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Articles from the Silver Shemmings Ash Team on contractual matters, recent case law changes and items of interest in the construction and property world

Cross Contract Set-Off – Why Is It Important? by Richard Silver

September 13, 2018 | Silver Shemmings

What is cross contract set-off and why is it important?

When disputes arise, it is most often the case that it relates to money. Both parties claim that the other party is liable to make payment. In such circumstances one question that frequently arises, is whether a party can reduce, or even eliminate, its liability under one contract by setting off that liability against debts due under another contract. For example, suppose Party A owes Party B £1,000 under Contract A, and Party B owes Party A £1,500 under Contract B. The question here is whether Party A can eliminate its liability under Contract A by setting off the sum of £1,000 against the sum of £1,500 that it due under Contract B, resulting in Party A being owed the sum of £500.

This question is particularly important, in light of Section 111 of the Housing Grants, Construction and Regeneration Act 1996 as amended by the Local Democracy, Economic Development and Construction Act 2009 (“the Construction Act”).

Section 111(1) of the Construction Act provides that “a party to a construction contract may not withhold payment after the final date for payment of a sum due under the contract unless he has given an effective notice of intention to withhold payment”.

For the notice to be effective it must, pursuant to Section 111(2)(a) of the Construction Act, specify the amount proposed to be withheld and the ground for withholding payment. If it meets these requirements, then the sum detailed in the notice will become the Notified Sum.

A ground for withholding payment is cross-contract set-off, i.e. where there are two or more contracts between the same parties, and one seeks to set-off their liability under one or more contracts against debts owed to them under one or more contracts. However, for this ground to apply, and the notice to have effect, the party seeking to rely on the notice must have a right to cross set-off sums.

When will a party have a right to cross set-off?

There are three main instances when a party will have a right to cross-contract set-off:

i. There is an express provision for cross set-off in one of the contracts;

ii. Outside of the contract, there is an express agreement in writing between the parties for cross set-off; and

iii. The test for equitable set-off between separate contracts applies.

The test for equitable set-off between separate contracts is clarified in the case of Geldof Metaalconstructie NV v Simon Carves Ltd [2010] EWCA Civ 667 (“Geldof”). It was held in this case that cross set-off could only occur where the separate contracts had an “intimate relationship with one another” so that it would be “manifestly unjust” to allow the claim without considering the counterclaim.

This test was held to have been satisfied in the case of Geldof. By way of background, the case concerned Simon Carves Ltd (“SCL”) seeking to set off a counterclaim for damages for repudiation of an installation contract into which it entered with Geldof Metaalconstructie NV (“Geldof”) against Geldof’s claim for the price of equipment which SCL bought from Geldof under a separate supply contract. The two contracts, although completely separate, were for the same project. It was held that the test was satisfied because restarting the works under the installation contract was conditional upon receiving payment under the supply contract.

Two important questions therefore follow from this case, and they will be addressed in turn:

a. What amounts to an “intimate relationship”?

b. When will it be “manifestly unjust” to allow consideration of one party’s claim without considering the other party’s claims?

a. It is useful to note the helpful guidance given by Lord Justice Rix on what may amount to an “intimate relationship”, as provided in the case of Geldof at paragraph 26:

“… On behalf of SCL, Mr Friedman acknowledges that the supply contract and the installation contract are separate contracts, concluded at separate times, separately tendered, and ultimately independent of one another in their origins. Nevertheless, he emphasises a number of elements about the two contracts which link them together. Thus both are related to the same site and the same main contract which SCL has made with Ensus UK. Both tenders were discussed together at the meeting of 5/6 June 2007. Above all, however, he relies on the way in which Geldof itself linked the two contracts together by demanding payment of invoices under the supply contract, the invoices upon which it sues in these proceedings, as a condition of continuing with performance of the installation contract. That in turn led to the acceptance of that conduct as a repudiation of the installation contract, which is one of the ways in which SCL’s counterclaim is pleaded. In such circumstances, he submits that the counterclaim is inseparably connected with the dealings and transactions which also gave rise to the claim.”

From the guidance given by Lord Justice Rix, an “intimate relationship” was found to exist because:

i. the two contracts related to the same site; and

ii. the two contracts were placed under the same main contract; and

iii. both tenders were discussed together at the same meeting; and

iv. Geldof itself linked the two contracts together by demanding payment of invoices under the supply contract, as a condition of continuing with performance of the installation contract.

The above reasons, therefore, give a good indication, as to the factors that need to be satisfied, in order for it to be found that an “intimate relationship” exists between the two contracts, and thus a party has a right to cross set-off.

b. The answer to this question can be found at paragraph 43 point (vi) of the judgment in Geldof:

“cross-claims… So closely connected within [the plaintiff’s] demands that it would be manifestly unjust to allow him to enforce payment without taking into account the cross-claim”

This suggests that the two claims must be “closely connected”, and in determining whether this is the case, it is useful to refer to the above question and guidance of what amounts to an “intimate relationship”.

This second requirement reiterates the point that equitable set-off is primary a tool of equity, and that the concerns of fairness and justice are paramount in determining whether a party has a right to cross set-off.

Conclusion

Cross set-off is where there are two or more contracts between the same parties, and one seeks to set-off their liability under one or more of the contracts against debts owed to them under one or more of the other contracts. For a party to have a right to cross set-off one of the following instances must exist:

i. There is an express provision for cross set-off in one of the contracts;

ii. Outside of the contract, there is an express agreement in writing between the parties for cross set-off; or

iii. The test for equitable set-off between separate contracts applies.

For the last instance to apply, there must be an “intimate relationship” between the contracts, and it must be “manifestly unjust” to allow consideration of one party’s claim without considering the other party’s claim

If you have any questions of a similar nature to this, please feel free to contact myself on richardsilver@silverllp.com or another member of the Silver Shemmings Ash team for advice

Author Richard Silver is Senior Partner at Silver Shemmings Ash. He is multi qualified as a Barrister, Solicitor & Chartered Quantity Surveyor with over 30 years of experience in the Construction Industry

Aside from his work globally as a legal advisor, his main focus is dispute resolution, encompassing the Construction, Building, Rail & Civil Engineering sectors. Having acted as Arbitrator, Adjudicator, Mediator, Lead Representative and Expert Witness on quantum, programme & planning he is widely experienced, as Lead Representative & Advocate, in all forms of Dispute Resolution

At Silver Shemmings Ash, we provide seminars and training alongside our core activities in contentious and non-contentious matters, the purpose if these is to facilitate a greater knowledge and understanding of construction and property law, there remains a considered lack of training in such areas for companies and one to which we look to address

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