Right of Appropriation :

In case of his usual business, a banker receives payments from his customer. If the latter has more than one account or has taken more than one loan from the banker, the question of the appropriation of the money subsequently deposited by him naturally arises. Section 59 to 61 of the Indian Contract Act, 1872 contains provisions regarding the right of appropriation of payments in such cases. According to Section 59 such right of appropriation is vested in the debtor, who makes a payment to his creditor to whom he owes several debts. He can appropriate the payment by (i). an express intimation or (ii) under circumstances implying that the payment is to be applied to the discharge of some particular debt. If the creditor accepts such payment, it must be applied accordingly. For example, A owes B several debts, including Rs. 1,000 upon a promissory note which falls due on 1st December, 1986. He owes B no other debt of that amount. On 1-12-1986 A pays B Rs. 1,000. The payment is to be applied to the discharge of the promissory note.

If the debtor does not intimate or there is no other circumstances indicating to which debt the payment is to be applied, the right of appropriation is vested in the creditor. He may apply it as his discretion to any lawful debt actually due and payable to him from the debtor (Section 60) Further, where neither party makes any appropriation, the payment shall be applied in discharge of each proportionately (Section 61).

In M/s. Kharavela Industries Pvt. Ltd. v. Orissa State Financial Corporation and Others [AIR 1985 Orissa 153 (A)], the question arose whether the payment made by the debtor was to be adjusted first towards the principal or interest in the absence of any stipulation regarding appropriation of payments in the loan agreement. The Court held that in case of a debt due with interest, any payment made by the debtor is in the first instance to be applied towards satisfaction of interest and thereafter toward the principal unless there is an agreement to the contrary.

In case a customer has a single account and he deposits and withdraws money from it frequently, the order in which the credit entry will set off the debit entry is the chronological order, as decided in the famous Clayton’s Case. Thus the first item on the debit side will be the item to be discharged or reduced by a subsequent item on the credit side. The credit entries in the account adjust or set-off the debit entries in the chronological order. The rule derived from the Clayton’s case is of great practical significance to the bankers. In a case of death, retirement or insolvency of a partner of a firm, the then existing debt due from the firm is adjusted or set-off by subsequent credit made in the account. The banker thus loses his right to claim such debt from the assets of the deceases, retired or insolvent partner and may ultimately suffer the loss if the debt cannot be recovered from the remaining partners. Therefore, to avoid the operation of the rule given in the Clayton’s case the banker closes the old account of the firm and opens a new one in the name of the reconstituted firm. Thus the liability of the deceased, retired or insolvent partner, as the case may be, at the time of his death, retirement or insolvency is determined and he may be held liable for the same. Subsequent deposits made by surviving/ solvent partners will not be applicable to discharge the same.