Introduction:
In construction contracts, the right to set off allows a general contractor or owner to withhold payment from a subcontractor. Contractors often use set-offs to cover claims, penalties, damages, or other costs tied to performance issues.
While set-off rights can protect contractors, they also create serious risk for subcontractors. Broad or loosely written clauses can disrupt cash flow, increase liability, and quietly erode profit over the life of a project.
For subcontractors, set-off clauses are not just legal language. They are margin exposure points. Even temporary or disputed withholdings can force borrowing, delay payroll, or eliminate expected profit.
This guide explains common set-off risks and outlines practical steps subcontractors can take to reduce financial exposure through contract negotiation, legal review, and proactive planning.
How Set-Offs Work in Practice
Set-off clauses allow contractors to deduct certain costs from amounts they owe a subcontractor.
For example, if a subcontractor damages materials or causes delays that lead to penalties, the contractor may deduct those costs from future payments. Contracts usually define when and how this can happen, and local law may also apply.
Key points to understand:
- Set-offs reduce payments owed to subcontractors
- Contractors often link them to damages, delays, or alleged breaches
- Contract language largely controls how broadly they apply
Set-Off Clauses That Put Your Margin at Risk
Some set-off clauses give contractors extremely broad discretion to withhold payment. These clauses often shift cost, schedule, and third-party risk directly onto the subcontractor.
Below is an example of a clause that should raise serious concerns.
“Company may withhold and set-off against amounts due and payable to Subcontractor under this Subcontract or any other subcontract or agreement that may be entered into between the Parties, all damages, back charges, expenses, fees and any other amounts that Company, the Owner and or/any third party (including any agent, employee supplier or subcontractor or Subcontractor) may incur or has incurred, including but limited to (i) the estimated cost to remedy Subcontractors defective work; (ii) third-party claims filed or reasonable evidence indicating the probable filing of such claims;
(iii) Subcontractor’s failure to make payments for labor, materials, supplies or equipment; (iv) personal injuries or property damage caused by Subcontractor and/or its subcontractors or any person employed directly or indirectly by Subcontractor or its subcontractors; (v) reasonable evidence that the Work or Project does not or will not comply with the work schedule; (vi) the cost to complete warranty or punch lists items not completed or corrected by Subcontractor or any agent, employee and any subcontractor, material supplier or laborer or Liens or claims relating to the monetary disputes or controversy between Subcontractor and any subcontractor, material supplier or laborer or liens or claims relating to the project; (viii) any dispute or controversy between Company and excess of Subcontractor’s insurance coverage; (x) the cost of obtaining the required insurance and//or subcontractors, suppliers or any of their agents or employees in the performance of the Work; plus a markup for Company’s overhead and profit at the greater of a a) $750.00 or b) fifteen percent (15%). As a long as such withholding and set-off exercised by Company in good faith, Subcontractor hereby waives any claims against Company for any consequential damages following from such withholding or set-off, even if it is later determined that such withholding or set-off was improper.”
Why This Clause Is Problematic
This clause allows withholding under many conditions, including:
- Estimated costs to fix alleged defective work
- Third-party claims that may never materialize
- Payment disputes involving lower-tier subcontractors or suppliers
- Personal injury or property damage claims
- “Reasonable evidence” of potential schedule delays
The clause also allows the contractor to apply a markup of $750 or 15%, whichever is greater, on withheld amounts.
In addition, it requires the subcontractor to waive claims for consequential damages—even if the withholding later proves improper.
How Set-Off Clauses Quietly Erode Margin
From a subcontractor’s perspective, clauses like this create multiple layers of financial risk.
Cash Flow Becomes Unpredictable
The contractor can withhold payment for speculative claims or future risks. This can disrupt cash flow and force the subcontractor to finance the project out of pocket.
Estimated Costs Inflate Real Exposure
The clause allows withholding based on estimated repair costs. These estimates can be subjective and inflated, creating margin pressure before any issue is resolved.
Unproven Claims Still Cost Real Money
The contractor can withhold funds for third-party claims before anyone confirms their validity. The timing mismatch hurts subcontractors the most.
Liability Extends Beyond Direct Control
Subcontractors may bear responsibility for the actions of their own subcontractors or suppliers, even when the issue is indirect or disputed.
Schedule Risk Shifts Downstream
Payment can be withheld based on “reasonable evidence” of potential delay, even if no delay has occurred.
Markups Turn Deductions Into Added Cost
Applying overhead and profit markups to withheld amounts increases the financial hit and can turn deductions into profit centers for the contractor.
Waived Rights Limit Recovery
By waiving claims for consequential damages, the subcontractor loses recourse even when the contractor withholds payment improperly.
Practical Ways to Protect Margin Before Problems Start
Margin protection begins long before a dispute arises. It starts with contract language, documentation discipline, and early visibility into financial risk.
Negotiate the Clause
- Narrow the scope of allowable set-offs
- Limit withholding to actual, documented costs
- Cap or reduce markups on withheld amounts
- Remove waivers of consequential damages
- Define “good faith” clearly and objectively
Strengthen Contract Controls
- Require written notice before any withholding
- Include cure periods to address issues
- Limit liability to claims directly tied to your work
- Use mediation or arbitration to resolve disputes faster
Protect Operationally
- Confirm insurance requirements are reasonable and aligned with coverage
- Monitor cash flow closely and track exposure in real time
- Document all communications, approvals, and changes
- Maintain contingency funding for delayed payments
Many subcontractors struggle not because risks are unknown, but because they surface too late. Without early visibility into cost exposure, schedule pressure, and unresolved claims, margin erosion often becomes visible only after cash is gone.
Conclusion
Set-off clauses are one of the most common—and least monitored—sources of margin erosion in construction contracts. When written broadly, they allow contractors to withhold payment based on estimates, potential claims, or future risks.
Subcontractors can protect themselves by negotiating tighter language, demanding transparency, and actively tracking financial exposure throughout the project. Early action reduces the risk of cash flow disruption and protects profit before disputes escalate.
Addressing set-off risk upfront helps ensure smoother project execution—and prevents avoidable margin loss caused by unfair or excessive withholdings.