When a company winds up, begins restructuring proceedings or
goes bankrupt, a debtor or creditor may be able to cancel out the
amount payable to the other party by using the remedy of
"set‐off". Set‐off involves the
cancelling of crossliabilities between two parties who owe each
other money. It is a valuable tool that can increase a
creditor's percentage of recovery and decrease the debt burden
of a debtor.
Types of Set‐off: Contractual, Legal or
If a contract exists between parties, rights of setoff can be
created by including set‐off provisions in the contract.
Where a contractual set‐off provision does not exist,
parties may still assert a claim for set‐off on the basis
of legal set‐off or equitable set‐off. The
common law has developed a number of formal requirements for the
allowance of a claim for legal set‐off. In comparison,
equitable set‐off is granted by the court in cases where
the parties do not meet the formal requirements of legal
set‐off, but where the circumstances of the
cross‐obligations are so closely related or connected,
that it would be unjust to permit one party to enforce its
obligations without permitting the other to set‐off
In order to establish a successful claim for legal
set‐off, the following formal requirements must be
the parties must be able to ascertain the exact amounts of the
debts owing and the debts must be recoverable on the basis of a
legally enforceable claim for monetary payment;
all conditions to the debts becoming due and payable must be
the debts claimed must be mutual in the sense that they are
between the same parties in the same right and the parties are
solely liable to each other for the debts.
In a situation where the requirements for legal
set‐off cannot be met, the court may allow an equitable
set‐off. Unlike legal set‐off, equitable
set‐off requires that the debts owing between the parties
be strongly connected. Generally, equitable set‐off
requires that a cross‐claim be so clearly connected with
a party that it would be manifestly unjust to allow a plaintiff to
enforce payment without taking into consideration the
cross‐claim by the defendant. In addition, a claim for
equitable set‐off will only be granted in circumstances
the party relying on set‐off has shown some equitable
ground for being protected against the counterparty's claim;
the equitable ground goes to the very root of the party's
In order to establish a successful claim for equitable
set‐off, the plaintiff's claim and the
defendant's cross‐claim need not arise out of the
same contract nor is there any requirement that the claims be for
A claim for legal or equitable set‐off can be asserted
in proceedings under both the Bankruptcy and Insolvency
Act and the Companies' Creditors Arrangement Act.
Legal setoff is best claimed in situations where the exact amounts
to be set‐off have been determined, the debts are owed
between the same two parties, but are not necessarily connected and
arising out of the same transaction. Equitable set‐off is
more appropriate if the debt has been subject to an assignment or
if the amount owing has yet to be determined since the remedy of
legal set‐off is generally not available in either
scenario. Common types of transactions where the court has allowed
equitable set‐off include transactions where there has
been defective workmanship by a contractor and the claimant is
seeking to set‐off the amount payable to a
Whether or not a claim for set‐off is successful will
depend greatly on the specific facts of the case. It is important
that parties understand their rights of contractual, legal and
equitable set‐off when structuring their arrangements,
contractual or otherwise, to ensure that set‐off, in one
form or another, is available down the road should one of the
parties experience financial difficulties.
About Fraser Milner Casgrain LLP (FMC)
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