Alex is Sprintlaw's co-founder and principal lawyer. Alex previously worked at a top-tier firm as a lawyer specialising in technology and media contracts, and founded a digital agency which he sold in 2015.
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If you run a business, you’ve probably had this frustrating situation at some point: you’ve delivered goods or services, you’re owed money, but the other party claims you owe them something too. Or maybe you’re the one thinking, “Why should I pay this invoice in full when the supplier hasn’t fixed the problems we’ve raised?”
This is where a right to set off can become incredibly important. When it’s drafted properly (and used carefully), set off can help you manage risk, protect cashflow, and resolve disputes without immediately escalating to formal debt recovery or litigation.
But it’s also a common source of confusion and conflict. Set off can be misunderstood, misused, or drafted in a way that doesn’t actually give you the protection you thought it did.
Below, we break down what the right to set off means in Australia, when it applies, how it can be built into your contracts, and the practical steps you should take before relying on it.
What Is The Right To Set Off?
The right to set off is the ability to reduce (or “set off”) an amount you owe to someone by an amount they owe to you.
In a business context, set off usually comes up when there are mutual debts between the same two parties. Instead of paying each other separately, one party may offset the amounts so only the net balance is paid.
A Simple Example Of Set Off
Let’s say:
- You owe a supplier $10,000 for stock you’ve received; and
- The supplier owes you $2,000 because they agreed to a rebate or refund for faulty items.
If you have a set off right (and it applies in the circumstances), you may be able to pay only $8,000, rather than paying $10,000 and chasing the $2,000 separately.
Set Off vs “Withholding Payment”
Set off is not simply refusing to pay an invoice because you’re unhappy. A proper set off is usually tied to an actual, identifiable amount the other party owes you, and it needs a sound legal basis to be enforceable (often contractual, but not always).
If you withhold payment without the right to do so, you may trigger:
- late fees or interest;
- default notices;
- suspension of supply; or
- debt recovery action.
Where Does A Right To Set Off Come From In Australia?
A right to set off can arise in different ways, and the source matters because it affects how confidently you can rely on it.
1. Contractual Set Off (The Most Common In Business)
In most commercial relationships, the safest approach is to include a set off clause in your contract (or in your terms of trade). This clause sets out:
- whether set off is allowed at all;
- what types of amounts can be set off (for example, refunds, damages, credits, chargebacks);
- what notice needs to be given; and
- any exclusions (such as not being able to set off certain disputed amounts).
If you sell goods or services under written terms, those terms are often your first line of defence. This is why having clear terms of trade is so valuable when a payment dispute pops up.
2. Legal (Equitable) Set Off
Even without an express clause, set off may be available under equitable principles in certain circumstances. In simple terms, equitable set off may apply where the cross-claims are so closely connected that it would be unfair to require one party to pay without taking the other claim into account.
In practice, relying on equitable set off can be harder because it can involve legal arguments about the connection between the claims, evidence, and fairness in the circumstances.
For small businesses, the practical takeaway is: if set off is important to your cashflow and risk management, it’s usually better to deal with it in the contract upfront.
3. Statutory Set Off (Common In Insolvency Situations)
There are also statutory regimes where set off can apply, especially where insolvency is involved. For example, in a company liquidation, insolvency set off may operate under section 553C of the Corporations Act 2001 (Cth) to net out certain mutual credits, mutual debts and other mutual dealings.
If the other party is insolvent (or close to it), set off can become more technical, time-sensitive and fact-dependent, so it’s worth getting advice early.
When Can A Business Use The Right To Set Off?
Whether you can actually use set off depends on a few practical (and often contractual) factors.
Are The Parties The Same?
Set off usually requires that the amounts are owed between the same legal entities.
For example, if your customer is “ABC Pty Ltd” but the debt you want to rely on is owed by “ABC Trading Trust”, you may not be able to set off without very careful structuring and drafting. Even where the trading name looks similar, the legal entity matters.
Is The Amount Certain Or Undisputed?
Many contracts only allow set off for amounts that are:
- agreed;
- invoiced/credited; or
- finally determined (for example, by a court or an agreed dispute process).
If your “counterclaim” is more like an estimate (for example, “we think you caused us $30,000 in lost profits”), you may not have an immediate contractual right to set off unless the contract allows it clearly.
Is The Claim Connected To The Same Transaction?
Some set off clauses are narrow and only allow set off where the claim relates to the same supply, invoice, or project.
Others are broad and allow set off against any amounts owed between the parties, across multiple jobs or invoices. Broad drafting can be useful for cashflow, but it can also be heavily negotiated (because it shifts risk).
Is There An “No Set Off” Clause?
It’s very common for suppliers (especially larger ones) to include “no set off” wording requiring you to pay invoices in full without deduction.
If your contract says payment must be made “without set off or counterclaim”, you may be contractually restricted from using set off (even if you believe you have a legitimate complaint).
This is one reason why contract review matters before you sign, especially where the commercial relationship is ongoing and invoices are frequent.
How To Draft A Set Off Clause That Actually Helps Your Business
A set off clause can be a powerful tool, but only if it’s drafted clearly and fits how your business operates.
Below are the key drafting points we typically look at when helping businesses build set off into their commercial contracts.
1. Define What Can Be Set Off
A strong clause usually spells out the types of amounts you can deduct. Depending on your business model, this might include:
- refunds and credits;
- rebates and volume discounts;
- chargebacks;
- returns;
- liquidated damages (if you use them);
- amounts payable for breach (where appropriate).
The clearer you are, the less room there is for dispute about whether your deduction is legitimate.
2. Decide Whether Set Off Applies To Disputed Amounts
This is a major negotiation point.
From a cashflow perspective, many customers want the ability to set off even if the amount is disputed (for example, where they are alleging defects or delays). From a supplier perspective, that can feel like the customer is “holding invoices hostage”.
A middle-ground approach is often to allow set off only where:
- the amount is agreed in writing; or
- the amount has been determined under a dispute process; or
- the customer has issued a compliant notice explaining the basis and calculation.
If you already use a written customer contract for your services, it can be worth building this alongside other payment protections (like interest, suspension rights, and clear invoicing requirements) in your customer contract.
3. Include A Notice Process
In practice, set off works best when the contract requires the party setting off to provide notice with details, such as:
- the amount being set off;
- the invoice(s) affected;
- the reason for the set off; and
- supporting documents (like credit notes, photos, or agreed variation emails).
This reduces the risk of surprise deductions and improves the chance you can resolve the issue quickly.
4. Consider Carve-Outs (What Can’t Be Set Off)
Sometimes you’ll want to exclude certain amounts from set off, for example:
- amounts owed for professional fees;
- amounts owed under a payment plan;
- amounts owed under a settlement deed; or
- invoices for third-party disbursements.
Carve-outs can be particularly useful if your business has high pass-through costs and you can’t afford to have clients deduct amounts without agreement.
5. Make Sure Your Set Off Clause Matches Your Dispute Resolution Clause
Set off is often triggered by disputes. If your contract has a dispute resolution process (for example, good-faith negotiation, mediation, escalation to management), your set off clause should align with it.
Otherwise you can end up with practical problems like:
- a client setting off immediately, while the dispute clause says both parties must continue performing and paying;
- unclear timelines for when set off can occur; or
- arguments that the set off is a breach of the payment clause.
Common Risks And Mistakes When Relying On Set Off
Even if you understand set off, there are some common traps that can lead to disputes or even legal liability.
Using Set Off As Leverage (Instead Of A Genuine Offset)
Set off is meant to net out genuine cross-claims. If you use it as a pressure tactic (for example, “we’re deducting 30% until you respond”), it can escalate quickly.
If you’re on the receiving end of this behaviour, it’s often a sign that your contract needs tighter payment wording, or that you need a clearer process for variations, defects, and acceptance.
Set Off Across Different Contracts Without Permission
Businesses often have multiple agreements running at once with the same counterparty (for example, supply agreements, service agreements, and ad hoc purchase orders).
Unless your terms allow it, setting off across different contracts can be risky, particularly if each contract has its own payment and dispute wording.
Ignoring Unfair Contract Term (UCT) Risk
If you use standard form contracts with smaller counterparties, a very broad set off right (especially if it operates one-way in your favour) could increase the risk of being challenged as unfair.
This is particularly relevant where your other terms are also heavily weighted (for example, broad limitation of liability, unilateral variation rights, or harsh termination rights). If you’re concerned about your overall risk position, it can help to review how your set off clause sits alongside your broader approach to contract enforceability.
Not Documenting The Underlying Claim Properly
Set off often fails in practice because the business asserting it can’t show evidence of:
- what was agreed;
- what went wrong;
- how the amount was calculated; and
- why it is payable now.
This is why contract administration matters. Good records (emails, variation approvals, delivery notes, photos, meeting notes) can make the difference between a clean set off and a messy dispute.
Practical Steps: How To Use Set Off Without Damaging The Relationship
Set off isn’t just a legal concept. It’s also a relationship and negotiation issue, especially if you want to keep working with the supplier or customer.
Here’s a practical approach that usually helps small businesses use set off in a controlled way.
1. Check The Contract First
Before you deduct anything, confirm:
- does your contract allow set off?
- is there a “no set off” clause?
- are there notice requirements?
- is the amount you want to set off covered by the wording?
If you don’t have a written agreement (or you’ve been operating on emails and invoices), it’s often worth formalising your commercial arrangements with contract drafting so you’re not relying on assumptions.
2. Calculate The Amount Conservatively
If your set off amount is arguable or involves estimates, consider whether it’s safer to:
- set off only the clearly provable portion; and
- reserve your right to claim the rest separately.
This can help you avoid allegations that you’re withholding payment without basis.
3. Give Clear Written Notice
Even if the contract doesn’t require it, a short written notice can reduce misunderstandings. Keep it factual and businesslike.
For example:
- identify the invoice;
- state the set off amount;
- briefly explain the reason; and
- attach evidence (credit note, agreed rebate, defect report, etc.).
4. Keep Talking (And Use A Dispute Process Early)
If set off is being used because of performance issues, it’s usually better to raise the dispute early rather than letting it build over multiple invoices.
If you regularly work with suppliers or contractors, a clear dispute process can sit alongside other key protections like limitation of liability and variations clauses, so disagreements don’t immediately become payment standoffs.
5. If You’re On The Receiving End, Respond Quickly
If a customer sets off against your invoice and you think it’s not valid, don’t ignore it.
Consider:
- responding in writing disputing the set off;
- requesting evidence and a breakdown;
- issuing a formal notice under your payment clause; and
- invoking the dispute resolution process (if your contract has one).
It can also be a sign you need to tighten your standard terms, especially your invoicing and acceptance provisions.
Key Takeaways
- A right to set off can allow you to reduce amounts you owe by amounts owed to you, which can be a powerful tool for managing cashflow and disputes.
- The safest set off position for most businesses is a clear contractual set off clause in your commercial contract or terms of trade.
- Whether set off can be used often depends on whether the parties are the same legal entities, whether the amount is certain or agreed, and whether the contract restricts or excludes set off.
- A well-drafted set off clause should define what can be set off, set out notice requirements, and align with your dispute resolution and payment provisions.
- Misusing set off (or setting off without a valid right) can trigger default, late fees, and debt recovery action, so it’s worth checking your documents before relying on it.
If you’d like help reviewing or drafting a contract with a set off clause that protects your business, you can reach us at 1800 730 617 or team@sprintlaw.com.au for a free, no-obligations chat.
