The Joys of ‘Setoff’ in a Construction Contract

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Monday, April 13th, 2015
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For the uninitiated, dumb and desperate, setoff is an evil tool used by the upstream client on the contractor/subcontractor on an ad hoc basis, without any check or balance in place to stop this filthy practice.

Horror stories abound, and I have seen several cases where main contractors or clients use the setoff clause in the contract to milk any profit that there was once in the project, but that clearly will not be there at the end of the day.

However, let’s put a bit of realistic perspective on this issue. Let’s have a quick look at what setoff really is – an ability by one party to automatically set off an amount owing to it from a payment that it owes to another party. In other words, if the downstream person (subcontractor) owes the upstream person (main contractor) an amount of money (let’s say for defective works that had to be completed by the main contractor), then the main contractor is entitled to deduct this amount from any amount it owes to the subcontractor.

Depending on the clause in the contract that was signed between the parties, the upstream person may well be entitled to dip into the retention monies and the (bank) guarantees (which I remind you all are put in place to ensure performance values only) as well as any certified amounts owed to the subcontractor for work properly done.

And here’s the part where you get the free set of steak knives strategically placed in your throat, heart and back…

If the upstream person is of a mind to be unconscionable, and to press a point knowing that you will most likely not resist (this used to be called standover bullying), they can and will rapidly erode your earnings which they have control over, and they will drip feed you your earnings until you fall over.

I currently have a client that is in this exact position, whereby their $800,000 retention monies should have been returned to them, together with payment for their certified payment claims shortly after achieving practical completion.

The issue is that the upstream person is playing hardball. All monies are being withheld pending “defective work” contra charges being claimed. This means that the upstream contractor is clearly making unsubstantiated frivolous and vexatious contra payment claims on the downstream person, because they can under the contract.

Unfortunately for my client, a family-owned business in Western Australia, they relied on someone completely incompetent – someone who talked the talk but could not walk the walk when it counted – to negotiate and settle the contract, which this bloke did by simply accepting all the terms and conditions of a design and construct contract, of which my client has no design scope or capability, but which finds them liable for it.

For those of you in similar positions, let’s get one thing straight. If you sign a contract blind or uncaring, and you do not understand the risks attached to each and every clause, or you are of the opinion that if you “talk back” or query the contract you will not be awarded the work, then you, more than anyone else, are one of the parties responsible for this filthy behaviour in our industry. People who are either too feckless or lacking in intellect and backbone truly should not be allowed to run a company.

Be that as it may be, the downstream person, the victim of this disgusting commercial behaviour is able to achieve balance and compensation in this issue, although they will have to push back pretty hard on the upstream person to get anywhere.

The best options available to you are to (a) immediately issue a formal Notice of Dispute to the upstream person pursuant to the relevant clause in your existing contract, which could well include the pathway to arbitration or litigation, and (b) without waiting for the upstream person to engage in the dispute, issue an Application for Adjudication pursuant to your local security of payment legislation (Construction Contracts Act 2004 in WA) on the “setoff” charge, or the contra charge, whichever it is, or (c) providing the contract does not bar this, prepare to litigate.

If there is more than one contra charge or setoff, then issue a Notice of Dispute for each and every contra charge/setoff, and likewise make separate and individual Applications for Adjudication for each and every contra charge/setoff.

In WA, despite the very best efforts of the various parties involved in these processes to seemingly deviate completely from the spirit of such legislation as what Parliament intended, to bend and twist, chop and dice, and pick the eyes out of each application, there remains a core band of adjudicators and may I respectfully include certain members of the judiciary who steadfastly apply the law and the intent of the Act to the benefit of the broader industry.

Your ace up the sleeve is that there are sufficient superior court authorities which clearly state that a counterclaim such as a contra charge must be properly proven before it may become a setoff.

Keep in mind for those in Western Australia that you only have 28 days from the date of the dispute to lodge this application, so get the wheels in motion sooner rather than later.

If at the end of the day you cannot in all good conscience state that you did everything within your power to stand up for yourself and demand what is rightfully yours, then you do not have the right to complain about your circumstances.

As always, risk safely.

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