In the case of running accounts like current accounts or cash credit accounts, normally there is no specific appropriation of funds to exact debit. In such cases, it is the first item on the debit side that is discharged or reduced by the first item on the credit side. This principle was originally formulated in Devaynes v. Noble known as Clayton’s Case. The principle of “first in, first out” was established in Devaynes v Noble (1816) 35 ER 767 (often referred to as “Clayton’s case”). The rule in Clayton’s case creates a presumption as to the appropriation of payments into a running account being attributable to the repayment of the oldest debits from the account. In the other words, when in the absence of a contrary intention, payments are presumed to be appropriated to debts in the order in which the debts are incurred. The same clause is incorporated in Section 61 of the Indian Contract Act, of 1872.
Appropriation means the ‘application’ of payments. In the case of a creditor and a debtor, Sections 59 to 61 of the Indian Contract Act, of 1872, lay down certain rules regarding the appropriation of payments. When a debtor pays an amount to the creditor, the creditor is to take note of these sections before applying the payment to a particular debt, because the creditor would be inclined to appropriate payments to the debt which is not likely to be realized easily. In case both parties do not specify the appropriation then the law would take responsibility and appropriate accordingly.
The rule of Clayton’s case applies to overdrawn current accounts when the liability of any party is determined. However, the rule of Clayton’s case does not apply when a trustee mixes trust money with his own money in his banking account.
Related article: What is a right of set-off?