Payment disputes are all too common in the construction industry. When faced with a claim, a logical solution will often be for the contractor to try to reduce or extinguish the claim by deducting debts or liabilities owed to it by the claimant. The primary benefit of being able to do this is to maintain cash-flow: by reducing or extinguishing the claim the contractor may be able to avoid a situation in which it is forced to pay the full amount claimed against it before pursing the claimant separately for debts or liabilities arising out of the same project.
This process of using a counterclaim to reduce or extinguish a claim can be by way of abatement or set-off, depending on the type of claim in issue1.
Abatement is a common law right to reduce the price or value of work on the grounds that the work is defective or incomplete. Abatement is therefore only available where there are defects in the quality of the works. It cannot be used as a defence to claims for delay or disruption to the works, or claims for damage to other property. Nor can it be used as a defence to payment for professional services, such as design and engineering work or technical and supervisory services.
The measure of the abatement will be the amount by which the works have diminished in value as a result of the deficient or defective performance. The method of assessing the diminution in value will depend on the facts and circumstances in each case. In some cases, the diminution in value may be determined by comparing the current market value of the item as constructed, with the market value that it ought to have had. In other cases, the diminution in value may be determined by reference to the cost of remedial works.
To take an example, in the case of Multiplex Construction v Cleveland Bridge2 the Court considered the best method for ascertaining the diminution in value of defective steelwork under a subcontract for the new Wembley Stadium project in England. In the circumstances, the Court found that the diminution in value should be ascertained by reference to cost of remedial works. This was because:
- The partially completed steelwork of a national stadium which was under construction did not have a market value in the conventional sense. That steelwork only had a value to the main contractor who was under an obligation to produce a completed stadium.
- From the point of view of the main contractor (who was the only interested party) the difference in value between the steelwork in its actual condition and the steelwork as it ought to have been, was the cost of the remedial works.
The abatement, however, can never exceed the sum which the contractor would otherwise have been entitled to be paid for those works.
Set-off is the process of using a counterclaim as a defence to a claim. For example, where a subcontractor makes a claim for payment for works carried out, the main contractor may seek to set off against that progress payment, liquidated damages arising as a result of the subcontractor's failure to complete the works by the time for completion.
Set-off under separate contracts
The general position is that set-off is only available where there is a close relationship between the transactions that give rise to the respective claims. Therefore, set-off of claims and counterclaims arising out of the same contract will be permitted in most situations.
In some cases, the defendant may have entered into a series of contracts with the claimant for a number of different projects and will be looking to try to use a claim arising under one contract as a set-off in response to a claim made against it under another contract. However, in absence of clear words in the contracts, the defendant will only be entitled to set-off its claim in such circumstances if it arises out of the same transaction, or is so closely connected with it that it would be "manifestly unjust" not to permit the set-off3. Whether this criteria can be met will be a matter of assessing the facts and circumstances particular to each case.
In the rare situation where both parties have claims for money demands that are clearly established and certain at the time of making the claim (such as liquidated damages and debt claims), then the parties will be entitled to set-off their claims even if they do not arise out of the same or a connected transaction.
Subject to any express provisions in the contract to the contrary, a contractor will be entitled to set-off its anticipated future losses arising as a result of the counter-party's breach, so long as the counterclaim is a reasonable assessment, made in good faith, of its future losses4.
Express terms in the contract
Clear words are required to exclude or extend these rights of set-off and abatement. It is therefore important to check the terms of the contract before making abatement or set-off to avoid any inadvertent breach of the contract payment terms.
If two parties are embarking on a series of projects under different contracts, and wish to have the right to set-off cross-claims arising under the various contracts, each contract will need to have a carefully drafted clause granting express rights of set-off across those contracts.