setoff

Setoff is a legal and financial mechanism that allows one party to reduce or extinguish a debt it owes to another by the amount the other party owes to it. It is used to simplify settlements, conserve liquidity, and avoid two-way transfers of money.

Typical requirements include mutual debts between the same two parties in the same transaction or contract, and that the debts are presently due and payable and not contingent or disputed beyond a certain magnitude. In many systems the debts must also be in the same currency and arise from the same right of action, though rules vary by jurisdiction. Some jurisdictions distinguish between a setoff and a mere counterclaim, with setoff often requiring ordinary mutuality of obligations.

Setoff can arise under common law or by statute. Common-law setoff is available when the parties owe each other money and one can reduce their obligation by the other’s claim. Statutory setoff exists where legislation grants a right to offset particular debts, sometimes in consumer or government contexts. In bankruptcy or insolvency, setoff rights may be limited by applicable laws, and may require court authorization or adherence to procedural rules; not all claims are eligible, and security interests or certain transfers can constrain the right.

Example: If Party A owes Party B $100, and Party B owes Party A $60, Party A may set off the $60, leaving a net obligation of $40 to Party B.

Setoff is distinct from recoupment (which typically arises within the same contract) and from general damages claims. It is closely related to netting in financial markets, where multiple obligations are settled on a net basis.