Set-off is a legal principle that permits a debtor to reduce or discharge their liability to a creditor by asserting a reciprocal claim against that creditor, arising from a separate and independent transaction. It functions to reconcile mutual debts, allowing only the net balance to be payable, thereby streamlining the enforcement of obligations between parties with cross-liabilities. This mechanism enhances transactional efficiency by eliminating the need for monetary transfers and related costs. It also serves as a form of security by mitigating exposure to third-party creditor claims in cases of insolvency. Under Bahraini Law, set-off may take one of three forms: legal, contractual, or judicial. This article seeks to examine each form, outlining the legal conditions and practical scenarios in which each applies.
Legal Set-Off
The right to exercise legal set-off arises automatically by operation of law without the need for additional formalities where its conditions are satisfied. Pursuant to Article 353(a) of Decree Law No. 19/2001 Issuing the Civil Code (the “BCC”) the right to set-off shall arise where the following conditions are met:
- The debts are mutually owed between the parties in the same legal capacities; this condition is not satisfied where one obligation is personal and the other arises in a representative or fiduciary role (e.g., as guarantor, agent, or company manager).
- The debts are of the same kind and quality; this requirement is not met where one debt is monetary and the other is not, or where, despite being of the same category, the debts differ in quality.
- The debts are not subject to legal dispute; meaning both debts must be liquidated and not legitimately contested by either party.
- The debts must be due for payment and not subject to a suspensive condition.
- The debts must be legally enforceable and actionable through judicial proceedings; this excludes debts that are time-barred by statutory limitation periods or otherwise precluded from enforcement.
It is relevant to note that pursuant to Article 355 BCC, the debt must also not be (i) a claim for restitution of a thing of which the debtor has been unjustly deprived, (ii) a claim involving something that has been deposited or lent for use, or is itself subject to restitution, (iii) a right that is not subject to attachment, or (iv) a debt payable in respect of alimony.
Accordingly, where the above conditions are met (subject to certain statutory exceptions) a party may extinguish its debt against the amounts owed to it by another party and only pay or receive the remaining balance (if any) by operation of law without the need to conduct additional formalities.
An example of legal set-off is observed in Challenge Nos. 745 and 749 J.Y. 2010, wherein the Bahraini Court of Cassation held that the employer's deduction of end-of-service entitlements was permissible, as both the employee's loan and the employer's obligation became due upon termination of employment, satisfying the conditions for set-off.
Contractual Set-Off
Contractual set-off arises by agreement between the parties, who expressly determine the terms and conditions governing its application. It generally operates without the need for additional formalities where the conditions required for legal set-off are not exhaustively met, allowing commercial parties to extend its application to a broader range of circumstances. It typically applies where the debts are not of the same kind or are not mutually owed.
An example of contractual set-off is observed in Challenge No. 83 J.Y. 1995, wherein the condition requiring mutuality of the debts in the same capacity was not met and the Bahraini Court of Cassation held that “If an individual holds multiple accounts with the bank, each account shall be deemed independent and separate from the others, by way of exception to the principle of the unity of financial liability. Accordingly, none of these accounts shall be allocated for the settlement of debts arising from the other accounts, nor shall set-off be permissible between them, unless otherwise agreed”.
Judicial Set-Off
Judicial set-off is typically considered where a party raises an independent claim or counterclaim in the course of litigation, where the conditions for legal set-off are satisfied, except for the condition requiring absence of a dispute between the parties as to the owed amount. In such cases, the court may establish set-off through a constitutive judgment, as opposed to the declaratory effect of legal set-off.
An example of judicial set-off is observed in Challenge No. 163 J.Y. 2017, wherein the Bahraini Court of Cassation overturned a lower court's judgment for failing to apply set-off in respect of the amount owed by the respondent to the appellant, despite mutual debts being established, and ordered a corresponding reduction in the adjudicated amount.
Concluding Remarks:
Set-off serves as a vital tool in commercial transactions, allowing parties to simplify reciprocal obligations, reduce litigation risk, and limit exposure to third-party creditor claims in insolvency. Whether effected by operation of law, contractual arrangement, or judicial decree, the right to set-off reinforces commercial certainty and transactional efficiency.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
