A Legal View: What is meant by 'withholding and setoff?'

A company official raised the following topic: An agency has threatened to retain payments owed to our company on one contract as supposed compensation for a claim that it has asserted on another contract. The agency said this is permitted under the rules of "withholding and setoff." What are these rules, and what do they allow?

The terms "withholding" and "setoff" generally are used synonymously and refer to a creditor's right to retain money in its possession that it otherwise might owe to the debtor and to apply that money to the extinguishment of the debt. For example, if a debtor owes his creditor $100, and the creditor has possession of $10 that belongs to the debtor, the creditor may use the $10 to pay down the $100 debt, leaving a balance of $90.

These concepts are well-developed in common law. Moreover, it is generally well-recognized that the government has the same rights. [See, for example, United States v. Munsey Trust Co., 332 U.S. 234, 239 (1947).] No specific statutory authorization is necessary for an agency to exercise these rights.

Nevertheless, Congress has enacted several laws pertaining to this area. The most noteworthy is the Debt Collection Act of 1982 [31 U.S.C. :: 3701, et seq.]. The act defines an administrative offset as "withholding money payable by the United States Government to, or held by the Government for, a person to satisfy a debt that the person owes the Government." [31 U.S.C. : 3701(a)(1)] According to the act, "After trying to collect a claim from a person under Section 3711(a) of this title, the head of an executive or legislative agency may collect the claim by administrative offset." The act also established various procedures to be followed by the agency to protect the debtor's interests.

The enactment of the Debt Collection Act created a great deal of confusion in this area. The confusion was especially apparent in government contracting. In many cases filed with the various boards of contract appeals, the parties argued over how the Debt Collection Act's procedures applied to government contracting. The early cases mostly involved the applicability of the act to setoffs in which both the debt and the credit arose under the same contract. In general, the boards found the act to be inapplicable in that situation.

Subsequent cases addressed the applicability of the Debt Collection Act to situations in which the government sought to offset payments due to a contractor under one contract against a debt owed to the government under another contract. Some of these cases were decided in favor of the act's applicability. Those decisions required the government to comply with the Debt Collection Act's procedural safeguards prior to any setoff.

However, in Cecile Industries Inc. v. Cheney [995 F.2d 1052 (Fed. Cir. 1993)], the Federal Circuit Court of Appeals ruled that the Debt Collection Act has no applicability to the government's common law right to offset contractual debts, whether those debts arise under the same contract or a different contract.

In general, the Federal Acquisition Regulation requires responsible officials to expeditiously collect from their contractors any amounts due to the government for any reason. The FAR encourages the contracting officer to negotiate with the contractor, if possible. However, the FAR also states that the contracting officer should enter a unilateral decision on the matter if an agreement cannot be reached relatively quickly. A unilateral decision ordinarily is issued as a "contracting officer's final decision" pursuant to the disputes clause of the contract and the Contract Disputes Act of 1978. [See FAR 32.608.]

After the contracting officer's final decision is issued, the responsible official issues a "demand for payment" to the contractor. Such a demand must include: a description of the debt; a notification that any amounts not paid within 30 days will bear interest; a notification that the contractor may submit a proposal for deferment of collection if immediate payment is not practicable or the amount is disputed; and the identification of the responsible official designated for determining the amount of the debt and for its collection. [See FAR 32.610.]

If payment is not made within 30 days or if a deferment agreement is not reached, the responsible officials are supposed to initiate withholding immediately. [See FAR 32.612.] In addition, the responsible official should notify any disbursing officers who may have contractor invoices on hand for payment.

Indeed, even if the contractor appeals the contracting officer's decision regarding the debt, the government's right to withhold pending resolution of the appeal will be unaffected.

As discussed above, the government's rights in this area are relatively clear. On the other hand, any reading of the relevant cases shows how confused people can become regarding the applicable grammar rules.

-- Peckinpaugh is a member of the government contracts section of the law firm of Winston&Strawn, Washington, D.C.