Tuesday, July 31, 2012

Offsetting Defects against Payment

In another forum I had an individual ask about whether you could offset the value of defects in the work against payment that are due and payable. Offset involves the setting off receivables versus payables as is a common law right.

The answer is always in the contract terms, and if I was involved in a situation where a buyer or owner was trying to do this to me, the first thing I would look at is the defects language. What is the other party’s responsibility to notify me of the defect? What obligations do I have to correct the defect? If I have obligations to correct the defects how long do I have from being notified of them to correct the defect? I would also look within that section to see whether there is a specific right to make an offset for the reasonable value of the defect in lieu of correcting the defect(s).

If the contract does not allow for the immediate right to offset the value of the defects, then the next thing I would want to verify is if the other party followed the process for correction of defects. If you were notified of the defect and failed to act within the time frame allowed to correct the defect(s), that would be an anticipatory breach where the other could claim damages that they seek to offset against payments. A repudiatory breach would exist if you have an obligation to correct the defect, and state that you will not perform that obligation. That would also create the situation where they could claim damages that they seek to offset against payments.

It is the breaches that give rise to damages that create something you would owe them that would allow the set-off. If there were no breaches, there are no damages and they would not have the right to set-off claims for defects. The exception to that would be if the contract specifically established the right to set off the value of those defects in lieu of correction of the defects. If a party withholds portion of the payment as a set-off against defects and they didn’t have the specific right to do so or if there was no breach, the party performing the set-off would have breached the payment obligations and would be subject to damages.

Always take the time to understand what the contract says about the issue, as you need to act within the rights and obligations you have under the contract.

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