-off based on the latter’s claim only, but it does require the Principal’s claim to be honestly maintained and with an obligation of being made in good faith.

Good faith obligations are a topic for another article but suffice to say, a Principal claiming a right to set-off which is subject to it being on the claim being on a “bona fide” basis, would be under a duty to ensure its claim is fair, reasonable and honest not a mere whim with little or no basis.

It is a small protection but one that will have a Principal think more than twice before it purports to deduct monies owing to a Contractor.

Written by Tom Cranitch