What is Clayton Rule?

Business, banking, trade and monetary transactions have been the life blood of any civilization. Man has been engaged in trade and financial business since time immemorial.

However, certain times, difficult and confusing situations arises as to the distribution of assets and liabilities within a group of co-owners and in that case, certain laws have been made to ensure free and fair share of everyone’s rights and responsibilities to the funds and liabilities without fear, favour, affection or ill-will of any person.

The Clayton rule is a common law in relation to the distribution of assets in the form of money from a bank account. This rule was made as part of the judgement of the Devaynes vs. Noble case of 1816. The judgement was taken as a president and a common law known as Clayton’s rule was put into effect for further cases of such nature.

Case background

The famous case dates to 1816 when Mr. Clayton had an account with a banking form which was a partnership named Devaynes, Dawes, Noble, and Co. One of the partners William Devaynes died. The amount then due to Clayton was £1717. The living partners remaining there after paid out to mystically 10 more than the amount while Clayton himself on his part made for the deposits with the firm. The firm subsequently went bankrupt.

According to the judgement it was concluded that whatever period is paid or is to be applied according to the mode laid down by the payer. Therefore according to this when a debtor makes a payment, appropriation of the fund can be done to any of the debt that he pleases. And the creditors must be agreeing to it.

Clayton rule in the Indian context

In the Indian constitution the Clayton rule has been incorporated by the provision of the Indian contracts act 1872. Appropriation of payments and the rules relating to it made by the debtor who owes a number of distinct dates to his creditor are present in sections 59 to 61 of the Indian Contract Act 1872.

In order to further delve into the Indian Contract Act we need to first know the meaning of appropriation of funds. Appropriation of funds refers to the allocation of money for a particular purpose. Sometimes when there are multiple transactions we do not know which payment has been sent against which purchase. In order to clear out this confusion the Clayton’s rule is applied.

There are few distinct cases which call for different situations and applications of the law:

• Appropriation in order of receipts and payments– the rule of Clayton’s law is applicable when the two parties have an account that owns no interest. In that case appropriation takes place in the order in which the receipts and payments take place and are carried into the account. Thus as per the rule unless there is contrary intention the items on the credit of an account must be appropriated against the items on the debit in order of date.
• When the debtor does not intimate and creditor fails to appropriate – According to section 61, if the debtor does not expressly intimate and where the creditor fails to make any appropriation, the payment shall be applied in discharge of the debt in chronological order. If the debts are of equal standing, the payment shall be applied in discharge of each proportionately.
• Where the debtor intimates – According to section 59:
  (i) Appropriation of payment is a right primarily of thedebtor and for his benefit. If the debtor expressly intimates at the time of actual payment that the payment must be applied towards the discharge of a particular debt, the creditor must do so.
  (ii) If there is no express intimation by the debtor, the Law will look to the circumstances attending on the payment for appropriation. There is an established maxim that when money is paid, it is to be applied according to the express will of the payer, not to the receiver.
• When the debtor does not intimate and the circumstances are not indicative (Sec.60) :
  (i) When the debtor does not expressly intimate or where the circumstances attending on the payment do not indicate any intention, the creditor may apply his own discretion to any lawful debt actually due and payable to him from the debtor.
  (ii) The creditor may also, until he has declared appropriation to the debtor, alter the appropriation.
  (iii) He cannot, however, apply the payment to a disputed and unlawful debt, but he may apply it to a debt, which a barred by the law of limitation.
• Part-payment is applied for the interest first and for the principal afterwards – Regarding part-payment, the general principle, subject to any contract to the contrary, is that the payment should first be applied to the interest and after the interest is fully paid off, to the principal.

Whenever the borrower repays loans to lender, the interest amount will be satisfied first and then will eat satisfy the principal amount. Also these rules do not come into effect unless there are multiple transactions between the lender and the borrower.

That means number of monetary transactions have to be done in different period of time. Appropriation of payment does not apply to single transactions.

The rule is only a presumption, and can be displaced. Notwithstanding the criticisms sometimes leveled against it, and despite its antiquity, the rule is commonly applied in relation to tracing claims where a fraudster has commingled unlawfully obtained funds from various sources.

Exception

The rule does not apply to payments made by a fiduciary out of an account which contains a mixture of trust funds and the fiduciary’s personal money. In such a case, if the trustee misappropriates any moneys belonging to the trust, the first amount so withdrawn by him will not be allocated to the discharge of his funds held on trust but towards the discharge of his own personal deposits, even if such deposits were, in fact made later in order of time.