Where a debtor has a cross-claim ( www.practicallaw.com/A34778) against a creditor, the reduction or extinguishment of the creditor’s claim by the amount of his cross-claim. Set-off may be divided into the following categories:
Legal set-off. This can only be resorted to as a defence to a court action and is available where the two claims are liquidated or ascertainable with certainty and are both due and payable at the commencement of the action. The two claims do not have to arise from the same transaction or closely connected transactions. (In sale agreements, a set-off provision may, for example, set off claims under the warranties ( www.practicallaw.com/A37201) against claims for deferred consideration).
Equitable set-off. This is available to a debtor outside the context of litigation where his cross-claim arises from the same transaction (or a closely related transaction) as the debt owed. Either and probably both of the claims may be for an unliquidated sum. A debtor can simply deduct the amount of his mutual cross-claim from the debt he owes and tender the balance of the debt (if any) to the creditor. However, the sums in question must be due and payable or, in the case of unliquidated damages, must be a reasonable assessment of the loss made in good faith.
Banker’s set-off. This arises in a situation where a customer has more than one account with his bank, at least one of which is in debit and one of which is in credit. It is also known as the right to combine accounts. It is arguably of wider commercial application and could be available in any situation where one party has two or more accounts with another. A debtor can only invoke banker’s set-off if the two accounts are current or running accounts. This remedy can be automatically exercised without formality.
Insolvency set-off. The rules of insolvency set-off are mandatory and may not be varied by contract. Where a creditor ( www.practicallaw.com/2-379-0852) proves in a liquidation ( www.practicallaw.com/A36359), administration ( www.practicallaw.com/9-107-6363) or bankruptcy ( www.practicallaw.com/A35896), an account must be taken of the mutual dealings between the creditor and either the company in liquidation or administration or the bankrupt. The sums due from one party must be set off against the sums due from the other, except that sums due from the insolvent shall not be taken into account if the other party had notice at the time they were incurred of:
a resolution or petition to wind-up (if a company);
an application for an administration order or of notice of intention to appoint an administrator ( www.practicallaw.com/2-107-6366) (if a company); or
a pending bankruptcy petition (if a natural person).
All claims, including future, contingent and unliquidated sums, must be brought into account.
Contractual set-off. Where payments are due from both parties to a transaction, the parties may agree that, instead of both parties making separate payments, the party due to make the larger payment should pay the difference between the two amounts due.