Set off in construction contracts

Set off (sometimes called contra charging) is a legal process by which party A defends a claim brought by party B, by A setting off in extinction or diminution of B’s claim, claims which A alleges against B.

For example:

A client might reclaim the cost of water damage to their property caused by a contractor fitting out the floor above the damaged area.
A contractor might set off costs against a sub-contractor that caused damage to finished work adjacent to the working area of the sub-contractor.
In the case of late completion a client might set off the appropriate amount of liquidated and ascertained damages in accordance with the contract.

Whilst set off is often accompanied by a counterclaim it is to be distinguished in that set off cannot, unlike a counterclaim, give rise to a positive balance of claim.

Set off rights can either be contractual, equitable or in the case of insolvency, statutory.

Contractual set off will depend on the wording of the agreement between the parties. It is possible for contractual set off rights to extend to a wide range of different contracts, but the wording must be clear. Equitable set off arises by operation of law if there is sufficient proximity and connection between the parties (e.g. the same parties, site and project). A recent statement of the law of equitable set off is given in the Court of Appeal judgement in Geldof Metaalconstructie NV v Simon Carves Ltd [2010].

If a contracting party becomes insolvent, the Insolvency Act 1986 Section 323 (bankruptcy) and the Insolvency Rules Rule 4.90 (liquidation) provide for a statutory set off known as ‘mutual credits and mutual debits’.

This statutory set off requires account to be taken between the insolvent party and the proving creditor of mutual debts, mutual credits and mutual dealings arising before the insolvency which are then set off leaving only the balance, if any, provable in the insolvency. This is, of course, only fair as otherwise the creditor would be 100% liable on debts due to the insolvent and only receive the relevant distribution (often nothing) on debts owed by the insolvent.

In construction contracts, rights of set off and withholding payments are regulated by the Housing Grants, Construction and Regeneration Act 1996 Part II Section 111, amended, with effect from October 2011, by the Local Democracy, Economic Development and Construction Act 2009 Part 8 Section 144. These Acts regulate the contents and prescribed periods for 'pay less' notices which must be served if a party wishes to deduct sums from amounts otherwise due under the contract.

Adjudication procedures constrain the effect of set off to preserve the public policy of adjudication that it should be a relatively speedy interim solution. In M J Gleeson Group Plc v Devonshire Green Holding Ltd [2004], the court held that a respondent could not set off claims arising after the commencement of the adjudication to avoid payment of a sum awarded by the adjudicator.