Appropriation of Payments

In one line

Where a debtor owes several debts and pays less than the total, three rules decide which debt the money goes to, and they run in a fixed order: the debtor first, then the creditor, then the law.

In the words a student can write in an exam: sections 59 to 61 of the Indian Contract Act 1872 govern the appropriation of payments. Under section 59 a payment made with express intimation, or under circumstances implying, that it is to go to a particular debt must, if accepted, be applied accordingly. Under section 60, where the debtor has not intimated and no circumstances indicate, the creditor may apply it at his discretion to any lawful debt actually due, whether or not its recovery is barred by limitation. Under section 61, where neither party appropriates, the payment is applied to the debts in order of time, barred or not, and debts of equal standing are discharged proportionably.

Why the question matters

It looks like bookkeeping, and it decides real money, for three reasons.

Limitation. A debt whose recovery is time barred is still a debt: the Limitation Act 1963 bars the remedy and does not extinguish the obligation. So a creditor who can direct a payment to a time barred debt gets value he could never have sued for. Sections 60 and 61 both say expressly that appropriation may be made to such a debt.

Security. One debt may be secured and another not. Applying a payment to the secured debt frees the security; applying it to the unsecured debt leaves the security in place. The creditor's interest and the debtor's are opposite.

Interest and guarantees. One debt may carry a higher rate, or may be guaranteed by a surety who is discharged pro tanto as it is paid.

The Act resolves the conflict by a clear order of priority, and the order is the answer to almost every problem question on the topic.

The provisions

Section 59, where the debt to be discharged is indicated:

"Where a debtor, owing several distinct debts to one person, makes a payment to him, either with express intimation, or under circumstances implying, that the payment is to be applied to the discharge of some particular debt, the payment, if accepted, must be applied accordingly."

Section 60, where it is not indicated:

"Where the debtor has omitted to intimate and there are no other circumstances indicating to which debt the payment is to be applied, the creditor may apply it at his discretion to any lawful debt actually due and payable to him from the debtor, whether its recovery is or is not barred by the law in force for the time being as to the limitation of suits."