Must a creditor obey debtor’s direction as to which of several debts a payment is to be put towards?

(Amended on 31 May 2012) Except that I had a feeling creditors were obliged to apply debtors’ payments to the oldest outstanding debt, I have never known until recently what the law was exactly in relation to a creditor’s obligations and entitlements where a debtor makes a payment which could be applied to one of several debts.  I suspect many lawyers are in the same situation. Experience teaches that allocations of payments against debts can have many ramifications, the most obvious of which are in relation to interest, and the application of statutes of limitations.  This statement was recently re-stated as good law in Victoria:

‘When a debtor is making a payment to his creditor he may appropriate the money as he pleases, and the creditor must apply it accordingly. If the debtor does not make any appropriation at the time when he makes the payment the right of application devolves on the creditor.’

It is a statement of Lord McNaughten in Cory Brothers & Company v Owners of Turkish Steamship ‘Mecca’ [1897] AC 286 at 293 and Deeley v Lloyds Bank Limited [1912] AC 756, 783 is apparently to like effect.  In response to the original version of this post, two readers, fellow barrister blogger in Melbourne Paul Duggan and Brian Lambert of Brisbane’s Birch & Co, alerted me to an additional proposition, being the one I had had a vague undertanding of.  Namely that where neither creditor nor debtor makes any conscious appropriation (as will frequently be the case), the default position is that the payment will be applied to the oldest debts first: Devaynes v Noble (‘Clayton’s Case‘) (1816) 1 Mer 572.

The rule was re-asserted by Mason CJ and Dawson, Toohey and Gaudron JJ in Sibbles v Highfern Pty Ltd (1987) 164 CLR 214; [1987] HCA 66 at [11], and was neatly summarised by Lockhart J in Re Walsh; Ex Parte: Deputy Commissioner of Taxation (1982) 60 FLR 355; [1982] FCA 88 in a passage which also explains what is meant by the debtor making an appropriation. His Honour said:

‘A debtor who owes two debts to a creditor is entitled to appropriate a payment which he makes to his creditor to one debt rather than to the other. If he omits to do so, the creditor may make the appropriation. If neither makes any appropriation, the law appropriates the payment to the earlier debt. If there is specific appropriation by the debtor cadit quaestio. In the absence of a specific appropriation it is a question of fact whether there was any appropriation by the debtor. To constitute an appropriation there must be more than an intention to appropriate by the debtor. I respectfully adopt the following passage from the judgment of Greene L.J. in Leeson v. Leeson (1936) 2 K.B. 156 at pp. 162-163:-

“When, however, he does not notify the creditor of his intention, and when the circumstances are such that the creditor receives the payment merely in satisfaction of the debts and the payment is not more appropriate to the payment of the one debt than to that of the other the creditor is entitled to make the appropriation. When it is said that there need not be an express appropriation of a payment, but that the appropriation can be inferred, that does not mean that appropriation of a payment can be inferred from some undisclosed intention in the mind of the debtor. It is to be inferred from the circumstances of the case as known to both parties. Any other view might lead to injustice, as the creditor’s right to appropriate a payment would be defeated. When the matter is examined upon principle it will be found that an undisclosed intention in the mind of the debtor is not sufficient to support an appropriation. If authority is needed for that proposition it can be found in the judgment of Lush J. in Parker v. Guinness 27 Times L.R. 129, 130 where he said: ‘What is to be considered is this. Is the true inference to be drawn from all the circumstances of the case that the debtor paid the moneys generally on account, leaving the creditor to apply them as he thought fit, or is the true inference that he paid them on account of special portions of the debt for the purpose and with a view to wipe these out of the account? His undisclosed intention so to do would, of course, not benefit him. It is what he did in fact, and not what he meant to do that is to be regarded.’ A debtor’s undisclosed intention to appropriate a payment to one of two debts owed by him to a creditor cannot benefit him.”‘