Basics of Setoff Under New Jersey Law

Article

The Business Advisor

May 26, 2005

When people think of setoffs in a commercial setting, they generally think of setoffs between a bank and a depositor. Indeed, most of the reported cases addressing setoffs do so in that context. However, setoff is not limited to those situations and is generally available to parties who have claims against each other. See, e.g., Keegan v. Estate of Keegan, 179 N.J. 242, 244 (Ch. Div. 1981) (recognizing a common law right of setoff). 

A setoff is

the right which exists between two parties, each of whom under an independent contract owes an ascertained amount to the other, to set off his respective debts by way of a mutual deduction so that in any action brought for the larger debt, the residue only, after such a deduction, shall be recovered.

Keegan, 179 N.J. Super. at 246. There are three requirements for effectuating a setoff: (a) the person against whom the setoff is being effectuated must be indebted to the person effectuating the setoff; (b) the person effectuating the setoff must be indebted to the person against whom it is being effectuated; and (c) the obligations of the two parties must be mutual. In re Czyzk, 297 B.R. 406, 408 (Bankr. D.N.J. 2004).

As to the first two requirements for a setoff, it is unclear in the case law whether New Jersey law permits the setoff of a matured obligation against an unmatured one. To avoid unnecessary litigation, therefore, a setoff should not be exercised unless and until the two debts being offset against each other are actually due and payable. It may also be risky to set off an undisputed debt against a disputed one. The third requirement for a setoff, the requirement of “mutuality” means that the party exercising a setoff and the party against whom the setoff is exercised must each have a valid right to make a payment demand of the other. Czyzk, 297 B.R. at 409. Despite the “mutuality” requirement for setoff and in contrast to recoupment, debts to be set off against each other do not arise out of the same transaction. Guarantee Co. of N.A. v. Tandy & Allen Constr. Co., 66 N.J. Super. 285, 290 (L. Div. 1961).

Effectuating a setoff is generally a simple process. The party seeking to effectuate a setoff must (a) decide to effectuate a setoff; (b) take some action to effectuate the setoff; and (c) make some record of the setoff. Czyzk, 297 B.R. at 408 (citing Citizens Bank of Maryland v. Strumpf, 516 U.S. 16, 19 (1995)). In most situations, the second and third requirements are met at the same time. For example, a bank effectuates a setoff when it records the setoff in its records.

Current New Jersey law contains no express requirement that a common law right of setoff needs to be reduced to writing to be effective. However, it is not uncommon for parties to include express setoff provisions in their contracts. Indeed, lenders and banking institutions typically include such provisions in agreements with borrowers and depositors. Moreover, in the past, at least in some contexts, setoff rights had to be reduced to writing to be effective. Four-G Corp. v. Ruta, 45 N.J. Super. 128, 136 (App. Div. 1957), rev’d on other grounds, 25 N.J. 503 (1958). Thus, where parties anticipate engaging in a number of different transactions with each other where by each party will be indebted to the other, it would be prudent to set forth the parties’ setoff rights in writing. For example, it would be prudent for a supplier (who would have a claim for a price for the goods) anticipating numerous transactions with a customer (who might have claims for refunds or credits) to include express setoff provisions in any agreements it has with its customers.

In sum, the right of setoff is widely available under New Jersey law. Setoffs are easily effectuated. However, where a number of transactions is anticipated, they should probably be spelled out in the transaction documents.