Set-Off Clause

A set-off clause is a legal clause that gives a lender the authority to seize a debtor's deposits when they default on a loan. A set-off clause can also refer to a settlement of mutual debt between a creditor and a debtor through offsetting transaction claims. This allows creditors to collect a greater amount than they usually could under bankruptcy proceedings.

Set-off clauses are included in lending agreements and can be structured in various ways. A lender may choose to include a set-off clause in their lending agreement to help them receive a greater portion of the amount owed to them in the case of default. If a debtor is unable to meet an obligation to his or her bank, the bank can seize certain assets detailed in the clause. Set-off clauses are most commonly used in loan agreements between lenders and their customers. They may also be used in other industries where one party has a risk of payment default such as manufacturing. The Truth in Lending Act prohibits set-off clauses from applying to credit card transactions; this protects consumers who decline to pay for defective merchandise.

Lending set-off clauses may include assets held with the contracting lender in other accounts. A borrower contracting with a lender where they hold other assets such as deposits in a checking, savings, money market or certificate of deposit account will make these assets available to the lender in the case of default. If deposit account assets are held with the lender they can be more easily accessed to cover a defaulted payment. A set-off clause by a lender may also encompass rights to deposit accounts and other assets held at other institutions as well. While these assets are not as easily accessible for the lender, the set-off clause gives the lender contractual consent to seize the assets if a borrower defaults.

A manufacturing set-off clause may be included in a supplier agreement. This type of clause can be used in place of a letter of credit which gives the supplier access to the funds in a prearranged lending agreement if the buyer defaults. In a manufacturing set-off clause the supplier includes a provision in the contractual agreement between the seller and the buyer that gives the seller rights to deposit accounts and other assets held at a financial institution if the buyer defaults. With a set-off clause a seller can obtain payment equivalent to the amount owed under the manufacturing agreement by accessing funds outlined in the clause such as funds held in a checking, savings, money market or certificate of deposit account by the buyer.

Set-off clauses are for the advantage of the party at risk of payment default. They give the creditor legal access to a debtor’s assets at either the lending institution or another financial institution utilized by the debtor. Debtors should beware of set-off clauses as they release assets to lenders which they may have otherwise been able to retain through other means of debt settlement such as bankruptcy.