Time to set off

We’re often asked by contractor clients whether the employer can exercise a right of set-off over monies due under the contract and in what circumstances.

More accurately, the contractor wants to know why they're not getting their money and what we can do about it. Profit margins are tight and steady cash-flow is essential.

The starting place is the ubiquitous withholding notice. Under s111 of the Construction Act, a party to a construction contract may not withhold payment after the final date for payment of a sum due under the contract unless they are given an effective withholding notice. This acts as a statutory exclusion on the right of set-off. If, however, a withholding notice has indeed been given, that may not be the end of the story. There still has to be a valid right of set-off.

Broadly speaking, there are two types of set-off: (1) the common law right of set-off of mutual liquidated debts and (2) equitable set-off.

Mutual liquidated debts

The employer can set off a cross-claim whose amount is known or can be ascertained with certainty. So, for example, if the employer is owed a debt by the contractor on a separate project, they can set it off against money owing on this project, provided that the exact amount is known. This wouldn’t be the case if the amount owing could only be worked out by a court.

Equitable set-off

The employer can set off a cross-claim, even if the amount isn’t known, provided that it’s so closely connected with the contractor’s claim that it would be manifestly unjust to allow the claim without taking into account the cross-claim. This would apply, for example, to liquidated damages arising under the same contract.

Contractual set-off

It is, of course, possible to have a contractual right of set-off. Parties are perfectly entitled to provide for rights between themselves, whatever the common law says. In practice, most instances of set off are covered by mutual liquidated debts or equitable set-off anyway, but there are circumstances, for example the set-off of a claim under another unconnected contract with the same contractor, that would need an express contractual right of set-off.

Statutory set-off

Rights of set-off may also arise under statute, for instance under s323 of the Insolvency Act 1986 and r4.90 of the Insolvency Rules 1986, which allow the employer to set off cross-claims against any sums owing, for example as retention, in the event of the contractor’s bankruptcy or liquidation.

Abatement

It’s important not to confuse set-off with abatement. The employer doesn’t need to set off damages for breach of contract if the work is not up to scratch, they can simply defend a claim for payment by showing that what’s been done is worth less than what’s being claimed. This won’t apply where payment’s been certified by the architect or contract administrator, of course, but otherwise it’s a way round s111 of the Construction Act, which only applies to sums “due” under the contract.

Consistent with our policy when giving comment and advice on a non-specific basis, we cannot assume legal responsibility for the accuracy of any particular statement. In the case of specific problems we recommend that professional advice be sought.

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