It is common for an employer to use the same contractor on multiple jobs. This means that there will be a number of separate construction contracts in existence, each relating to a different site. On some of those contracts, the employer will owe the contractor money, whilst on others, the opposite will be the case.
A series of mutual debts will have been created between the parties. But is it possible for a party to deduct a debt owed to it under one contract from a debt owing to it under another?
This process is known as setting-off. Usually, set-off is only available where the debts arise from the same contract, except where litigation is pending, and the debts are liquidated or ascertainable, in which case it is sufficient that the debts have arisen between the same parties.
There is a further option if one party has gone into liquidation. In this case, insolvency set-off* may apply. Insolvency set-off arises when there have been mutual credits, debts and dealings between a company and its creditor before the company’s liquidation. If there are such credits, debts and dealings, the liquidator must take all of them into account (notwithstanding that they arise from different contracts), and the sums due from one party can be set off against the sums due to the other. In summary, this allows a party to set off sums that it is owed on one contract against sums it owes under different ones. It is mandatory and cannot be excluded by contract.
Another advantage of insolvency set-off is that the debt does not have to be liquidated or payable immediately. It can be a future debt or a contingent debt. So a draft final account could well count as a debt that can be used to set-off.
However, insolvency set-off does not apply where the debt arises out of an obligation incurred at a time when:
- the creditor knows that the company is being wound up, or
- if the liquidation was preceded by an administration, the creditor knows that the company is going into administration.
This doesn’t mean that insolvency set-off doesn’t apply if the debt itself was incurred at a time when the creditor knows of the liquidation or administration. Rather, it means that the obligation from which the debt arises cannot have been incurred at that time. So in the context of construction contracts, debts will usually arise from an obligation in the construction contract. It is highly unlikely that the creditor will have been aware of the company’s liquidation or administration at the time of the contract- if it had, it wouldn’t have entered into the contract in the first place.
Insolvency set-off may also apply where a party has gone into administration**. The rules are similar to the rules for liquidation, except that insolvency set-off for administration is only triggered if the administrator gives notice that he intends to make a distribution.
So, if you are faced with the liquidation or administration of a party with whom you have multiple contracts, and there are various amounts owing under the different contracts, insolvency set-off may prove to be a useful tool.
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*Rule 4.90 of the Insolvency Rules 1986
**Rule 2.85 of the Insolvency Rules 1986