Produce Pointers: Shady set-off on an old claim

The Problem: Shady set-off to recover on an old claim.

The Key Point: Set-offs must be applied in good faith.

The Solution: Pursue alleged obligations through proper channels.

Q. We are an importer based in Arizona. Two years ago, a shipper loaned us money as a crop advance. Unfortunately, production on the deal did not go as expected, resulting in a prolonged dispute. We ended up paying them more than we thought was fair and considered the matter to be fully resolved. 

Recently, however, this shipper contacted us and agreed to purchase nearly $40,000-worth of product. At no time did we discuss or agree that their payment for this product would be applied as a credit against any debt they alleged from the previous transaction. This was a completely separate purchase. 

But now they’re setting-off the amount they owe us for this purchase against the debt they claim we owe from two years ago. We’re planning on filing a PACA complaint, but before we do, we wanted to ask if this type of set-off is allowed. It feels awfully shady.

A. Set-offs are not necessarily improper and may be justified as long as the deduction is claimed in good faith and fully supported. That said, however, “setting up” an alleged debtor with a follow-up transaction to recoup losses from a prior transaction is inconsistent with good faith dealing and is therefore improper.

If, for example, in the ordinary course of business, your buyer owed you $40,000, but you owed them $10,000 in connection with another transaction—and if they could support this $10,000 claim—we would recognize their right to pay you just $30,000.

Of course, you could challenge the substance of the claim, but the set-off itself, if made in good faith, would not be improper.

The case you describe, however, is very different. It sounds like the buyer entered into this recent transaction with the undisclosed intention of collecting a debt allegedly incurred years before, and which they had stopped actively pursuing. 

It’s important to remember that the Uniform Commercial Code (UCC), Sec. 1-304, provides—“Every contract or duty within [the Uniform Commercial Code] imposes an obligation of good faith in its performance and enforcement.”

It appears to us that the buyer may have failed to act in good faith when it placed an order it did not intend to pay for. If the buyer believed it was owed additional money on the former transaction, it could have pursued the matter in court or through the PACA. 

It appears to us that the buyer may have failed to act in good faith when it placed an order it did not intend to pay for.

But, in our view, your buyer may not properly engage in a subsequent transaction as a means of remedying a perceived wrong in connection with a separate prior transaction.

What’s more, given that the prior transaction occurred more than nine months ago and is outside of PACA’s jurisdiction, we would expect you to recover in full, and without needing to delve into the merits of the prior transaction, at least before PACA. 

Of course, your buyer could always pursue the amount it alleges is owed in connection with the prior transaction in civil court, provided it is filed before the relevant statute of limitations runs out. 

Lastly, we’d add that you could have further strengthened your position and maybe avoided this situation entirely, by explicitly providing in your sales agreement (e.g., in your sales confirmation) that no set-offs would be permitted as compensation for this subsequent transaction. 

Although this is not a standard term in most sales agreements, given the lack of clear resolution to the prior transaction, a provision barring set-offs would have given you additional assurance in this instance.