The Best Defense Is A Good Setoff

If you got it, of course. Today, I’m talking about the common law doctrine of setoff as it applies in California litigation. Contractual offsets are a different topic for another day, such as offsetting worker’s compensation payments from uninsured motorist benefits. That’s not what I’m talking about here, though it is a related concept.

In California, setoff is a doctrine often alleged in an Answer but not actually litigated. The doctrine of setoff (sometimes also called “offset”) applies when the party being sued has or had a claim against the plaintiff/claimant that may be used to reduce the amount of money damages that the plaintiff can recover. Setoff was an equitable concept that the California Legislature codified in Code of Civil Procedure, § 431.70.

Setoff does not apply in every case. A good investigation of the facts, and especially a thorough interview with the insured defendant may disclose the existence of this defense. It applies where cross-claims for money exist or used to exist. Because it is an equitable doctrine, it has unusual characteristics. For example, even if the statute of limitations ran on the defendant’s claim against the plaintiff years before the plaintiff filed suit, the defendant can use this defense to reduce or eliminate the damages the plaintiff is presently seeking.

Take the following example, plaintiff and defendant had a “take or pay” contract for the purchase of motor fuel. In these agreements, the buyer agrees that it will take and pay the seller a minimum of X dollars per month, even if the buyer does not take any fuel. The buyer fails to pay the minimum contract price of $10,000 a month for six months. Six years later, the plaintiff buyer sues the seller for defamation, since the seller told anyone who would listen where a terrible business plaintiff ran. The seller/defendant is insured under a CGL providing a defense for defamation claims.

The statute of limitations for breach of written contract in California is 4 years. The defendant seller cannot sue to recover money from the plaintiff; however, § 431.70 allows that defendant/insured to reduce plaintiff’s recovery by $60,000.

So, if plaintiff tries its case, and obtains a verdict for $50,000, the judgment will be for the defendant/insured, and the insured would be able to recover its litigation costs as “the prevailing party.” Pretty cool, right?

To raise the defense properly, it’s not going to be enough under California or federal law to just plead “Offset” or “Setoff.” When attacked, courts generally hold the defendant has to plead all the facts necessary to support the cause of action or claim that the setoff is based on. If the claim is not time-barred, this can be done by filing a cross-complaint and incorporating the cross-complaint into the setoff defense. Note however that cross-complaints for relief other than indemnity trouble insurance defense counsel (and  the insurers who hire them) because defense counsel defends insureds; they are not hired to prosecute affirmative claims the plaintiff, generally speaking.

The limit of the defense is that the setoff can only be used defensively–especially if the defendant’s claim or cause of action that the setoff is based is time-barred. One other important limitation. If this is the second lawsuit between the plaintiff and the defendant, and the defendant either raised or “should have raised” the claim in prior litigation, the defendant cannot get a second bite at the apple by raising setoff for a claim that was or should have been litigated between the same parties in earlier litigation.

Another useful way that setoff may be used is in defense of a judgment. Let’s say that a judgment against an insured exists. The insured finds someone who the judgment creditor has wronged in the past, and buys that third party’s causes of action against the judgment creditor. The judgment debtor can bring a new action for declaratory relief seeking to setoff the judgment debt by the value of the assigned claims–even if those claims would be time-barrred. This can be helpful to private businesses suffering judgments and in cases where there is a blend of insured and uninsured claims where a well-funded insured may be actively participating in its defense.

Sometimes the best defense is a good offset.