CHAPTER 9
Set-Off—or Offset

Set-off—also known as offset—is the buyer’s ability to satisfy a seller’s claim by transferring dollars from one contract to another in compensation for that claim. There is considerable opportunity to abuse such a provision. In simple terms, set-off is analogous to self-help, whereby buyer plays judge, jury, and executioner. Set-offs do not need to be in the same cost grouping when transferring money from one account to another (e.g., material, direct labor, indirect cost). Set-off may also be purely subjective. For example, in the event that seller is late in delivering the final product and the delay costs buyer money, if the contract contains a set-off provision, buyer may elect to set-off the cost incurred by the delay from seller’s contract. If there are insufficient funds on that contract and buyer has other contracts with seller’s firm, buyer may elect to set-off the amount allegedly owed on one contract from another. If the contract states that the set-off may apply to other affiliated seller divisions, buyer may opt to transfer money from one division’s contract to another. An example of a set-off provision may read as follows:

Buyer shall have the right to set-off the amount of any obligation due and owing to buyer against any obligations at any time due and owing to buyer, whether under this contract or any other contract arrangement or understanding between buyer and seller. In addition, buyer may apply any amounts received from seller toward any other outstanding balance due buyer. Seller or its agency shall be liable for all moneys due and costs of collection, including attorneys fees, as a result of any collection efforts by buyer under this contract.

RISK

There is potential for loss of revenue when seller accepts a set-off provision. Additionally, if seller is a subsidiary or division of a larger organization, the set-off provision may grant buyer the right to set-off money owed from a contract administered by another division. Seller may not have the authority to commit the other subsidiary or division to such a clause. Therefore, by accepting such a clause, seller may be indirectly transferring some of their risk to an affiliated company.

RESPONSE

Resist set-off provisions by requesting that buyer omit the provision in its entirety. Depending on the circumstance, seller may use various arguments to justify the omission of a set-off provision. These arguments are annotated below:

1) When negotiating a firm fixed price contract with milestone payments, seller may argue that buyer has the ability to hold back money until such time that seller performs in accordance with the contract.

2) If authorized in the terms and conditions of the contract, seller may remind buyer that they have the right to withhold final payment until such time all of the requirements of the contract are met; hence, a set-off provision is not needed.

3) When dealing with a prime contractor to the U. S. Government, the seller may argue that buyer’s contract with the government does not include a set-off provision. Since buyer is not assuming the risk associated with this provision, seller may debate that they, too, should not assume that risk.

If buyer is not willing to delete the set-off provision, always resist buyer’s ability to set-off against another subsidiary or division of seller. Further, request that the following language be included in the contract, thereby allowing seller to scrutinize buyer’s actions:“Buyer will provide a reasonable time frame for seller to review a proposed set-off obligation on a case-by-case basis prior to its implementation by buyer.”