A. Illustrative example

ABC Engineering Limited, a Hong Kong company, enters into a written supply contract with Harbour Developments Limited for the supply and installation of air-conditioning units in a commercial building in Kowloon.

Under the contract:

ABC is to supply and install the units for $5 million.
Harbour must pay ABC by staged payments.
ABC gives a contractual warranty that the units will be fit for purpose and installed by a specified date.

ABC completes the installation and issues its final invoice for $1.5 million. Harbour refuses to pay. ABC then commences proceedings in the District Court claiming the unpaid $1.5 million.

Harbour’s defence and cross-claims:

(i) Set-off

Harbour says ABC had previously agreed, in writing, to give Harbour a $300,000 credit because ABC was late in completing an earlier stage of the works. That amount is certain and immediately due.

Harbour therefore pleads that, even if ABC is entitled to the invoice sum of $1.5 million, Harbour is entitled to set off $300,000.

Harbour also alleges that many of the air-conditioning units supplied by ABC were defective and failed shortly after installation. As a result, Harbour had to hire another contractor to replace the defective units and also suffered loss because tenants could not move into the building on time. Harbour claims these losses amount to $2 million.

Harbour can therefore claim $2 million as a set-off. Combined with the $300,000 set-off, Harbour’s total defensive set-offs ($2.3 million) exceed ABC’s $1.5 million claim, completely extinguishing ABC’s claim down to $0.

(ii) Counterclaim

Because a set-off operates strictly as a defence and cannot grant an affirmative monetary judgment for an excess sum, Harbour re-pleads the underlying material facts of both cross-claims under the formal heading “Counterclaim”. In its prayer for relief on the Counterclaim, Harbour claims total damages of $2.3 million.

Why both set-off and counterclaim are applicable

The set-off is used as a defence to reduce or extinguish ABC’s claim for the unpaid invoice. In this example, Harbour could plead the $300,000 and $2 million set-offs as defences. Because this exceeds ABC's $1.5 million invoice claim, it completely extinguishes ABC’s claim down to $0.

A set-off alone cannot grant an affirmative monetary award to a defendant for an excess sum. The counterclaim is a separate claim by Harbour against ABC seeking affirmative monetary award. Harbour is not merely trying to reduce ABC’s claim; it is asking the court to award it damages of $2.3 million for ABC’s alleged breach of contract.

If Harbour proves both, the court may give effect to the set-off and then determine the counterclaim. The net result could be that ABC recovers nothing and Harbour obtains judgment for the balance of its own claim.

The court will calculate the result as follows:

ABC’s proved claim: $1.5 million
Harbour’s proved cross-claims: $2.3 million ($300,000 + $2 million)
Effect on ABC’s action: Harbour’s set-offs completely defeat ABC’s claim. ABC recovers $0.
Judgment on counterclaim: The court gives judgment for Harbour on its counterclaim for the net balance of $800,000 ($2.3 million total cross-claim minus $1.5 million extinguished claim).
Costs: Because Harbour’s set-off defence entirely defeated ABC’s claim, ABC is ordinarily ordered to pay Harbour’s costs for defending the main action as well as Harbour’s costs on the counterclaim.