What is the Right of Setoff?

The right of setoff is a legal right by a debtor to reduce the amount owed to a creditor by offsetting against it any amounts owed by the creditor to the debtor. For example, a bank can seize the amount in a customer’s bank account to offset the amount of an unpaid loan. It is a useful legal right when a borrower goes bankrupt, since the creditor will likely obtain more asset value by seizing assets than by gaining a lesser amount through the bankruptcy process. Therefore, set-off clauses are most frequently found in lending arrangements where the lender suspects that the borrower may not be able to continue as a going concern.

Another good use for the right of setoff is when a seller of goods is selling to a buyer that has questionable credit. In this case, the seller will want to retrieve its goods if the buyer is unable to make payment within the agreed-upon credit terms. It can do so by including a right of setoff clause in its sale agreement with the buyer.

In addition, this right allows businesses to avoid situations where the party owed more money is still obligated to pay an amount due to the other party.