Set-off, and what it costs you to use it
Netting what you owe against what you are owed is quick and tempting. It also collapses two records into one and removes the evidence for both.
Set-off is the practice of netting an amount you owe somebody against an amount they owe you, and paying only the difference.
A subcontractor has certified work worth a sum. They also damaged something, or were supplied material from your store, or were overpaid on a previous bill. So the certificate is reduced by that amount and the balance is paid.
It is quick, it is common, and it is often the right commercial answer. It also does something to your records that is worth understanding before it becomes routine.
Two obligations become one number#
Before set-off there are two facts: you owe them a certain amount for work done, and they owe you a certain amount for a specified reason.
After set-off there is one payment.
The two original facts still existed. But if the only entry in the system is the net payment, they are no longer recorded anywhere except in whatever note accompanied it. The certified value of the work is understated. The recovery is invisible. And the reason for the recovery — which is the only part anybody will want six months later — is nowhere at all.
Then somebody asks a perfectly ordinary question: how much have we certified on this contract to date? The answer from the ledger is wrong, low by the amount of every set-off ever applied — and on the other side it is an unexplained deduction, which is the commonest entry in when your ledger and theirs disagree.
The right shape#
Record both sides. Pay the net.
- Certify the work at its full measured value.
- Raise the counter-claim as its own entry, dated, with its own reason and its own authorisation.
- Show the payment as the certified value less that specific recovery, itemised.
Three entries instead of one. It costs a minute and it preserves the two facts that actually happened.
On a running account bill this matters even more than usual, because those bills are cumulative. A set-off buried in a net figure corrupts every subsequent cumulative comparison, and the corruption compounds silently across the project.
What makes set-off contentious#
The counter-claim is usually an assertion, not an agreed figure.
Damage to a wall is a fact. The cost of repairing it is a judgement. Material issued from your store is a fact; the rate at which it is charged back is a decision. When you set off, you are simultaneously deciding the amount and enforcing it, without the other party having agreed to either.
Legally the position varies with the contract and the circumstances, and it is not something to settle from an article. What is universally true is procedural: a set-off applied without notice, without a stated basis, and without a chance to respond is the single most reliable way to convert a commercial disagreement into a dispute, because it takes money out of somebody's hands before the argument has happened.
The practical rules that follow from that are unglamorous:
- Notify before, not with, the payment. A deduction discovered on a remittance advice reads as a decision already taken.
- State the basis in a sentence somebody can dispute. "Recovery: material issued from store, 14 items, list attached" can be argued about. "Recovery" cannot, so the argument becomes about the whole relationship instead.
- Keep it separate from retention. Retention will come back. Retention money is a balance held against a future event; a set-off is gone. Lumping them into one deduction line means neither can be reconciled.
The reason is the record#
Once a set-off is applied, the reason for it becomes the only thing standing between you and a claim.
This is a specific case of something we keep running into in our own systems. When a payment is recorded for less than the agreed amount, our software now requires an explanation before it will accept the entry — the gap and its reason land on the record together, and the originally agreed figure stays reconstructible as paid plus deducted. That was built after we watched what happens when it is not there. The mechanics are in paying less than agreed.
We also refused, deliberately, to let anybody delete a payment schedule that contained written-off stages, because deleting it would take with it every recorded reason for the write-off — and those reasons are the only surviving answer to who decided that money would never come.
A deduction with a reason is a commercial position. A deduction without one is an unexplained shortfall, and unexplained shortfalls are what the other side's lawyer builds a case from.
Set-off across contracts#
The tempting extension is to net across relationships: they owe us on project A, so reduce their payment on project B.
Whether this is permitted is a contract question and often a legal one, and the answer is frequently no. Separate contracts are separate obligations, and sometimes separate legal entities are involved even when the same people are.
Beyond the legal position, it has a practical cost that people underestimate. Once amounts move between contracts, no single contract's account is self-contained. The cumulative figures on both projects are now wrong in opposite directions, the final accounts cannot be prepared independently, and tracing anything requires a person who remembers.
If it must be done, do it as two explicit transfers with a stated reason, so each contract's own account still tells the truth about that contract.
The short version#
Set-off is netting two obligations into one payment.
The payment is fine. The netting of the records is not, because it destroys both original facts and keeps neither reason.
Certify in full, raise the counter-claim as its own entry with its own basis, notify before you deduct, and never let a set-off share a line with retention.