The trouble with set-off

Not surprisingly, set-off is the reason for most of the industry’s payment disputes. Over the years, the big construction companies have had few qualms about using set-off as a blatant attempt to hang on to as much cash as possible for as long as they can.
Contractual set-off provisions have been drafted widely to provide for extensive rights of set-off, including cross-contract set-off where the payer seeks to withhold moneys that he claims is owed on other contracts. Sir Michael Latham in Constructing the Team recommended outlawing it through legislation. Unfortunately, the Construction Act did not ban it; instead, legitimising it by reference to the possibility of cross-contract set-off in section 110.
Section 111 of the act does seek to impose a discipline on set-off rights, by requiring that the ground(s) for set-off, together with the amount(s), is contained in an effective notice. Such notice must be issued within a period prescribed in the contract, but not later than the prescribed period before final date of payment.
The most effective antidote to set-off abuse is, of course, adjudication. In fact, section 111(4) of the act requires the payer to pay up within seven days of the adjudicator’s decision (or longer if the final day for payment is more than seven days).
If I was facing set-off abuse, I would refer the matter to the adjudicator and ask him to look carefully at the set-off provision. In most cases, it is likely to be far more extensive than the law would permit. Those with long memories will recall the Broadgate litigation at the beginning of the 1990s and in particular Rosehaugh Stanhope vs Redpath Dorman Long Ltd.

Bovis, the construction manager, was relying on the following set-off clause: “If the trade contractor is in breach of any of his obligations … he shall … forthwith pay or allow the client such sums as the Construction Manager shall bona fide estimate as the amount of any such loss or damage. Such estimate to be binding and conclusive upon the trade contractor until such final ascertainment or agreement.”

The Court of Appeal said that this kind of clause should be interpreted against the interest of the client – the contra proferentem rule. The court held that Bovis could make such a bona fide estimate only after agreement of the loss involved or proof of breach by the trade contractor. Lord Justice Nourse said: “I absolutely decline, on the words of this contract, to impute to the parties an intention that the construction manager should have power to impose on the trade contractor a liability which is neither admitted nor proved to exist at the time, which may later be proved never to have existed at all, but which may in the meantime have brought him into bankruptcy, being a power which is not claimed even by the court on an application for interim damages where an arguable defence is shown.”
Strong words. The courts may even go further and strike down wide set-off provisions as penalties. In Gilbert-Ash vs Modern Engineering Ltd (1973), the contractor reserved the right to suspend or withhold payment of any moneys due or becoming due to the subcontractor where the subcontractor fails to comply with the terms of his subcontract. Lord Reid had no hesitation in holding that this provision was unenforceable as a penalty. “Read literally, this provision would entitle the contractor to withhold sums far in excess of any fair estimate of the value of his claim.”

As a consequence, JCT had set-off provisions in subcontracts linked to JCT main forms that sought to reduce the scope of set-off abuse by providing that the amount of set-off be quantified in detail and with reasonable accuracy; the set-off could be in respect only of losses that had actually been incurred by the contractor; the grounds of set-off and quantification had to be contained in a notice issued not less than three days before interim payments became due.
But this very sensible protection has now been removed from JCT subcontracts. It is no accident that this occurred once the Specialist Engineering Contractors Group was no longer part of the JCT.

Now, here is an interesting provision I recently discovered in a bespoke works contract: “On receipt of a notice to withhold payment the Works Contractor will immediately issue a credit note in the value of the notice to enable any balance due against the Contract Administrator’s certificate to be paid. Failure to issue the appropriate credit note will prevent any payment being made.”
I would like to meet the clever dick who drafted this. He has not done the client any favours because this provision will not work. It will lead to disputes because no one in his right mind will issue a credit note admitting that he owes whatever amount is contained in the set-off notice. No court will interpret this nonsense as meaning that the works contractor has sacrificed his payment entitlement on the altar of the other party’s capriciousness. If the author thinks that I have been too harsh, perhaps he or she should write to Building.
The point is that, where there are set-off disputes, the likelihood is that the relevant provision has been drafted to provide extensive rights of set-off. The law has always been careful to cut these down; adjudicators should be thinking of doing the same.