The rule in Clayton's Case (to give it its full legal name and citation: Devaynes v Noble (Clayton's

Case) (1816) is a common law presumption in relation to the distribution of money from a bank account. The rule is based upon the deceptively simple notion of first-in, first-out to(FIFO) determine the effect of payments from an account, and will normally apply in the absence of evidence of any other intention. Payments are presumed to be appropriated to debts in the order in which the debts are incurred. In Claytons Case, one of the partners of a firm with which Clayton had an account died. The amount then due to Clayton was BP 1,717. The surviving partners thereafter paid out to Clayton more than that amount while Clayton himself, on his part, made further deposits with the firm. On the firm being subsequently adjudged bankrupt, it was held that the estate of the deceased partner was not liable to Clayton, as the payments made by the surviving partners to Clayton must be regarded as completely discharging the liability of the firm to Clayton at the time of the particular partners death. It is based on the legal fiction that, if an account is in credit, the first sum paid in will also be the first to be drawn out and, if the account is overdrawn, a payment in is allocated to the earliest debit on the account which caused the account to be overdrawn. It is generally applicable in cases of running accounts between two parties, e.g., a banker and a customer, moneys being paid in and withdrawn from time to time from the account, without any specific indication as to which payment out was in respect of which payment in. In such case, when final accounts, which may run over several years, are made up, debits and credits will be set off against one another in order of their dates, leaving only final balance to be recovered from the debtor by the creditor. The rule is only a presumption, and can be displaced. Notwithstanding the criticisms sometimes levelled 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 to the rule

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 In such a case, if the trustee misappropriates any moneys belonging to the trust, the first amount so withdrawn by him will not be allocated to the discharge of his funds held on trust but towards the discharge of his own personal deposits, even if such deposits were, in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. In such cases, the fiduciary is presumed to spend their own money first before misappropriating money from the trust; see Re Hallett's Estate (1879) 13 Ch D 696. The rule is founded on the principles of Equity. If a fiduciary has mixed his or her own money with sums of trust money in a private account, withdrawals are attributed to his or her own money as far as possible, Re MacDonald [1975]. However, if the funds of two beneficiaries, or of a beneficiary and an innocent volunteer, are mixed the rule determines their respective entitlements, Re Diplock [1948] Ch 465.

Applications to a partnership

The rule has special application in relation to partnerships upon the death of a partner. In most jurisdictions, the death of a partner ordinarily has the legal effect of dissolving the firm.[1] The partners' personal representatives have no right to step into the partner's shoes; they cannot take part in its management; they can only claim the deceased partner's share in the assets of the firm. The banker, who provides financial accommodation to the firm, can have no objection in continuing the account; the bank can presume that the surviving partners will account to the representatives of the deceased for his share in the assets. Where the firm has a debit balance the account should be stopped to fix the liability of the estate of the deceased partner and to avoid the operation of the rule in Clayton's case.

Bankers Right of Appropriation : In the course of his usual business, a banker receives payments fro his customer. If the m latter has more than one account or has taken more than one loan fro the banker, the question of m 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 owns several debts. He can appropriate the payment to his creditor to whom he owes several debts. He can appropriate the payment by i) an express intmation i or ii) under circumstances implying that the payment is to be applied accordingly. For example, A st owes B served debts, including Rs. 1,000 upon promissory note which falls due on 1 December 1996. He owes B no other debt of the amount. On 1-12-1996 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 circumstance indicating to which debt the payment is to be applied, the right of appropriation is vested in the creditor. He may apply it at his discretion to any lawful debt actually due and payable to him from the debtor. (Sec 60)

Further, where neither party makes any appropriation, the payment shall be applied in discharge of the debts in order of time. If the debts are of equal standing the payment shall applied in discharge of each proportionately (Sec, 61). In a recent case M/s Kharavela Industries Pvt. Ltd. Vs Orissa State Financial Corporation and Others (AIR 1985 Orissa 153 (A)), the question arose whether the payment made by the debtors was to be adjusted first towards the principal or interest in his absence of any stipulation regarding appropriation of payments in the loan agreement. The Court held that in the case of debt due with interest, any payment made by the debtor is in the first instance to be applied towards satisfaction of interest and thereafter towards 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 money is the chronological order, as decided in the famous Claytons Case, discussed below

Claytons Case (Deveins V. Noble: 1816)

A firm of banker knows as Deveins, Derives, Noble & Co., had five partners. Devaynes, the senior partner, died and the surviving partners, carried on the business of banking under the same name. The executors of the deceased partner objected to the continuance of the name of Devaynes in the firms name. After a year the firm became bankrupt and various classes of creditors of the firm placed their claims against the estate of Devaynes, the deceased partner.

N. Clayton was one of those creditors who continued to deal with the surviving partners by making payments to and receiving payments from the firm. At the time of death of Devaynes, Claytons balance was $1,713. During the next few days he withdrew several times and thus the balance was reduced to $453. Thereafter surviving partners paid more than $1,713 to him and subsequently his deposits with the firm largely exceeded the amounts withdrawn by him and thus his credit balance at the time of bankruptcy of the firm was larger than the amount which was due to him at the time of death of Devaynes.

Clayton claimed that the amount of $453 (as reduced by the divided on this amount which he received from the Liquidator of the firm) was due to him from the estate of the deceased partner. His contention was that-

i) the withdrawals from the account after the death of the partner were paid out of the deposits made in the same period and thus. ii) The credit balance standing at the time of the partners death was recoverable from the deceased partners assets.

These arguments were not accepted by the Cour and Claytons claim was rejected. Sir t William Grant M.R. observed the general rule of appropriation as follows: General rule of appropriation: This is the case of a banking account where all the sums paid in form one balanced fund, the parts of which have no longer any district existence In such a case there is no room for any other appropriation than that which arises from the order in which the receipts and payments take place and are carried into the account. Presumably, it is the sum first paid in, that is first drawn out(FIFO). It is the first item on the debit side of the account that is discharged or reduced by the first item on the credit side.

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.

Therefore, to avoid the operation of the rule given in the Claytons case the bank closes the old account of the firm and opens a new open 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 deposit s made by surviving/solvent partners will not be applicable to discharge the same.

Conditions for applying the rule in Clayton s case:

The rule derived from the Claytons case is of great practical significance to the bankers. In case of death, retirement or insolvency of a partner of a firm, then the existing debt due from the firm is adjusted or set off by subsequent credit made in the deceased, retired or insolvent partner and may ultimately suffer the loss if the debt cannot be recovered from the remaining partners. Thus this rule is of great importance for the bankers while providing overdraft and cash credit however there are certain pre-determined conditions to apply these rules. They are as follows: When a debtor owing several debts makes a payment, the creditor should appropriate it as per the rules of appropriation. The rules of appropriation are laid down in section 59, 60 & 61 of Indian Contract Act. Sec. 59 states that if the borrower expressly mentions the debt to which the payment will be credited or if it is implied from the circumstances, the creditor must appropriate the payment of the debt. Sec. 60 : In the absence of the express or implied intention of the borrower, the creditor may use his discretion and apply the payment to any lawful debt actually due and payable including time barred debt from the debtor. Sec. 61 : Where neither of the two parties makes any appropriation, the payment will be applied for discharging debt in order of time. If the debts are of equal time, the payment will go to discharge the debts proportionately. The provision of this section is same to that of the rule laid down in famous Clayton's case. APPLICATION OF CLAYTON'S RULE -Importance of the rule in practice: Death / Insolvency of borrower Where an individual borrower or the proprietor expires / becomes insolvent, we stop operation in his cash credit account. In case any fresh credit is allowed to the account, the liability of such deceased borrower stands reduced by the amount and his estate can not be made liable for the same. The estate of the deceased / insolvent borrower can not be made liable for all fresh debit after his death / insolvency. Death / Retirement / Insolvency of a partner in partnership firm On the death / retirement / insolvency of a partner the liability of such partner stands determined. In case of any fresh debit to the account, the deceased / retired / insolvent partners' estates can not bebmade liable for the same. On the contrary their liability stands reduced by the credit. For this reason, the operation in the account should be stopped to determine the liability of the deceased / retired / insolvent partner. In case the bank decides to allow operation to the new firm, it should be done after ruling off breaking the account and allowing operation in a fresh page. Death of guarantor of a Cash Credit / Overdraft account

On receipt of notice of death / insolvency of a guarantor the operation of the account should be stopped or should be ruled off. In case it is not done, the rule in Clayton's case will apply and the liability of the estate on the guarantor will diminish to the extent of credits allowed in the account after the receipt of news of death/insolvency. The same principle also holds good in case of revocation of guarantee. Joint Account On receipt of news of death / insolvency of one of the joint account holders the operation in the account should be stopped or the account should be ruled off as otherwise the rule in Clayton's case will apply.