Set Off Clause – Definition

Cite this article as:"Set Off Clause – Definition," in The Business Professor, updated September 17, 2019, last accessed September 26, 2020, https://thebusinessprofessor.com/lesson/set-off-clause-definition/.

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Set-Off Clause Definition

A set-off clause is a legal provision that allows a lender to take the deposits of a debtor who has defaulted on a loan. A set-off clause is also a provision that allows a party to set off the financial liability of an obligor in a financial contract. Oftentimes, a set-off clause is a settlement method between a lender and a debtor, through this method, both parties can reach a mutual agreement on how financial claims in the transaction can be offset.

A Little More on What is a Set-Off Clause

There are many structures of set-off clauses, they are often used in loan arrangements especially when a borrower defaults on the terms of the loan. The amount of money that lenders collect when a set-off clause is used is often greater than what they would have received in a bankruptcy proceeding. Set-off clauses are used when borrowers are unable to fulfil their debt obligations as stated in the loan agreement.

Not all lenders add a set-off clause to the contractual agreement, lenders that include this provision do so to protect themselves when a borrower defaults. A set-off clause allows the lender to seize the assets contained in the clause.  According to the Truth in Lending Act, lenders cannot use set-off clauses for unsecured debts such as credit card transactions.

Lending Set-Off Clause

Usually, asses that borrower use when entering a lending agreement are seized by the lender who they go into default, using the set-off clause provision. For instance, assets such as deposits of the borrowers in a savings account or certificate of deposit account  or borrowers with banks are relinquished to the lender when the borrower defaults. If the assets are held by the lender, such assets can be seized easily to repay the loan.

A set-off clause is an agreement that permits a lender to seize the assets of a default borrower, this is however not applicable to unsecured debts. According to the Truth in Lending Act, lenders cannot use set-off clauses for unsecured debts such as credit card transactions.

Manufacturing Set-Off Clause

A manufacturing set-off clause gives the lender in a supplier agreement the right to funds in the lending agreement is the buyer or receiver fails to fulfill their part of the agreement. A manufacturer set-off clause can be used instead of a letter of credit. This clause is an agreement between the two parties in which the seller or supplier has the right to access accounts and assets belonging to the buyer that are held with a financial institution in case of default by the buyer.

Set-Off Clause Advantages

The major advantages of a set-off clause are;

  • A set-off clause is a legal clause that protects a lender when the borrower defaults in a lending agreement.
  • This clause allows the lender seize the assets of the borrower who is at default.
  • A set-off clause is a provision that permits creditors to collect a greater amount than they could under bankruptcy proceedings.
  • Lenders can obtain payment equivalent to the amount borrowers owe in the lending agreement.
  • Assets and accounts of a debtor held with a lending institution or financial institution can be accessed through the provisions of a set-off clause.

References for “Set-Off Clause

https://www.investopedia.com/terms/s/set-off-clause.asp

https://www.lawinsider.com/clause/set-off

https://uk.practicallaw.thomsonreuters.com/1-107-3801

https://www.lawinsider.com/clause/right-of-set-off

https://www.upcounsel.com/set-off-contract

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