Set-Off and Backcharges in Malaysian Construction Claims

An employer or main contractor can often deduct money from a contractor's payment claim, but the deduction must have a proper contractual or legal basis and must be supported by evidence. Backcharges for defective or incomplete work are particularly vulnerable where the contractor was never told about the problem, was not given a reasonable opportunity to rectify it, or the amount deducted cannot be properly proven.

The first question is therefore not simply whether the employer can deduct. It is what gives the employer the right to deduct, and whether the particular deduction can be justified.

What are set-off and backcharges?

A set-off means that one party reduces the amount it owes by taking into account a separate amount that it says is owed back to it.

For example, a contractor claims RM500,000 for completed works, but the employer says it has a valid RM100,000 claim for defects. If the set-off is valid, the employer may argue that only RM400,000 is payable.

A backcharge is a common type of deduction in construction projects. It normally arises where an employer or main contractor incurs costs because a contractor or subcontractor failed to complete, rectify or properly perform part of its work, and then seeks to recover those costs by deducting them from money otherwise due.

The two concepts overlap, but the important point is that a deduction still needs to be legally justified.

Start with the contract

The first place to look is the construction contract.

Many contracts contain clauses allowing the employer or main contractor to deduct or set off amounts from progress payments, retention sums or the final account. Some clauses are drafted narrowly, while others give a much wider right.

In Bukit Cerakah Development Sdn Bhd v L'Grande Development Sdn Bhd [2008] 1 MLRA 22, the Court of Appeal considered a broadly drafted set-off clause and confirmed that an employer may have a right to make deductions where the contract allows it.

Even where the contract is silent, a right of set-off may still exist under general law, unless the contract excludes or limits it.

The practical point is simple. Before arguing about whether a deduction is valid, first identify the clause or legal basis the employer is relying on. Then ask whether the amount deducted can actually be proven.

An employer cannot simply invent a deduction

Having a right of set-off does not mean an employer can choose an arbitrary figure and reduce the contractor's claim accordingly.

The employer must still establish the factual basis for the deduction and provide reasonable evidence of the loss or cost said to have been incurred.

This becomes particularly important with backcharges.

An employer may say that it had to appoint another contractor to rectify defective work. That may justify a deduction, but the employer should be able to show what the defect was, why the original contractor was responsible, what opportunity was given to rectify it, what replacement work was actually carried out and how much it genuinely cost.

A debit note prepared after the event is not necessarily enough on its own.

What makes a backcharge valid?

The High Court's approach in Kayangan Kemas Sdn Bhd v Kay Corporation Sdn Bhd [2024] MLRHU 539, drawing on earlier Malaysian authorities, provides a useful practical framework.

Where defective or incomplete work is alleged, the employer should ordinarily notify the contractor of the problem, identify what needs to be rectified and give the contractor a reasonable opportunity to carry out the rectification.

If the contractor fails to do so, the employer may then arrange for someone else to complete or rectify the work. The employer must still be able to prove the cost and should take reasonable steps to prevent the amount from becoming unnecessarily high.

A backcharge is therefore much stronger where the employer can show four things:

Question	Why it matters
Was the contractor notified?	The contractor should know what failure is being alleged
Were the defects or incomplete works identified?	A vague complaint is difficult to verify or answer
Was there a reasonable opportunity to rectify?	The employer should not normally replace the contractor immediately and simply send it the bill
Can the actual cost be proven?	Invoices, quotations, delivery orders, site records and payment evidence should support the amount

In Kayangan Kemas, some categories of backcharges failed because the documents did not sufficiently connect the expenditure to the subcontractor or establish responsibility for the cost.

The case illustrates why backcharges are decided on evidence rather than labels.

If the contract sets a procedure, follow it

The contract may impose further requirements before a backcharge can be made.

For example, a clause may require written notice before the employer can remove work from the contractor, appoint another party to complete it and charge the cost back.

If the contract requires 7, 14 or 21 days' notice, the employer should not assume that the requirement can be ignored simply because the contractor was genuinely in default.

In Ahmad Zaki Sdn Bhd v Seacera Ceramics Sdn Bhd [2018] MLRHU 545, a backcharge claim failed where the contractual notice procedure had not been complied with.

For contractors, this is one of the first matters to check when a deduction appears in a payment certificate. The issue is not only whether the underlying complaint is justified, but whether the employer followed the agreed procedure before making the deduction.

What if no opportunity to rectify was given?

This is a common weakness in backcharge claims.

In HCM Engineering Sdn Bhd v Kuasatek (M) Sdn Bhd [2022] MLRHU 683, certain backcharges were disallowed because the contractor had not been given proper notice or an opportunity to rectify the alleged defects before others were brought in.

Similarly, in Casa Tenaga Sdn Bhd v Efektif Sempurna Sdn Bhd [2015] 5 MLRH 1, the lack of proper documentary evidence and notice affected the attempt to recover rectification costs.

An employer should therefore avoid treating backcharges as an accounting exercise carried out only after the works have been completed. The process should begin when the alleged defect or incomplete work is identified.

What does a properly documented backcharge look like?

Recent decisions also show what can make a deduction more convincing.

In BIM Engineering & Construction Sdn Bhd v Sunway Construction Sdn Bhd [2025] MLRHU 2467, the set-off was supported by contemporaneous site documents and evidence concerning the work carried out by a replacement contractor.

That is very different from simply producing a spreadsheet months later showing an amount labelled "backcharge".

Useful evidence may include defect notices, site memos, photographs, correspondence, quotations, invoices, delivery orders, third-party contractor records and proof that the relevant invoices were actually paid.

The clearer the connection between the contractor's default and the cost incurred, the stronger the deduction is likely to be.

What about deductions from certified payments?

A certified amount carries weight because it usually reflects an assessment that work has been completed and a particular amount is payable.

This does not mean that an interim certificate can never be affected by a valid set-off, particularly where the contract preserves such a right. However, an employer should not treat certification as meaningless and simply reduce a certified amount without identifying a proper contractual or legal basis.

In Bumimetro Construction Sdn Bhd v Sun-Jaya M & E Sdn Bhd [2020] MLRHU 2117, the employer's own conduct and earlier verification of amounts became relevant when it later attempted to reduce sums that had already been accepted.

The practical question remains whether the contract allows the deduction and whether the employer can prove the underlying amount.

Can LAD be deducted from a contractor's claim?

Potentially, yes.

Liquidated and ascertained damages, commonly called LAD, may operate as a set-off where the employer has a valid contractual entitlement arising from delay.

In Tenaga Poly Sdn Bhd v Crest Builder Sdn Bhd [2016] MLRHU 1754, the High Court recognised that LAD could be used defensively in CIPAA adjudication to reduce a contractor's payment claim.

There is an important limit.

If the contractor claims RM300,000 and the employer has a valid LAD set-off of RM400,000, the set-off may reduce the contractor's adjudicated claim to zero. It does not ordinarily mean that the employer can use that adjudication to obtain a positive award requiring the contractor to pay the remaining RM100,000.

The employer would generally need to pursue the balance through the appropriate separate process, such as arbitration or court proceedings.

What happens to set-off in CIPAA adjudication?

CIPAA adds a procedural layer because payment disputes move through a payment claim, payment response, adjudication claim and adjudication response.

Section 6 of the Construction Industry Payment and Adjudication Act 2012 requires a respondent who disputes a payment claim to serve a payment response within 10 working days, stating the amount disputed and the reasons.

An employer or main contractor should therefore raise known defects, LAD, backcharges and set-offs as early as possible.

However, the current law is more flexible than some earlier CIPAA decisions suggested.

In View Esteem Sdn Bhd v Bina Puri Holdings Bhd [2018] 1 MLRA 460, the Federal Court held that an adjudicator should not automatically refuse to consider a defence simply because it was not included in the earlier payment response. A defence properly raised in the adjudication response may still need to be considered.

This does not mean that the payment response should be ignored. Raising the defence early makes the dispute clearer and reduces arguments over procedure. The important point is that a genuine defence does not necessarily disappear merely because it was first fully explained at the adjudication stage.

Can an employer deduct losses from another project?

This is more complicated.

Outside CIPAA, a sufficiently wide contractual clause may sometimes allow deductions involving another contract between the same parties. Bukit Cerakah is an example of how broad contractual wording can matter.

In CIPAA adjudication, the position is more restricted because the adjudication concerns a payment dispute arising under a particular construction contract.

Parties should therefore not assume that an amount owed under a different project can automatically be deducted in a CIPAA adjudication concerning another contract. The wording of the contract and the scope of the adjudication must both be considered.

What should employers keep before making a deduction?

An employer intending to impose a backcharge should keep the site instruction, defect notice, photographs, correspondence, evidence that the contractor was given an opportunity to rectify, quotations from replacement contractors, invoices, delivery orders and proof of payment.

The amount claimed should reflect the reasonable cost of dealing with the contractor's actual default, rather than unrelated improvements or additional work that the employer chose to undertake, and should not be confused with a legitimate variation order that the contractor was separately instructed to carry out.

For contractors, the same documents should be requested when a backcharge appears. If the employer cannot identify the notice, defect, opportunity to rectify or supporting cost, there may be a proper basis to dispute the deduction. A contractor who disagrees with a deduction should also be careful about how it responds: stopping work over a disputed set-off carries its own separate risks.

Frequently Asked Questions

Can an employer deduct money for defects without telling the contractor?

The answer depends on the contract and the circumstances, but a backcharge is much more difficult to justify where no notice was given and the contractor was denied a reasonable opportunity to rectify the problem.

What is a backcharge?

A backcharge is a cost which one party says it incurred because another party failed to perform its work properly, and which it then seeks to deduct from money otherwise payable.

Can LAD be set off against a payment claim?

Yes, where there is a valid entitlement to LAD. In CIPAA, the set-off may reduce the claimant's payment claim, but it does not normally turn the respondent into a claimant entitled to a positive payment award.

Must a set-off be included in the CIPAA payment response?

It should be raised as early as possible. However, following View Esteem, a defence is not necessarily barred simply because it was first raised in the adjudication response.

Can an employer deduct for defects from another project?

Potentially, if the contract contains a sufficiently broad cross-contract set-off clause. In CIPAA adjudication, however, cross-contract deductions are more difficult because the adjudication is tied to a particular construction contract.

Final takeaway

An employer or main contractor may have a legitimate right to deduct from a construction payment, either because the contract expressly permits it or because a right of set-off exists under general law.

That right does not make every deduction valid.

Backcharges should be supported by proper notice, clear identification of the defective or incomplete work, a reasonable opportunity to rectify and reliable evidence of the actual cost incurred. Where the contract imposes its own procedure, that procedure should also be followed.

For contractors, the strongest response to a deduction is therefore not simply to say that the employer has no right to deduct. The better question is whether the employer can prove the contractual or legal basis for the deduction, the contractor's underlying default and the amount claimed.

Speak to JPP LAW

Justin, Poh & Partners, also known as JPP LAW, assists employers, main contractors, subcontractors and consultants with construction payment disputes, set-offs, backcharges, LAD claims, CIPAA adjudication and construction litigation in Malaysia.

If deductions have been made from a payment claim, or you are considering imposing backcharges against a contractor or subcontractor, you may contact us to assess the contractual basis, supporting evidence and available remedies.

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Disclaimer: This article is for general information only and does not constitute legal advice. Set-off and backcharge disputes depend heavily on the wording of the construction contract, notices given, certification, site records and evidence of the losses claimed.