FinTech Glossary

What is the Right of Set-Off?

Right of set-off is the legal or contractual right of a lender, bank, or creditor to adjust money it owes to a borrower against money the borrower owes to it. In banking, this usually means a bank may use funds lying in a customer’s account to recover overdue amounts owed by that customer, subject to applicable law, contract terms, account nature, and due process.

The principle is simple: if two parties owe each other money, one amount may be adjusted against the other instead of making separate payments. In business finance, set-off clauses are often included in loan agreements, guarantees, supply contracts, and settlement arrangements.

How It Works in Banking and Contracts

A set-off right usually becomes relevant when a borrower defaults or when mutual debts exist between two parties. For example, if a company has an overdue loan with a bank and also maintains a current account with that bank, the loan agreement may allow the bank to recover overdue dues from available balances.

Important considerations:

• The debts should generally be mutual and between the same parties.

• The right may arise from contract, law, banking practice, or court proceedings.

• Certain accounts or amounts may be protected or restricted depending on their nature.

• Borrowers should review loan documents to understand when set-off can be exercised.

In commercial contracts, set-off may also be used when a buyer deducts penalties, damages, credit notes, or outstanding claims from supplier payments.

Why It Matters for Businesses

Right of set-off can materially affect liquidity planning. A business may assume that cash in a bank account is available for salaries, vendor payments, or tax dues, but a lender exercising set-off could reduce that balance to recover overdue obligations.

For businesses, set-off clauses matter in:

• Loan agreements

• Overdraft and cash credit facilities

• Supplier and customer contracts

• Group-company guarantees

• Settlement agreements

• Insolvency and dispute situations

Understanding set-off rights helps finance teams avoid surprises, negotiate clearer contract language, and maintain separate cash-management arrangements where necessary.

Example and Risk-Control Tips

Example: A company has ₹20 lakh overdue on a loan and ₹12 lakh in a current account with the same bank. If the loan documentation permits set-off and conditions are met, the bank may adjust the account balance against overdue loan dues.

Practical checks for businesses:

• Read set-off clauses before signing loan documents.

• Understand whether the bank can combine accounts across branches or facilities.

• Check whether notice is required before set-off.

• Avoid mixing restricted funds with general operating cash.

• Track overdue obligations daily if the business has cash balances with the same lender.

Set-off is not just a legal clause. It can directly affect working capital availability.