Set-Off Clauses in NZ Contracts

If you run a business, cash flow is everything. You can do the work, deliver the goods, and still find yourself chasing invoices (or being chased) when something goes wrong in a commercial relationship.

That’s where set-off clauses can help. Done properly, they can be a practical tool for managing payment disputes and reducing your risk when the other party owes you money (or claims you owe them).

But set-off isn’t a “one size fits all” concept. In New Zealand, the way set-off works depends on the wording of your contract, the nature of the debts, and the surrounding legal rules (including insolvency and unfair contract terms issues).

This guide breaks down what set-off clauses are, when they’re useful, how to draft them sensibly, and what to watch out for in real-world business situations.

Note: This article is general information only and doesn’t take into account your specific circumstances. It isn’t legal advice. If you need advice on your situation, get in touch with a lawyer.

What Is A Set-Off Clause (And How Does Set-Off Work In Practice)?

A set-off clause is a contract term that allows one party to reduce (or “set off”) the amount they have to pay the other party by the amount the other party owes them.

In plain English: if you owe someone money, but they also owe you money, a set-off clause can allow the amounts to be netted off so only the balance is payable (if the clause is drafted to permit that).

A Simple Example

You’re a supplier. Your customer owes you $10,000 for delivered stock.
You also owe that customer $2,500 because you agreed to reimburse them for a verified delivery error.
If your contract allows set-off, you may be able to deduct the $2,500 from what the customer owes and require payment of the $7,500 balance (or apply the $2,500 as a credit against the customer’s invoice/account, depending on how your contract and invoicing process works).

Without a clear set-off clause, you may still be able to argue for set-off in some circumstances (depending on legal principles and the facts), but it becomes messier and more dispute-prone. Most businesses prefer certainty, which is why set-off clauses are commonly built into terms of trade and service agreements.

Set-Off vs “Withholding Payment”

It’s worth separating two ideas that often get mixed up:

Set-off: netting mutual debts so only the balance is payable.
Withholding: refusing to pay an invoice because you’re unhappy (for example, alleging defective work).

A well-drafted set-off clause can sometimes operate like a controlled form of withholding, but only within the boundaries you agree in the contract (for example, “only for agreed credits” or “only for liquidated amounts”).

Why This Matters For NZ Businesses

Set-off issues show up constantly in day-to-day operations, including:

trades and construction arrangements where defects and variations are common
supplier/customer relationships with credit notes and returns
service contracts where performance disputes arise mid-project
ongoing commercial relationships with multiple invoices running at once

Getting the clause right upfront can save you a lot of time (and legal spend) later.

When Should Your Business Use Set-Off Clauses?

Set-off clauses aren’t just “legal fine print”. They’re a commercial lever. The right clause can protect your cash flow and reduce disputes, but the wrong clause can create uncertainty or strain relationships.

Common situations where set-off clauses can help include:

1. Managing Disputed Invoices Without Derailing The Entire Relationship

If you have an ongoing relationship (say you deliver weekly, or you’re on a retainer), disputes are often inevitable. A set-off clause can give you an agreed pathway to adjust accounts without either party needing to stop paying everything or threaten immediate legal action.

2. Credit Notes, Returns And Adjustments In Supply Chains

Many product-based businesses need to handle:

returns
damaged stock
price corrections
rebates or volume discounts

If your terms clearly allow set-off, you can apply a credit against future invoices rather than processing refunds each time (provided your clause allows that approach and it aligns with the commercial arrangement).

3. Ongoing Services With Multiple Streams Of Charges

For service providers, it’s common to have multiple moving parts:

fixed fees
time-based billing
reimbursable expenses
service credits for downtime or issues

A carefully scoped set-off clause can help prevent confusion about what gets deducted and when.

4. Controlling Risk Where You’re Extending Trade Credit

If you let customers pay later (or you pay subcontractors before getting paid), a set-off clause can be part of your broader risk strategy. It won’t replace good credit processes, but it can reduce the “double payment” problem where you pay out while chasing money in.

Set-off clauses often sit inside broader Terms of Trade or your main service agreement framework.

Key Types Of Set-Off Clauses (And Which One Is Right For You)

Not all set-off clauses do the same job. The “best” one depends on your business model, bargaining power, and how you handle disputes.

1. Mutual Set-Off (Standard Commercial Set-Off)

This is the classic approach: either party can set off amounts owed by the other party against amounts payable.

This can feel “fair” because it applies both ways, but it can also create cash flow risk if the other party uses set-off aggressively.

Where it fits:

balanced commercial relationships
long-term supplier and customer arrangements
contracts where both parties regularly invoice each other

2. One-Way Set-Off (Supplier-Favourable Set-Off)

Some businesses want set-off rights for themselves but don’t want the customer to set off. For example, you might allow yourself to set off credits or customer debts, but require the customer to pay invoices in full (and separately pursue disputes).

This is more protective of your cash flow, but it’s also more likely to be negotiated (especially with sophisticated customers).

3. “No Set-Off” Clauses

A no set-off clause usually says the customer must pay invoices in full without deduction or set-off.

Where it fits:

service providers who need predictable cash flow
industries where clients may otherwise withhold payment as leverage
contracts where disputes should be handled through a dispute resolution process instead of self-help deductions

A no set-off clause is often paired with clear dispute and remedies wording (for example, timeframes for notifying defects, service credits, or a structured variation process).

4. Limited / Conditional Set-Off

Many businesses land here because it’s practical and reduces fights. A limited set-off clause might allow set-off only where:

the amount is agreed in writing (for example, an issued credit note)
the amount is “liquidated” (a definite amount) and due
the set-off relates to the same contract (not a separate relationship)
the set-off is not disputed

This approach can stop people inventing deductions while still allowing legitimate adjustments.

Common Set-Off Clause Pitfalls (And How To Avoid Them)

Set-off clauses can cause problems when they’re vague, overly broad, or copied from a generic template that doesn’t match how you actually operate.

Here are common pitfalls we see in practice.

1. Letting The Other Party Deduct “Alleged” Losses

A clause that allows set-off for any “loss, damage, costs, or expenses” can invite disputes-because the other party might claim losses that are unproven or inflated, then pay you less.

If you want to reduce that risk, consider limiting set-off to:

amounts agreed in writing
credit notes you’ve issued
court-determined or legally recoverable amounts (depending on your risk appetite)

2. Mixing Up Set-Off Across Different Contracts Or Entities

Businesses often have more than one relationship at the same time (for example, you sell goods and also provide services). Set-off can get complicated if the debts arise under different contracts, or different legal entities (like your trading company vs a related company).

If you do want cross-contract set-off, it should be drafted carefully so it’s clear what is included and what isn’t-and to avoid accidental outcomes you didn’t intend.

3. Not Aligning The Clause With Your Payment Terms

Your set-off clause should “match” how your billing works. For example:

If you invoice monthly, does set-off apply per invoice or across the account?
If you use progress payments, can set-off apply to progress claims?
If you charge interest on overdue amounts, does set-off affect what is “overdue”?

This is one reason why set-off clauses work best when embedded into a properly structured contract or terms framework, rather than inserted at the last minute.

4. Forgetting About Insolvency Risk

Set-off and insolvency can interact in ways that surprise business owners. If the other party becomes insolvent (or you do), special rules can affect whether set-off is available and how it is calculated or applied. In practice, insolvency set-off may apply automatically in some situations, and contractual set-off wording may not operate the way you expect once a formal insolvency process starts.

The key point: don’t rely on set-off clauses as your only protection. If your exposure is significant, you might also consider:

security interests (where appropriate)
retention of title terms for goods
personal guarantees (carefully drafted)
tight credit controls and stop-supply triggers

If your business is carrying meaningful receivables risk, it’s worth having a lawyer pressure-test your overall contracting approach.

5. Using Broad Set-Off In Consumer-Facing Contracts

If you deal with consumers, you need to be careful about how set-off rights interact with consumer protections and “fairness” expectations. New Zealand consumer law (including the Fair Trading Act 1986 and the Consumer Guarantees Act 1993) can shape what’s acceptable in practice.

Even for B2B contracts, you should think about whether a set-off clause could be challenged as unreasonable in context (particularly where one party has much more bargaining power).

How To Draft Set-Off Clauses That Actually Help Your Business

A good set-off clause doesn’t just “sound legal”-it supports your operations and reduces disputes. When you’re drafting or reviewing set-off clauses, here are practical points to work through.

1. Be Clear About What Can Be Set Off

Define the category of amounts that can be set off. Common options include:

amounts the other party owes you under the same contract
amounts the other party owes you under any agreement between the parties
credit notes you issue
agreed rebates or discounts

If you don’t define this clearly, you risk arguments about whether set-off is allowed at all (or whether it extends to unrelated claims).

2. Decide Whether You Want “No Set-Off” Or “Limited Set-Off”

There’s no universally “right” answer. A supplier dealing with frequent quality disputes might prefer “no set-off” so invoices are paid on time, while a long-term commercial partner may want mutual set-off so adjustments can happen smoothly.

What matters is choosing deliberately-and aligning it with your leverage and risk profile.

3. Include Process Rules (So It Doesn’t Become A Free-For-All)

Set-off clauses work best when they include a simple process, such as:

the party claiming set-off must notify the other party in writing
the notice must set out the amount and why it’s being set off
set-off can only occur once the amount is agreed or determined

This keeps things transparent and reduces the “surprise short payment” problem.

4. Think About Dispute Resolution Alongside Set-Off

Set-off and dispute resolution should work together. If your set-off clause is restrictive (for example, “no set-off”), you usually want a clear path for resolving issues without the customer feeling like they have no options.

This is often handled through well-structured service agreements and operational terms. For many small businesses, that starts with properly drafted Service Agreement terms that reflect how you deliver, invoice, and fix problems when they arise.

5. Match The Clause To Your Contracting Setup

Your set-off clause should sit consistently with other key clauses, including:

payment terms and interest
variation and change request processes
warranties and remedies
limitation of liability
termination rights

It’s also worth checking that the contract is being signed by the right entity (and with proper authority), especially if you operate through multiple companies or a group structure.

Set-Off Clauses In Real-World Scenarios (Suppliers, Services, Leases And More)

Set-off clauses show up in lots of commercial contexts. Here’s how they commonly play out for small businesses in New Zealand.

Supplier And Wholesale Relationships

If you sell goods B2B, set-off is often tied closely to:

returns policies
credit notes
short deliveries
warranty or defects claims

A limited set-off clause that only permits deductions for issued credit notes can be a practical compromise: it allows genuine corrections but avoids “self-assessed” deductions.

Service Providers And Contractors

If you provide services (marketing, IT, consulting, trades, professional services), your biggest risk is usually a client withholding payment because they’re unhappy with deliverables.

A “no set-off” clause can help protect cash flow, but you should also make sure your agreement is crystal clear on:

what is included and excluded from the scope
acceptance criteria and sign-off
timeframes and client responsibilities
what happens if the client wants changes

For more complex work, you might structure delivery in stages under a master agreement model, like a Master Services Agreement, with statements of work that define each project.

Commercial Leases And Property Arrangements

Set-off issues can also arise in leases (for example, where a tenant claims they can set off rent against alleged losses, repairs, or outages). Whether that’s allowed will usually come down to the lease wording and the circumstances.

If you’re signing a lease, it’s important to understand how rent, outgoings, and abatements are handled-especially before a dispute happens. That’s one reason many businesses choose to get a Commercial Lease Review before committing.

When You’re Buying Or Selling A Business

Set-off can become a deal issue during a business sale, particularly where there are unpaid invoices, retention amounts, or customer claims floating around at completion.

If you’re buying a business, you’ll want to understand:

what debts exist between the business and key customers/suppliers
whether set-off rights could be asserted post-completion
how the sale agreement allocates responsibility for pre-sale claims

These risks are typically handled through a properly drafted Business Sale Agreement and a sensible due diligence process.

Set-off disputes often involve sharing documents to justify deductions-emails, invoices, delivery records, performance reports, or customer complaints. If those materials contain personal information, you should handle them carefully and consistently with your privacy obligations (including under the Privacy Act 2020).

This usually isn’t about “set-off law” itself, but it can become relevant if a dispute escalates and lots of documents start being exchanged.

Key Takeaways

Set-off clauses let you net off amounts owed between contracting parties, which can be a powerful cash flow and dispute-management tool when drafted clearly.
There are different approaches, including mutual set-off, one-way set-off, no set-off, and limited/conditional set-off-the best option depends on your business model and bargaining position.
Vague set-off clauses can create more disputes than they solve, especially if they allow deductions for “alleged” losses or unclear cross-contract claims.
A practical set-off clause usually includes clear limits on what can be set off, and a simple notice/process requirement to prevent surprise short payments.
Set-off can interact with other legal risk areas, including insolvency and consumer law (and sometimes privacy in the way disputes are documented and managed)-so it should be reviewed as part of your overall contract framework.
If you rely on trade credit or deal with frequent invoice disputes, having tailored contracts and terms (rather than a generic template) can protect your business from day one.

If you’d like help reviewing or drafting set-off clauses in your contracts (or setting up stronger terms for your business), you can reach us at 0800 002 184 or team@sprintlaw.co.nz for a free, no-obligations chat.

Set-Off Clauses in NZ Contracts: Managing Invoice Disputes