Set-off rights enable defendants to set off mutual debts arising from closely connected cross-obligations. A defendant successfully relying on a set-off defence may reduce its liability to a plaintiff by accounting for its own losses occasioned by these cross-obligations. A recent Ontario decision considered the practical application of a set-off defence against a factoring company, particularly in the absence of a corresponding counterclaim. The court held that the set-off claim against a factoring company could not exceed the amount of the factor’s lien claim in the absence of a counterclaim.
In the course of developing several apartment buildings, The Block retained Nikom Construction ("Nikom") to provide drywall and related labour. Nikom, in turn, entered a factoring agreement with IPSC, a factoring company. Under this factoring agreement, Nikom would issue an invoice to The Block; upon its approval by The Block, Nikom would then assign the invoice to IPSC in exchange for 90% of the invoice’s face value up front.
The arrangement came into issue several months into the project, when The Block claimed that certain invoices were deficient, leaving them unpaid and resulting in Nikom walking off the project site. Nikom and IPSC registered lien claims against The Block for a total sum of about $402,000 and subsequently filed a claim for the values of their respective liens. The Block claimed set-off as a defence against both lienholders and counterclaimed against Nikom alone for $1,500,000.
The trial judge dismissed both lien claims and allowed The Block’s counterclaim against Nikom . The trial judge also found that The Block was entitled to set-off under Ontario’s Construction Act and equitable set-off as a defence to both of the lien claims. Ultimately, The Block was found to be owed over $325,000 in damages, payable by both Nikom and IPSC.
Grounds for Appeal
IPSC appealed, arguing in part that The Block’s damages award should not exceed the value of IPSC’s lien claim, particularly given that the entire extent of The Block’s damages was caused by Nikom. They argued that the principles of equitable or legislative set-off limited The Block’s set-off to the amount IPSC received from Nikom.
Equitable set-off and legislative set-off differ in their origins. The Court clarified that legal set-off could not apply, as there was no mutuality of debts or common contract between The Block and IPSC. However, both equitable set-off and set-off arising from the Construction Act could be used as defences to the lien claims.
Equitable set-off applies where the parties owe one another obligations that are so closely connected it would be “inequitable to permit one party to enforce its obligation” without allowing for a defence of set-off to be raised by the other party. At its core, equitable set-off allows the Court to acknowledge the commitments flowing both ways between the parties.
The Construction Act also recognizes set-off as a defence, though it explicitly states that set-off may be applied in determining the amount of a lien. Historically, this kind of statutory set-off has been applied broadly. That said, and as a result of the wording of the Construction Act, the Court concluded that set-off in these circumstances could not exceed the value of the underlying claims.
What the Court Said
The Court clarified that the trial decision had the effect of relying on The Block’s counterclaim against Nikom in awarding a set-off that exceeded the combined value of the lien claims. Unlike the defence of set-off, counterclaims are distinguished as being independent actions that are to be used offensively and not to be mistaken as a defence.
The decision went on to cite Tri-Lag Corp v York Region District School Board, stating that conflating a counterclaim and the defence of set-off effectively “bestow[s] a damages windfall in circumstances that would be unfair and inequitable.” Allowing The Block’s entitlement to set-off against IPSC to exceed IPSC’s lien claim would amount to exactly this, whether it was advanced under the rubric of either equitable set-off or statutory set-off.
Relying on The Block’s decision to bring a counterclaim solely against Nikom, as well as the principles of equitable set-off and the wording of the Construction Act, the Court held that the value of a lien that is set off by a debt that is greater than the lien can only reduce the lien to zero. The defence of set-off cannot, however, result in an award against the lienholder. Therefore, the award against IPSC was overturned.
Key Takeaways
This decision clarifies the law of set-off as a defence, particularly in the absence of a counterclaim. Where a defending party successfully raises the defence of set-off in response to a lien claim, the outstanding debts, claims, or damages owing to the defending party may apply to the total lien amount. However, where the sum of these debts amounts to more than the balance of the lien claim, and where the defendant does not counterclaim against the lienholder, the defence of set-off can only effectively eliminate the lien without awarding the defendant a windfall in damages.
Understanding set-off rights is complex, particularly where factoring arrangements are in place. Timely legal advice is critical to ensuring payment rights and obligations are strictly adhered to. Contact Anthony Burden in Calgary, Ryan Krushelnitzky in Edmonton, or any member of Field Law’s Construction Group for advice.
