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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Late payments and disputed invoices can put real pressure on your cash flow. One tool businesses use to manage that risk is a set-off clause.
In simple terms, a set-off clause lets one party deduct (or “set off”) amounts they’re owed from amounts they otherwise have to pay under the same contract. Used well, it can reduce back-and-forth over small adjustments and help keep money flowing.
But set-off isn’t a free-for-all. The wording matters, the law sets limits, and “overreaching” clauses can be unfair - or unenforceable. In this guide, we’ll explain what set-off clauses are, when to use them, how to draft them fairly, and the traps to avoid under Australian law.
What Is A Set-Off Clause?
A set-off clause is a contract term that allows a party to net out mutual amounts owed, so only the balance is paid. If you owe your supplier $10,000 but have a $2,000 credit note for defective goods, a set-off clause may let you pay $8,000 instead of paying the full $10,000 and separately chasing the $2,000 credit.
Set-off comes in different flavours. Understanding the type you’re using helps you draft (and negotiate) it the right way.
Common Types Of Set-Off
- Contractual set-off: Created by the contract. It usually allows set-off of amounts arising under the same agreement, and sometimes (if drafted broadly) across other contracts between the same parties.
- Equitable set-off: Available at law when cross-claims are so closely connected that it would be unfair to enforce one without accounting for the other. This can apply even without a clause, but the rules are stricter.
- Bank set-off (account set-off): Banks commonly set off funds between accounts when a customer is in default. For small businesses, this is relevant if your lender’s terms allow them to sweep funds.
For most small businesses, the focus is contractual set-off: the wording you agree in your customer terms, supplier terms, or master supply/service agreements.
If you’re new to contract risk tools generally, it can also help to look at how other clauses (like limitation of liability) work alongside set-off to balance risk.
When Should You Use A Set-Off Clause?
Set-off clauses can be helpful in everyday trading relationships. They reduce admin, give practical flexibility, and help you protect against non-payment. That said, what you want will depend on whether you’re the buyer/customer or the seller/supplier.
If You’re Supplying Goods Or Services
- Limit or exclude set-off by the customer. As a seller, you usually want to be paid in full and on time. Allowing unlimited set-off gives the customer power to short-pay on disputed issues. Many supplier terms state that the customer must pay all invoices “without set-off or deduction,” and require disputes to be handled via a formal process while the customer continues paying.
- Reserve your own set-off rights. You might still want set-off in your favour-for example, to net out credit notes or unpaid fees across multiple orders under a single Terms of Trade or a Goods and Services Agreement.
- Use credit frameworks. If you trade on credit, set-off can be paired with credit application terms, personal guarantees, and security interests (discussed below) to tighten recovery options.
If You’re Buying From Suppliers
- Seek a fair set-off right. Where there are short deliveries, quality issues or agreed rebates, a reasonable set-off right lets you deduct those amounts and keep cash moving without endless credit notes.
- Be clear on scope. If you buy under multiple purchase orders or related contracts, make sure your set-off right covers “any amount owing or payable under this or any other agreement between the parties,” if that’s commercially agreed.
- Don’t rely on set-off alone. For serious disputes, you’ll still want clear warranty, indemnity and dispute resolution clauses. Set-off is a cash flow tool-it’s not a substitute for solid contract rights.
As a rule of thumb, the party in the stronger bargaining position limits the other side’s set-off and reserves its own. In balanced relationships, both sides usually accept a narrowly tailored set-off for undisputed amounts only.
How Do Set-Off Clauses Work In Practice?
Good set-off clauses are practical. They spell out what can be set off, how, and when-even simple steps can prevent arguments later.
Key Elements To Cover
- Scope: Are you setting off only amounts due under the same contract (narrow) or across all dealings between the parties (broad)? If it’s multi-entity groups, will the clause allow “triangular” set-off with affiliates? Most small businesses keep it simple: same parties, same contract, unless your relationship is more complex.
- Type of amounts: Limit set-off to amounts that are due and payable. Many clauses also require the credit to be undisputed, or determined by agreement, invoice, or a court/tribunal. This keeps people from short-paying based on untested claims.
- Notice process: Require written notice that identifies the amount being set off, the reason, and supporting documents (e.g. RA numbers, emails confirming returns). A short notice window (say, at least 5 business days before the due date) gives the other side a chance to respond.
- Interaction with interest and late fees: Clarify whether interest and late fees still accrue on the original invoice if the set-off turns out to be invalid, and how adjustments will be handled.
- No waiver of other rights: State that set-off does not limit your right to recover any remaining balance or to pursue other remedies.
Worked Example
Let’s say you’re a retailer who ordered 500 units from a wholesaler. You discover 40 units are faulty and the supplier agrees via email to issue a $1,200 credit note.
With a clear set-off clause, you can deduct $1,200 from the next invoice (after giving the required notice), pay the balance, and everyone keeps moving. If there’s no clause-or if the seller’s terms say “no set-off”-you may have to pay the invoice in full and wait for the credit note. That’s slower for you, which is exactly why suppliers often exclude set-off by customers.
To ensure the clause fits your business and bargaining position, it’s wise to get a quick contract review before you sign.
Are Set-Off Clauses Enforceable In Australia?
Generally yes-courts will enforce clear, properly drafted set-off clauses. But there are important limits to be aware of.
Unfair Contract Terms (UCT)
If you contract with small businesses or consumers, the expanded unfair contract terms regime under the Australian Consumer Law (ACL) may apply to your standard form contracts. A set-off clause that is one-sided, unclear, or causes significant imbalance may be void and attract penalties. To reduce risk:
- Make the scope clear and proportionate to the contract’s purpose.
- Avoid allowing set-off of disputed and unliquidated claims without any process.
- Consider mutual rights where appropriate, or justify asymmetry (e.g., legitimate business interests such as credit risk).
Where UCT risk is on the table, it’s a good idea to pair drafting with a UCT review and redraft of your standard terms.
Security Interests And Insolvency
Set-off is different to taking security. A set-off clause doesn’t give you a proprietary interest in the other party’s assets or priority in insolvency. If your counterparty goes under, you’ll want backup protections:
- Security interests: If you supply on credit, consider a General Security Agreement and properly register the security interest on the PPSR. This can put you ahead of unsecured creditors if things go wrong.
- Personal guarantees: For closely held companies, personal guarantees can help bridge the enforcement gap if the company can’t pay.
No Set-Off Clauses
Many supplier terms include a “no set-off” obligation on the customer-i.e., the customer must pay invoices in full and cannot deduct or withhold amounts. These are generally enforceable in business-to-business contracts, provided they don’t fall foul of UCT laws and the rest of the contract is fair.
If your customer insists on a limited set-off right (e.g., for undisputed credit notes), you may choose to allow it within a tight process that preserves your cash flow.
Other Legal Interactions
- Liquidated damages and price adjustments: If your contract also includes liquidated damages for delay or performance credits, the set-off clause should make clear how those amounts can be applied, and when.
- Liability caps: If you’ve negotiated a liability cap, ensure set-off of claims still respects that cap (this is a common drafting miss). For context, see how liability caps and exclusions work.
- Dispute resolution: Set-off should align with your dispute pathway (e.g., negotiation, mediation, arbitration). For disputed claims, require use of that process rather than unilateral deductions.
How Do You Draft A Fair Set-Off Clause (With Examples)?
Here’s a simple framework you can adapt with your lawyer. Keep it proportional to your deal size and the nature of your relationship.
1) Decide Your Commercial Position
- As a seller: Default to “no set-off by the customer,” except for credits you’ve issued or agreed in writing. Retain a set-off right in your favour (e.g., to apply credits across orders).
- As a buyer: Seek a right to set off undisputed, due and payable amounts (e.g., agreed rebates or credits) with a simple notice requirement.
2) Define Scope And Process
Consider including the following elements:
- Scope: “Amounts due and payable under this Agreement” (broader only if commercially agreed).
- Undisputed only: “The party may only set off amounts that are not in dispute or have been agreed in writing.”
- Notice: “At least 5 Business Days before the due date, the party must give written notice describing the basis and amount of the set-off and attaching reasonable supporting evidence.”
- Reservations: “Exercising set-off does not limit any other rights or remedies.”
3) Sample Wording (Illustrative Only)
“To the extent permitted by law, Party A may set off any undisputed amount that is due and payable by Party B to Party A under this Agreement against any amount due and payable by Party A to Party B under this Agreement, provided Party A gives Party B at least 5 Business Days’ prior written notice with reasonable details of the set-off.”
For supplier-friendly terms, you might include: “The Customer must pay all amounts without set-off, counterclaim or deduction, except to the extent the Supplier has issued a credit note or otherwise agreed in writing.”
These are starting points only. You’ll want to adapt them to your contract style, dispute process, pricing model and industry norms-ideally as part of your broader Terms of Trade or customer contract.
4) Align With The Rest Of Your Contract
Set-off doesn’t live in a vacuum. Make sure it’s consistent with:
- Invoicing and payment mechanics: due dates, partial payments and credit note processes.
- Claims process: time limits, evidence, and remedies for defective goods or services.
- Liability and remedies: caps, exclusions, indemnities and liquidated damages.
- Security and credit: guarantees, PPSR security, retention of title, and your credit application workflow.
Related Clauses And Alternatives
Set-off is one tool in your risk toolkit. Depending on your role and risk appetite, you may want to combine or substitute with other protections.
Security Interests (PPSR)
A security interest (for example, a General Security Agreement or retention of title in your terms) can give you priority over other creditors and more options if a customer defaults. To be effective, most security interests need PPSR registration-our team can help you register a security interest correctly and on time.
Payment And Remedies Clauses
- Suspension for non-payment: Clear rights to suspend supply after notice can be more impactful than set-off alone.
- Interest and late fees: These encourage timely payment and compensate you for delays.
- Liquidated damages: For predictable losses (like delay), pre-agreed damages can simplify claims-be sure they’re a genuine pre-estimate, not a penalty.
- Liability settings: Balance your set-off approach with appropriate caps, exclusions and indemnities. Our guide to limitation of liability explains what to consider.
When To Avoid Set-Off
There are times when excluding set-off entirely makes sense-for example, high-volume, low-margin supply where short payments would create significant admin and cash flow issues. In those cases, ensure you have practical alternatives like rapid credit note processes and clear defect claim timelines.
Deep Dive Resource
For more technical detail and examples, you can also read our dedicated guide to set-off clauses in Australian contracts.
Common Pitfalls To Avoid
Even well-meaning clauses can create headaches if they’re vague or out of step with the rest of your agreement. Watch out for:
- Vague scope: “Any amounts whatsoever” invites disputes. Define what can actually be set off.
- Unilateral power without checks: Allowing set-off of disputed, unassessed claims can trigger UCT issues and sour relationships.
- Conflicts with other clauses: Ensure set-off respects liability caps and works with your dispute process and payment mechanics.
- Silence on notice: Without a simple notice step, set-off surprises can become trust issues.
- Assuming set-off equals security: It doesn’t. If credit risk matters, look at PPSR security and guarantees in addition to set-off.
If you’re updating your standard terms, it’s smart to run the whole contract through a short contract review so the set-off clause is consistent and enforceable.
Key Takeaways
- A set-off clause lets you net out mutual amounts owed, which can streamline payments and reduce admin-but scope and process matter.
- Suppliers often limit customers’ set-off rights and reserve set-off in their own favour; buyers tend to seek a fair right for undisputed credits.
- To be enforceable and fair, define the scope (which amounts and which agreements), require notice, and limit set-off to due and undisputed amounts.
- Watch for UCT risk in standard form contracts-heavy-handed, one-sided set-off can be unfair; consider a targeted UCT review if you trade with small businesses or consumers.
- Set-off is not security-combine it with tools like a General Security Agreement and PPSR registration where credit risk is significant.
- Make sure your set-off clause aligns with invoicing, claims, liability caps and dispute resolution so your contract reads as one, consistent system.
If you’d like help drafting or reviewing a set-off clause in your terms or supplier contracts, you can reach us at 1800 730 617 or team@sprintlaw.com.au for a free, no-obligations chat.
