Setoff and Recoupment in California Business Disputes

Last updated: November 2026. Reviewed by Pavel Kolmogorov, California business litigation attorney (State Bar No. 321018).

Setoff is the rule that two parties who owe each other money owe only the difference. California recognizes it. When cross-demands for money have existed between two parties, the demands are treated as compensated so far as they equal each other, and Code of Civil Procedure section 431.70 lets a defendant raise that as a defense of payment. Whether your business may withhold payment and remit the net before anyone sues depends on both contracts. Kolmogorov Law, P.C., a business litigation firm in Irvine, handles these disputes.

Call (909) 235-6116 or contact us online to discuss an offset you want to take or one being taken against you.

What the setoff statute says

Section 431.70 is a single paragraph. It applies where cross-demands for money have existed between two persons at any time when neither demand was barred by the statute of limitations. If one of them later sues, the other may assert in its answer the defense of payment, on the ground that the two demands are compensated so far as they equal each other. (Code Civ. Proc., § 431.70.)

The California Supreme Court has explained the reason for the rule. Two parties with opposing claims, related or not, may each let matters rest on the assumption that the claims cancel. If one of them later sues, the other should be able to use its own claim defensively. (Construction Protective Services, Inc. v. TIG Specialty Ins. Co. (2002) 29 Cal.4th 189.) Two points follow. The demands need not come from the same contract. And both must be demands for money.

An expired claim can still work as a shield

One important function of the statute is to rescue an old claim. The defense is available even if an independent lawsuit on the defendant's claim would be time-barred on the day the answer is filed. The condition is that both demands coexisted at some point when neither was barred.

There is a ceiling. If the cross-demand would otherwise be time-barred, the relief may not exceed the value of the relief granted to the other party. An expired claim can therefore reduce the plaintiff's recovery to zero, but it cannot produce a payment in the defendant's favor.

There is also a trap. The defense is unavailable if the cross-demand was lost because it was not pleaded in an earlier lawsuit under the compulsory cross-complaint rule. (Code Civ. Proc., § 431.70.) Our page on being served with a cross-complaint explains that rule.

Setoff is a defense, not a claim for money

A setoff pleaded in the answer can defeat the plaintiff's claim in whole or in part, and nothing more. A defendant that wants an award in its own favor must file a cross-complaint, and the ordinary limitations period applies to that pleading. (Construction Protective Services, supra, 29 Cal.4th 189.) A Court of Appeal decision adds that the plaintiff's complaint suspends that period for a defendant's claim against the plaintiff that was not yet barred on the filing date.

Take a customer that owes your company $80,000 and is owed $50,000 on a separate deal. If the customer sues for its $50,000, the setoff defense wipes that claim out. It does not deliver the remaining $30,000. For that, your company needs its own timely claim. Do not let your limitations period run on the assumption that setoff protects the full amount. Our page on the statute of limitations for contract claims lists the periods.

Recoupment and deductions under the same contract

Recoupment is a narrower idea. The California Supreme Court described it in 1886 as a defense available to a defendant sued on a contract. The defendant could reduce the plaintiff's demand by the damage caused by the plaintiff's own failure to perform that contract, up to the amount of the demand. (Roberts v. Donovan (1886) 70 Cal. 108, 113.) The court gave that description as background, and the case was decided on another point. Treat it as a description of the concept, not a statement of the current rule.

For sales of goods, the Commercial Code allows a deduction of the same kind. A buyer, on notifying the seller of its intention to do so, may deduct damages resulting from any breach of the contract from any part of the price still due under the same contract. (Com. Code, § 2717.) The notice matters, and so do the words "the same contract." A deduction taken without notice, or against a separate contract, is not what the section describes. Our page on sale of goods disputes covers the buyer's damages.

When the other side has assigned its claim

Setoff survives an assignment. Section 431.70 says neither party can be deprived of its benefits by the assignment or death of the other. A separate statute provides that an assignee's action is without prejudice to any setoff or other defense existing at the time of, or before, notice of the assignment. The exception is a negotiable promissory note or bill of exchange transferred in good faith, for good consideration, before maturity. (Code Civ. Proc., § 368.)

So if a supplier sold its invoices to a finance company, the offsets your company held before it was notified generally travel with the invoice. Offsets that arise after notice are not protected by that section. Our page on contract assignment disputes has more.

Can you net the invoices yourself?

That is the practical question, and the statutes above do not answer it. Section 431.70 describes a defense raised in an answer. It does not say a business may stop paying an undisputed invoice because it is owed money on another deal.

Whether withholding is safe depends on the two contracts. Some agreements expressly allow setoff. Others require payment "without setoff or deduction," and withholding under such a contract may itself be a default, with late charges or termination rights attached.

Before you net anything:

• Reconcile both accounts and send the other side the calculation in writing.
• Look for a setoff, no-setoff, or dispute resolution clause in each contract.
• If the other side agrees, record the netting in a short signed document.
• Be careful with a partial payment marked "paid in full." Our page on accord and satisfaction explains what that notation can do.

What to bring to the first meeting

Bring both contracts, the invoices and statements for each account, and a ledger of payments and credits in both directions. Add any letter claiming an offset and any notice that either debt was assigned. Note the date each amount first became due.

Frequently asked questions

A customer owes us $80,000 and we owe them $50,000 on a different deal. Can we just net the two and bill the difference?

California recognizes setoff of mutual money demands, but Code of Civil Procedure section 431.70 frames it as a defense in a lawsuit, not as permission to stop paying. Whether you may withhold the $50,000 depends on both contracts, including any clause requiring payment without deduction. A written reconciliation and a signed netting agreement are safer than silence.

What is CCP 431.70?

It is California's setoff statute. When two parties have held money demands against each other at a time when neither was time-barred, and one sues, the other may plead that the demands are compensated to the extent they are equal. The defense survives the expiration of the defendant's own claim, but relief on an expired claim cannot exceed what the plaintiff recovers.

What is the difference between setoff and recoupment?

Setoff under California's section 431.70 nets money demands between the same parties, whether or not the demands are related. Recoupment, as the California Supreme Court described it in 1886, is narrower: a reduction of the plaintiff's contract claim by damage from the plaintiff's own failure to perform that contract. For goods, Commercial Code section 2717 lets a buyer who gives notice deduct breach damages from the price still due under that contract.

Our claim against the company suing us is more than four years old. Can we still use it to reduce what we owe?

It can, if the conditions are met. Under California Code of Civil Procedure section 431.70, a time-barred money claim may be raised as a defense of payment if it coexisted with the plaintiff's claim when neither was barred. It can reduce the plaintiff's recovery, even to nothing, but no further. The defense is lost if the claim should have been pleaded as a compulsory cross-complaint in an earlier case.

Can a setoff get my business money back, or only reduce what it owes?

Only reduce. The California Supreme Court has held that a setoff under section 431.70 may be used defensively to defeat the plaintiff's claim in whole or in part. A defendant that wants an affirmative award must file a cross-complaint, and the statute of limitations applies to that claim. The plaintiff's own filing can suspend the period for a claim not yet barred that day. A business holding the larger claim should not rely on setoff alone.

Talk to a California breach of contract attorney

If your company and a counterparty each claim the other owes money, call (909) 235-6116 or contact us online. Kolmogorov Law, P.C. is located in Irvine, California. Related reading: our breach of contract practice and our page on unpaid invoices.

This page provides general information about California law and is not legal advice. Outcomes depend on the contracts, the facts, and the court.