Common Law Right of Set off in Government Contracts May Be Adjusted

The government has a federal common law right of set off costs, also referred to as offset, to balance mutual debts and it can be used as a defense against a contractor to better reconcile competing claims. 

It is important to understand, as a contractor, when the government may be able to set-off some of the costs that you incurred and that you will not be able to get back.

General Rule on Government Contractors’ Right of Set off:

The right of setoff allows parties that owe each other money to apply their mutual debts against each other.  This right, which applies to every creditor, also applies to the government.  United States v. Munsey Trust Co., 332 U.S. 234 (1947).

The right of setoff in federal government contracting refers to the government’s ability to offset or withhold payments owed to a contractor against any debts or claims that the government may have against the contractor. It allows the government to deduct amounts owed by the contractor from payments due to them for other contracts or obligations.

Under the Federal Acquisition Regulation (FAR) Subpart 33.8, the government has the authority to exercise the right of setoff if certain conditions are met. These conditions typically include situations where the contractor has a debt or liability to the government, such as outstanding taxes, penalties, or other unpaid obligations.

The right of setoff provides a mechanism for the government to recover amounts owed without initiating separate legal action. It allows the government to offset the contractor’s debt against any payments due to them, effectively reducing or eliminating the contractor’s claim to those payments.

It’s important for contractors to be aware of their obligations and promptly address any outstanding debts or liabilities to avoid potential setoff actions by the government. Contractors should maintain proper financial records, respond to government inquiries regarding debts, and work to resolve any outstanding issues to mitigate the risk of setoff.

The right can even be used against settlement proceeds and it applies to government claims under both other contracts and the same contract with the debtor.  This means that if you have incurred costs that the government can offset from another contract, then the full amount can be offset in the present claim; the goal is to be efficient and settle claims as quickly as possible.

How Can Government Contractors Defend Against Allegations of the Government’s Right to Set Off?

When faced with allegations of the government’s right to setoff, government contractors can take several steps to defend their position. Here are some strategies that contractors can employ:

1. Contract Review: Carefully review the terms and conditions of the contract to ensure that there are no provisions that explicitly grant the government the right to setoff. If the contract does not include such provisions, it strengthens the contractor’s position in disputing the government’s claims.

2. Documentation and Record-Keeping: Maintain accurate and detailed records of all transactions, payments, and correspondence with the government. This documentation can serve as evidence to challenge any inaccurate or unfounded allegations of debt.

3. Dispute Resolution: Engage in a formal dispute resolution process if the government initiates setoff actions. This may involve filing a claim or a request for equitable adjustment with the contracting officer, participating in alternative dispute resolution methods like mediation or arbitration, or pursuing litigation through the appropriate legal channels.

4. Communication and Negotiation: Open communication channels with the government and the contracting officer to discuss the allegations and potential resolution options. Present any evidence or arguments that support the contractor’s position and negotiate a fair and reasonable outcome.

5. Legal Assistance: Seek legal counsel specializing in government contracting to provide guidance and representation throughout the dispute resolution process. Experienced attorneys can help assess the situation, formulate a strong defense strategy, and advocate on behalf of the contractor.

6. Compliance and Mitigation: Proactively address any outstanding debts or liabilities to minimize the government’s justification for setoff. Promptly pay taxes, resolve disputes, or rectify any compliance issues to demonstrate good faith and reduce the likelihood of setoff actions.

Remember that each situation may be unique, and it’s crucial to consult with legal professionals who can provide specific guidance based on the contract terms, applicable regulations, and the contractor’s circumstances.

Overcome Set off only through Explicit Language

 The government’s common law right to setoff can only be defeated or constricted by explicit contractual, statutory, or regulatory language.  Courts have been very strict in this regard; without an express limit on setoff rights, the court will likely find that a right of offset is warranted. 

In one recent case, the contractor was in a lease, and the lease stated that if the property becomes unfit, the lessor either needs to repair the building or the government agency may cancel the lease.  Ensley, Inc. v. United States (2014). 

The government contracting agency took it upon itself to create a third option: repair the building and deduct the amounts from the rent.  Because the contract did not expressly disallow this, the government was able to offset the repair costs.

Any right to setoff is limited to the actual costs incurred; no future costs will be considered in determining the offset amount.  When costs have been deferred, not avoided, the right of offset is not available for the deferred costs.

CDA Application & No Independent  Common Law Right to Set off:

Like any other claim governed by the Contracts Disputes Act of 1978 (“CDA”), to be heard by a court, the government must first submit their claim to the contracting officer (“CO”) and either a contracting officer’s final decision must be rendered or the government could show it was exempt from a CO decision.

In Raytheon v. United States, the Court of Federal Claims held that the government did not have a separate common law right of setoff because the government had to first comply with the CDA, and they failed to do so.  Even if the setoff claim is raised as a defense, Contract Disputes Act jurisdictional requirements still apply and there is no independent right to set off. See also information about equitable subrogation and Miller Act Claims.

The Government cannot offset using debt owed by a different entity

In J.G.B. Enterprises v. United States, the government sought to offset a payment owed by a debt owed by a different entity.  Because the contractor who was owed money was actually a subcontractor and third-party beneficiary to the contract, it could bring claims under its own direct right to setoff. 

The government tried to argue that the distinction between direct and derivative common law right to set off was immaterial, but the Court of Appeals for the Federal Circuit did not agree.  The government must have a valid claim against the party subject to a right to setoff before the right can be applied. 

If you have any questions about the government’s right of setoff, please call the government contract claims attorneys at Watson & Associates, LLC to speak with any of our Federal Government Contract Attorneys at 1-866-601-5518 for a free consultation.