Construction law terms: set off, abatement and counterclaims

For example, faced with a claim for defective work, an employer or main contractor will want to account for this loss in the next, or final, payment certificate. Set off, abatement and counterclaim are the three different potential legal routes in the UK for this process.

This guide will explain the key features of each of these terms, explain the important differences, illustrate these points with some case law examples and common standard form provisions and offer some key practical takeaways.

What is set off?

Set off is a mechanism that permits a party to deduct amounts from sums that would otherwise be due because of a countervailing debt or claim, known as a ‘cross-claim’. Set off commonly occurs when an employer deducts sums from a contractor’s payment certificate due to, for example, defects in the works for the costs of putting them right or for lost income due to the defect. It is a right that arises at law as well as in many standard forms of contract. Those of main importance to the construction industry are:

• legal, or ‘independent’, set off.
• equitable, or ‘transaction’, set off; and
• contractual set off.

It is important to note that insolvency set off can also give rise to a right of set off in the construction industry in certain formal insolvency situations. This specialist topic is not covered in detail in this guide. The right to set off is curtailed in the UK by the 1996 Housing Grants, Construction and Regeneration Act, as amended by Part 8 of the 2009 Local Democracy, Economic Development and Construction Act (the Construction Act) and the 1998 Scheme for Construction Contracts, which is also a separate subject in itself.

Legal and equitable set off

Legal set off operates in the context of court proceedings, acting as a procedural defence whereby mutual debts, which may be unconnected reciprocal claims which are independent of each other, can be set off against claims brought against a party.

To be available, both the claim and the cross-claim must be “due and payable”, liquidated or ascertainable without valuation or estimation, owed between the same persons and actionable in the English courts. The two claims need not be connected, for example, they might arise under two unrelated contracts.

Read more in our construction law terms series

• Construction law terms: general and liquidated damages
• Construction law terms: design development and design change
• Construction law terms: termination at common law and under contract
• Construction law terms: claims under contract vs breach of contract claims
• Construction law terms: assignment and novation
• Construction law terms: contractual notices and condition precedent notices

Equitable set off, on the other hand, occurs when two claims are so closely connected that it would be manifestly unjust to allow one party to enforce its claim without giving credit for the cross-claim of the other party. As with legal set off, both claims must be “due”. Importantly, it is not limited to liquidated claims, unlike legal set off. If the cross-claim is not ascertained, the debtor may deduct a reasonable assessment of the loss, made in good faith.

The table below summarises the differences between legal and equitable set off.

Contractual set off

Many of the industry’s standard contractual forms crystallise right of set off, although they vary slightly in their approach. The obvious benefit of an express contractual right to set off is that the parties can agree the precise circumstances in which it is applicable, without the need to rely on an implied legal or equitable right. This is another example of the difference between claims under a contract and claims for breach of contract.

Parties may also extend or curtail the situations in which legal and equitable set off are applicable, but cannot exclude the right of insolvency set off. For example, an employer could make provision for a right to set off a claim arising under another unconnected contract with the same contractor, importing the tenets of legal set off without the requirement that it can only be raised in litigation.

Common standard form provisions relating to set off

The table below sets out set off provisions in the main standard forms used in the UK:

Geldof Metaalconstructie NV v Simon Carves (2010)

This case considered what is meant by “manifestly unjust” for equitable set off to apply. The court said: “It is not coherent to have a doctrine of equitable set-off which ignores the need for consideration of aspects of justice and fairness”.

It found that the defendant, by insisting on payment under a supply contract as a pre-condition of returning to work on an installation contract, was “bringing the two contracts into intimate relationship with one another … and that relationship became inseparable and irrevocable” when the claimant brought the installation contract to an end in reliance on the defendant’s poor performance under it, coupled with the defendant’s insistence on payment under the supply contract.

The court held that: “Even if the two contracts had not been connected up to that point, those events brought the two contracts into a close and inseparable relationship with one another and, in my judgment, made it manifestly unjust to enforce payment under the supply contract without taking into account the cross-claim for repudiation of the installation contract.”

What is abatement?

Abatement is a close cousin of set off. Both set off and abatement are, in practise, used in construction to prevent the obligation to pay. The main difference is that abatement is usually used to reduce or ‘abate’ the sum due in the first place, as opposed to set off the amount to be paid by identifying that cross claim.

Abatement is restricted to contracts for work or goods, not for professional services. It is only available where there has been a breach of contract for performance of the work, or a breach of warranty in relation to goods. Importantly, it does not apply to claims relating to claims for delay, disruption or damage.

Abatement is available as of right in construction contracts and, in essence, permits a party to defend itself by demonstrating that the subject matter of the payment is worth less than claimed by reason of a breach. Parties may, by agreement, limit or exclude their rights to set off or abate, provided that clear words are used to do so and that to do so would not offend the 1977 Unfair Contract Terms Act.

Multiplex Constructions v Cleveland Bridge (2006)

In this case, the judge set out seven principles of abatement:

• In a contract for the provision of labour and materials, where performance has been defective, the employer is entitled at common law to maintain a defence of abatement.
• The measure of abatement is the amount by which the product of the contractor's endeavours has been diminished in value as a result of that defective performance.
• The method of assessing diminution in value will depend upon the facts and circumstances of each case.
• In some cases, diminution in value may be determined by comparing the current market value of that which has been constructed with the market value which it ought to have had. In other cases, diminution in value may be determined by reference to the cost of remedial works. In the latter situation, however, the cost of remedial works does not become the measure of abatement. It is merely a factor which may be used either in isolation or in conjunction with other factors for determining diminution in value.
• The measure of abatement can never exceed the sum which would otherwise be due to the contractor as payment.
• Abatement is not available as a defence to a claim for payment in respect of professional services.
• Claims for delay, disruption or damage caused to anything other than that which the contractor has constructed cannot feature in a defence of abatement.

Energy Works v MW High Tech Projects (2022)

This case is a good example of what is insufficient to exclude the right to set off or abate. The court held that an exclusive remedies provision in the IChemE Yellow Book was insufficient to exclude the remedy of abatement.

Topalsson v Rolls-Royce (2023)

In this dispute, the court was tasked with answering the question of whether a contractual cap limiting liability applied prior to setting off or after. In this case, which turned on the contractual wording, Rolls-Royce was found to have rightfully terminated its contract with Topalsson and was owed roughly €8 million in termination losses. Topalsson was found to be owed roughly €800,000 for services performed prior to termination. The judge found that the cap applied post set off, hence the full €5m was payable, rather than €4.2m.

What is a counterclaim?

It is generally agreed that set off and abatement are a defence, to be used only as a “shield, not as a sword”. However, counterclaims can be both. Counterclaims are thus key features of construction disputes in practise – where a separate claim, albeit between the same parties, can be run together in those same dispute proceedings.

In adjudication, this needs to be done with a ‘counter adjudication’ – particularly where there are issues over payment and ‘pay less’ notices preventing an abatement or set off. Crucially, counterclaims can result in a positive balance for the defendant, as opposed to set off and abatement, which are by nature limited to the amount of the original claim.

The table below sets out the differences between set off, abatement and counterclaim.

Practical takeaways

Set off, abatement and counterclaim are key mechanisms for balancing payment obligations. They are thus an important way of avoiding having to “pay now and argue later”.

All three arise in different ways and have different legal and contractual requirements for a party to be able to rely upon them. As a result, it is important to understand and follow those requirements in practice.

Co-written by Kerry Higgins and Mariam Hassaballah of Pinsent Masons.