Liquidated damages - Construction Contracts - page 283

172 If an employer has entered into two
separate contracts with the same contractor,
is it entitled to set-off liquidated damages due
on one contract against payment due to the
contractor on the other contract?
Set-off is when two parties owe money to each other. Suppose party A owes party B £200
and party B owes party A £500. Party B can pay party A £300, and party B is said to have
set-offonedebtagainst theother,leaving anetpayment due.Itfrequently occursinthecon-
struction industry when a contractor pays a sub-contractor for work done but reduces the
amount because the sub-contractor has caused a delay or done some damage which the con-
tractorwillhavetopaytogetrepaired.Thistypeofset-offistermed'equitable'.Thetypeof
set-off which is set out in a contract between the parties (for example, liquidated damages)
is termed 'contractual'.
The rules of set-off are quite complicated, but the general rule is that equitable set-off can
only occur between two parties to the same contract. Therefore, if a contractor owes money
to a sub-contractor on one contract, it is not usually permitted to reduce the amount to take
account of money owing from the sub-contractor on another contract. Section 10 of the Un-
fair Contract Terms Act 1977 also appears to exclude this.
However, there are exceptions to this rule. In Geldof Metaalconstructie NV v Simon
Carves Ltd , 12 Carves was the main contractor, entering into two sub-contracts with Geldof
on the same project. Geldof delivered equipment in the first contract and rendered its in-
voice. The second, installation, contract was terminated before completion. Geldof com-
menced legal action for recovery of the amount invoiced, and Carves said that it had the
right to, and did, set-off three separate amounts. The first was for defects in the equipment,
the second was for liquidated damages under the installation contract and the third was for
damages in connection with Geldof's repudiation of the installation contract. There was a
clause in the first contract which allowed Carves to set-off 'any amounts lawfully due . . .
whether under this Purchase Order or otherwise' from Geldof.
The Court of Appeal allowed the set-offs even though there were two separate sub-con-
tracts involved. It is instructive to note that the final phrase in the above-mentioned clause
was not enough on its own to allow the cross-contract set-off. In arriving at its conclusion,
the court applied the following test: There must be a close connection between the two con-
tracts, and it must be clearly unjust to allow the payment of the claim without taking into
account the cross claim or set-off. The court decided that the two contracts were closely
connected, because the contractor and the site were the same in each case and the warranty
under the first contract was linked to performance in the second contract. Moreover, Geldof