In law, a set-off is an equitable defence to the whole or to a portion of a plaintiff's claim. A set-off is the right of a debtor to balance mutual debts with a creditor. In bookkeeping terms, set-offs are also known as reconciliations. To determine a set-off, simply subtract the smaller debt from the larger. Any balance remaining due either of the parties is still owed, but the remainder of the mutual debts has been set off.
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The right to set off is particularly important when reporting a bank's exposures to regulatory authorities. The situation where a bank has to report that it has lent a large sum to a borrower (and is therefore exposed, because there is a risk that the borrower might default thereby leading to the loss of the bank's or its depositors' money) is thus replaced (where the bank has taken security over shares or securities of the borrower) with an exposure of the money lent minus the value of the security taken.
English law set-off
Under English law, there are broadly four types of set-off which have been recognised:
- Legal set-off. This arises where a claim and a counterclaim in a court action are both liquidated sums or ascertained with certainty. In such cases the court will simply set-off the amounts and award a net sum. The two claims do not need to be intrinsically connected.
- Equitable set-off. Outside of litigation, where two mutual claims arise out of the same matter or a sufficiently closely related matter, they will set off in equity. Both sums must be due and payable, but may be for liquidated or unliquidated sums.
- Banker’s set-off. Sometimes referred to as a banker's right to combine accounts, this is a special form of set-off which allows banks to offset sums in one account against another account which is overdrawn. However, the right cannot be exercised if one of the accounts is a loan account, or if the bank has agreed not to exercise the right, or if the bank has notice that the sums in the account are for a specific purpose, or on trust for another party.
- Insolvency set-off. Under section 323 of the Insolvency Act 1986 where a person goes into bankruptcy or a company goes into liquidation mutual debts are automatically set-off.
US law set-off
See De Magno v. United States, 636 F.2d 714, 727 (D.C. Cir. 1980) (district court had jurisdiction over claim involving VA’s “affirmative action against an individual whether by bringing an action to recover on an asserted claim or by proceeding on its common-law right of set-off”) (discussing similar language of predecessor statute, 38 U.S.C. § 211)
See, e.g., United States v. Munsey Trust Co., 332 U.S. 234, 239, 67 S.Ct. 1599, 1601, 91 L.Ed. 2022 (1947) ("government has the same right 'which belongs to every creditor, to apply the unappropriated moneys of his debtor, in his hands, in extinguishment of the debts due to him' " (quoting Gratiot v. United States, 40 U.S. (15 Pet.) 336, 370, 10 L.Ed. 759 (1841))); see also Tatelbaum v. United States, 10 Cl.Ct. 207, 210 (1986) (set-off right is inherent in the United States government and grounded on common law right of every creditor to set off debts).