Discharge by agreement
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This article is written by Nishtha Pandey (batch 2023), from Dr. Ram Manohar Lohiya National Law University. In this article basic aspects of the Appropriation of payment and the Discharge by agreement, have been discussed in detail. 

Introduction 

Appropriation means ‘application’ of payments. In case of a creditor and a debtor, Section 59 to 61 of the Indian Contract Act, 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 the responsibility and appropriate accordingly.

A discharge of a contract by agreement, on the other hand, is when the contract is ended because the conditions are not fulfilled. However, the involved parties can also terminate a contract when the primary terms and conditions of the said contract have not been fulfilled. Essentially, the difference between a discharge of a contract and terminating contract is the reasons why the contract is coming to an end.

 Appropriation by debtor

Under Section 59 of the Indian Contract Act, 1872, it is stated that if the debtor owes several debts to the creditor, and makes a payment to any of them and later requests the creditor to apply the payment to the discharge of a particular debt. If the creditor agrees to this request, he is bound by such appropriation. This section applies to several distinct debts and not to a single debt, or to various heads of one debt. This is not applicable where the debt has merged into a decree. The appropriation may be implied or expressed by the creditor. The basic idea is that “When money is paid, it is to be applied according to express the will of the payer and not the receiver. If the party to whom the money is offered does not agree to apply it according to the will of the party offering it, he must refuse it and stand upon the rights which the law has given him

Clayton’s Case

In England, it has been considered a basic rule since the case of Devaynes vs Noble, also known as Clayton’s case. In this, it was held that the debtor can request the creditor to appropriate the amount to any of the debt in case he owes to the creditor several and distinct debts, if the creditor agrees to it, then he is bound by it. 

Several and Distinct Debts

Section 59 applies to the debt which is several and distinct and does not apply in the cases where there is only one debt even if it is to be paid in installments. The test to know whether the debts are distinct is the person can sue for it separately. 

Intimation by the Debtor

The debtor must at the time of the payment of the debt, must intimate the creditor that the amount must be paid for the liquidation of a certain debt, and the creditor has to appropriate it accordingly. The creditor has the right to refuse any conditions made by the debtor during the payment of the debt. Once appropriation has been accepted, then the creditor cannot alter the terms of the appropriation, without the consent of the debtor. 

The debtor should communicate his appropriation either expressly or impliedly, through the circumstances indicating such intention.

Proof of Intention

Intention about the appropriation of the payment by the debtor must be proved by circumstances. Where the debtor alleges appropriation in a particular manner then he must prove it. Moreover, entries in the book of the creditor could be considered for the proposed appropriation by the debtor.

Contract of Guarantee

The right to appropriate is available to the debtor and not the surety. A surety is also bound by the creditor’s appropriation. Also, the surety has no right to insist on the appropriation of any payment to the guaranteed debt, unless the circumstances of the case are such that they show such intention.

Appropriation by creditor 

Under Section 60, the creditor is also competent for appropriation. If the debtor makes any payment without any appropriation then the creditor can use his discretion to wipe out any debt which is due. He may use it for the payment of a time-barred debt or wipe out the debt which is carrying a lower interest rate. The right of appropriation lies with the creditor until the last moment, even when he is examined at the trial or before any act which renders him inequitable for him to exercise this right. The creditor, in this case, has a lot of scope for exercising his right, he can put himself in the most advantageous position. Moreover, he need not express himself in express terms while doing so. As long as notice has not been given in respect of the appropriation of any amount, the creditor can change it and can appropriate some other claim.

Lawful Debts

The creditor must establish the existence of a lawful debt actually due. Under this section, the appropriation cannot be made against any unlawful debt. In several cases, it was held by the court that a creditor can even appropriate towards an unenforceable debt due to some defect.

Time-Barred Debts

The creditor, in the absence of any appropriation by the debtor, can appropriate the amount of a debt barred by the Limitation Act,1963. This usually happens as the creditor appropriate the amount to a time-barred debt and sue the debtor for the ones not barred. However, the amount cannot be appropriated to a debt barred by a statute after an action has been brought and judgment has been delivered. 

Principal and Interest on Single Debt

There is a lot of conflict amongst the opinion of the court as to whether the provisions of this Section would apply to the principal and interest of the debt or not. In the case of Jia Ram vs Sulakhan Mal (Air 1941 Lahore 386), it was held that the principal and the interest would not be applicable under this. 

As under the common law, the rule that applies is that where the principal and interest has accrued on a debt, sums paid where interest has accrued must be applied first to the interest. This rule is based on “common justice” else it would deprive the creditor of the benefit to which he is entitled under his contract and would be most unreasonable for him.

Appropriation by law 

Section 61 is applied in a situation when neither of the parties makes the appropriation. To settle this deadlock, then the law gets the right to appropriate. In such cases, the debt is settled in accordance with the order of the time they have incurred. In case all the debts are of the same time then the debts would be discharged proportionately. Under this Section not only the express agreement but also the mode of dealing between the parties.

Assignment of contracts 

Assignment of contract means the transfer of the contractual rights or liabilities by a party of the contract to some other person who is not a party to the contract. For Example- A owes B debt and B owes to C. B can ask A to directly pay the amount to C, and if A agrees to this, then this will be an assignment of a contract. 

Assignment of liabilities 

In an assignment of the contract, it is important to note that the liabilities cannot be assigned. The promisor has to insist that the responsibility of the performance of the contract lies on the promisor himself. It becomes more important when the work is of personal nature and demands personalized skills like painting, singing. The promisor, in that case, can object to the performance of the contract which is done by some other person who is not a party to the contract.

The contractual liabilities may be assigned in the following two ways:

By the act of the party

  • Assignment with the consent of the other party and the assignee;

For Example- novation of a contract. 

  • Assignment with the consent of other parties, but without the consent of the assignee. 

For Example- A and B are party to a contract, they both decided to assign the liabilities on C, who is a stranger to a contract.

  • The assignment without the consent of the other party but with the consent of the assignee i.e. a voluntary assignment.

For Example- A and B are party to a contract, B assigns the liabilities of the contract to C, who is a stranger to contract, with his consent but without the permission of A.

By operation of law

The operation of law is another mode of a valid assignment of any contractual liabilities to a stranger. Such assignment is also called an ‘involuntary assignment’ or an ‘automatic assignment’ of contractual burdens or obligations. Such assignment may take place in the following circumstances:

  1. On the death of the promisor.
  2. On the retirement of a partner.
  3. On insolvency of the promisor.
  4. On winding up of a company.

Assignment of rights 

The rights are assignable under a contract unless the contract is personal in nature or the rights are incapable to be assigned either by law or under any contract that is entered by the parties. The intention regarding the assignment of the rights needs to be gathered from the nature of the agreement or from the prevailing circumstances. 

Even when there is no prohibition as to the assignment of the rights, but if the court from the facts of the case determines that there are various personal obligations under the contract, hence the rights under this cannot be assigned. 

One of the leading authorities is the decision of the Supreme Court in the case of Khardah vs Raymon, in this case, it the dispute arose because of a contract for the purchase of mill by a Pakistani jute dealer who failed to supply the goods as agreed. The court held that the contract for the purchase of the foreign jute was not assignable because the goods had to be imported from under the license which was not transferable. The other question which was put up was whether the dealer could assign his rights to that price on the delivery of the goods. The court accepted that there is nothing personal about the sale of goods. Moreover, it is established that the arbitration clause does not take away the right of the party to assign if it is otherwise assignable. In fact, the rights of the seller also do not obstruct the assignability of the contract. In the case, there was no provision in the contract which prohibits the assignment. The court stated that in the law there is a clear distinction between the assignment of the rights under a contract by the party who has performed the contract and his obligations, and the assignment of a claim for compensation which one party has against the other party for the breach of contract. The latter is just a claim of damages that can not be assigned in law, the former is the benefit under the agreement, which is capable of assignment.

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Personal Nature of the Contract

The contract of personal nature involved the personal creditworthiness of the buyer even in the case of the mode of payment, which was not capable of being assigned. This was held in the case of SAIL vs State of MP in which the central government assigned a piece of land to its own corporate undertaking with rights, liberties and privileges, one of which was the exemption from tax. The court rules that the assignee became entitled to the exemption as the successor.

Unilateral cancellation of the sale deed

It is not possible for the vendor to make a deed of cancellation of the sale deed made, even if the ground is full of consideration was not received by the vendor. Such a deed would result in the revocation of the contract and would require the order of the court. Moreover, a deed of cancellation of a sale unilaterally executed by the transferor does not create, assign, limit or extinguish any right, title or interest in the property and is of no effect. Hence such a deed could not be accepted for registration.

Effect and formalities of assignment

Consideration 

The assignment requires some form of consideration from the assignor to the assignee. In the absence of any consideration between them, the assignment will be revocable. But when an assignment is made by way of gift, by following all the essential conditions of a gift, then it can not be revoked. In order to make a voluntary settlement valid, the settlor must do everything, which according to the nature of the property was necessary to do in order to transfer the property.

Subject to equities 

The title of the assignee is subject to all the equities that exist or arise up to the time when the notice of assignment is given to the debtor. (for instance, A is the assignor, B is the assignee and C is the debtor).The assignee would not be affected by the equity of personal nature between the assignor and the assignee. For example, the right to claim damages for the fraud committed by the assignor cannot be used to defeat the right of the assignee. 

Notice of assignment 

Notice of assignment should be given to the debtor. This is very useful as it binds the debtor. If the notice is not given then the debtor could make the payment of the assignor himself and will get discharged. Moreover, if notice is given then the assignment would not be affected by any equity that may arise. Moreover, if the notice is paid to the assignor who has many assignments then, in that case, the notice is given to him at that point of time, then that assignment will have priority over others even if it was received later.

Discharge by agreement

Discharge of a contract means to end a contract. Discharge of the contract can take place through:

  • By Performance;
  • By agreement or by consent;
  • By promise failing to offer facilities for performance;
  • By breach of contract;
  • By impossibility of performance;
  • By death;
  • By refusing tender of performance;
  • By unauthorized material alteration of the contract;
  • Discharge by lapse of time;
  • By operation of law.

The parties to a contract are free to alter or rescind the entire term of the contract. Novation or modification can happen in the same manner as that of the conclusion of the contract. If one party proposes a novation and the other party accepts it but in a qualified manner, then it will not amount to novation. A mutual abandonment, cancellation, or rescission must be clearly expressed. Novation or modification is effected only when all the parties agree to it. The substituted contract need to be enforceable just like the original contract. In case the new contract is not enforceable then the original contract would be operative. In such cases, the consideration would be the release of the existing contract for a promise to undertake a new contract. 

Contracts which need not be performed 

Under Section 62 of the Indian Contract Act, 1872, it is given that if the parties to a contract agree to substitute a new contract for the earlier contract or rescind it all together then the original contract need not be performed.

Novation 

The word “novation” is not used in the section per se but is present in the marginal notes. It is defined that a contract that is already in existence is substituted by a new contract and the consideration mutually discharged of the old debt. The outline principle of novation is “discharge of one debt or debtor and substitution of one debt or debtor”. Novation cannot be done unilaterally, it has to be with the consent of both the parties. Novation is the complete substitution of the old contract with the new contract and not mere variation in the terms of the original contract. Novation would come into effect when the terms of the new contract are so inconsistent with the former, that it is impossible to perform the former. In the case of Vishram Arjun vs Irakulla Shankaraiha, the court held that the essence of novation does not lie in the complete dissimilarity of the terms but in the intention of the parties to substitute the original contract with the new one. 

A common instance of the novation of the contract is in the case of a partnership where on the dissolution if some partners continue to do business and undertake between themselves and the retiring partner that they will assume and discharge the liabilities of the business. They give this notice to the creditor and if he gives his asset to it then a contract and a new firm is formed.

Hence novation of a contract is of two kinds:

  • Novation involving a change of the party.
  • Novation involving the substitution of a new contract in place of the old.

A novation usually takes place:

  • When a new partner is admitted,
  • When a partner retires,
  • The new firm is constituted after the admission or retirement and it accepts the liabilities of the old firm.

Change of parties 

The substituted contract would subsist between the parties of the original contract. The novation cannot be forced on a party. It has to be considered in every case not only whether the new debtor has accepted the liability but also if the creditor has agreed to accept his liabilities in substitution of the original debtor. The discharge of the original debtor must precede and is distinct from the acceptance of the creditor. The statutory novation is usually comprised in a single statue or decree of practical purposes, they function simultaneously but has a distinct legal identity of its own. 

Substitution of a new agreement

If A is a debtor, and the creditor agrees to accept B in the place of A as a debtor, then the previous contract between A and the creditor comes to an end.

For the novation of the contract, the original contract must be substituted by a new contract and the original contract is now discharged and need not be performed. It is important that the original contract must be subsisting and unbroken. The substitution of the contract can not take place if the original contract is breached.

In the case of Koyal vs Thakur Das Naskar, the plaintiff sued to recover a sum owed to the defendant. After the due date, the plaintiff agreed to accept a particular amount in cash and the rest by way of the bond, which was to be paid on the installment basis. However, the defendant neither paid the bond nor the cash. The plaintiff subsequently sued him for the original bond. The court held that the original bond is discharged by the breach and not by novation, hence the plaintiff has to sue on the basis of breach of contract.

The Supreme Court in Lata Construction vs Rameshchandra Ramniklal stated that one of the essential conditions of the novation of the contract is that there should be a complete substitution of the new contract in place of the earlier contract. In this situation, the original contract need not be performed. Substitution of the new contract in place of the old which would have the effect of completely rescinding or altering the terms of the original contract has to be an agreement between the parties. The substituted contract should extinguish the previous contract. 

It is further necessary that the new agreement should be valid and enforceable. Thus where an existing mortgage is replaced by a new agreement of mortgage and the new agreement is not enforceable because of lack of registration, in this case, it is held that the original contract is still functional.

It is obvious that the presence of consideration in these cases is mandatory, as unilateral alteration of terms is permissible. The promise of a fresh contract in place of the original one is also a sufficient consideration in these cases. 

Effect of Novation

After a novation, when a new contract is enforceable, then the relationship between the parties would be governed by the new contract and the obligor will be relieved of all his pre obligations. The substituted agreement gives rise to a cause of action and limitation would be counted on the basis of a new promise. Where the parties release each other from the mutual obligation of each other, then at that point of time at which such settlement was made would be the time at which the contract terminates.

No Novation

However, where the parties had the option to terminate the contract and the parties by subsequent contract postponed the termination of the contract, then this will not amount to novation of a contract. Even if the terms of the old contract are kept alive, even then, it would not amount to proper substitution and hence no novation will take place. It is important to note that if in the original contract the provision of arbitration is present then the novation of the contract will have no effect on the arbitration clause and it would not get discharged.

There would be no novation where the contract itself contains a provision for the payment by one party of the enhanced rates dependent upon a contingency. Moreover, to secure a debt by a deed, which will operate only as a mortgage and would not replace the existing personal liability, then such is not a novation of a contract.

Formality

A subsequent contract substituting the original contract or rescinding it or altering it, may be oral or written or even be implied from the conduct of the parties. Section 92 of the Indian Evidence Act 1872, excludes the oral evidence from the purpose of varying, adding or subtracting from the terms of the contract or any matter required by law to be in writing. However, the proviso four of that section provides that the existence of any distinct subsequent oral agreement to rescind or modify such contract, grant or disposition of property may be proved. But where the original contract is of such a nature as that the law requires to be in writing or where its execution has been followed by registration, the only way of proving the modification the original contract will be by proof of an agreement with a like formality.

What do a novation contract consist of?

Release Clause

It is important that a clause in the novation deed outlines the discharge of both rights and obligations from the outgoing party. It is important to ensure that the clause is clear and concise so that there is no scope for confusion.

Representations and Warranty Provisions

The deed should also outline that both the outgoing and continuing party have the full legal capacity to proceed with business, including relevant authorisation. It should also evidence that both parties have taken all actions to the best of their abilities to finalise the novation deed.

Insurance/Indemnity Clause

If one is the incoming third party, he or she may want to have an indemnity clause. This can protect him or her from being liable for the work completed before the novation date. This again can help to reduce the chances of a conflict.

Costs

For various transactions like novated leases etc., parties should calculate and include the agreed costs.

Conclusion 

Under the appropriation of a contract, the debtor has the first right to intimate appropriation of a debt at the time of payment if he fails to exercise his right, this right then goes on the creditor and if the creditor also fails to exercise his right the appropriation will be done in order of time by the law itself. In case of debts of equal standing, each will be appropriated proportionately. 

The discharge of the contract involves the novation of the contract. In novation, the whole contract is substituted by a new contract. This substitution takes place mutually by both parties. The parties could communicate their opinions expressly or it could be implied due to the circumstances.

References 


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