Updated: May 13, 2022
A set-off clause is a term used in a contract that describes how one party can deduct amounts from a payment that is owing to another party. Set-off clauses ensure that the innocent party has an additional avenue of recourse for amounts that are or may be owed to them.
A set-off clause gives a party a contractual right to counterclaim against the other party and either:
pay the difference to the other party if an amount is still owed after applying the counterclaimed amount; or
seek to recover the outstanding balance if the amount owed is not sufficient to discharge the amount of the set-off
Author: Farrah Motley, a commercial contract lawyer.
What does a set-off clause look like?
A set-off clause may be written like this:
Party A may deduct from any payment that is or may be owing to Party B, any amounts for losses, damages, costs or expenses that are incurred by Party A or which Party A considers that it may incur at a future date. Nothing in this clause limits or reduces Party A's entitlement to claim any amounts owing by any other means.
Set-off clauses can also appear in employment contracts. Set-off clauses in employment contracts aim to ensure that:
if an employee is paid on the basis of an annual salary, rather than an hourly rate, the additional monetary benefit that the employee receives as an annualised salary can be set-off against the cost of any additional entitlements that may be payable to an employee under a Modern Award (and not in addition to the annual salary); or
if the employer pays for a benefit that is principally for the benefit of the employee, and the employee resigns from their employment, the cost of the benefits can be set-off against any outstanding entitlements that may be owing to the employee.
A set-off clause in an employment contract may be written like this:
The employer may apply against and set-off from any entitlements which may be owing to the employee at the termination of this employment contract any amounts which the employer has paid on the employee's behalf in respect of training or equipment relating to the employee's employment.
An example of set-off
Below is an example of when someone may want to use a contractual set-off clause:
Party A needed to hire an electrician and engaged Party B. Party A owes Party B $100 for electrical services provided by Party B to Party A. Party A discovers that the electrical services are defective and pays Party C $20 to fix the defects.
Party B then claims payment for $100 from Party A. Party A applies the $20 against the $100 owed to Party B (using the contractual set-off clause) and pays the difference of $80 to Party B.