Appropriation of Payments and Contracts Which need Not Be Performed | Indian Contract Act, 1872

Once a contract has been entered into, the parties are generally required to perform their respective promises. However, the law also recognises certain situations where the original contractual obligation may be adjusted, modified, discharged, or brought to an end.

Sections 59 to 67 of the Indian Contract Act, 1872 deal with important situations relating to appropriation of payments, novation, rescission, alteration, remission, restoration of benefits, communication of rescission, and the effect of neglect by the promisee.

Appropriation of Payments [Sections 59 to 61]

Sometimes, a debtor owes several distinct debts to the same creditor and makes a payment which is not sufficient to discharge all the debts. The question then arises: against which debt should the payment be adjusted?

Sections 59 to 61 lay down three rules:

1. Appropriation by the debtor (Section 59)
2. Appropriation by the creditor (Section 60)
3. Appropriation by law (Section 61)

1. Application of Payment Where Debt to Be Discharged Is Indicated [Section 59]

Section 59 provides that where a debtor, owing several distinct debts to one person, makes a payment with express intimation, or under circumstances implying, that the payment is to be applied towards a particular debt, the payment, if accepted, must be applied accordingly. Thus, the first right of appropriation belongs to the debtor.

The debtor may indicate the particular debt either:

• expressly, by communicating his intention; or
• impliedly, from the circumstances in which the payment is made.

If the creditor does not wish to accept the payment subject to the debtor’s appropriation, he may refuse to accept the payment.

Example

A owes B several debts, including ₹1,000 under a promissory note which falls due on 1 June. A owes B no other debt of ₹1,000. On 1 June, A pays B ₹1,000. The payment will be applied towards the discharge of the promissory note.

Note: - Section 59 applies where there are several distinct debts. It does not apply merely because a single debt is payable by instalments.

2. Application of Payment Where Debt to Be Discharged Is Not Indicated [Section 60]

Where the debtor:

• makes a payment,
• does not indicate the debt against which it is to be appropriated, and
• there are no circumstances indicating such intention,

the creditor gets the right of appropriation.

The creditor may apply the payment, at his discretion, to any lawful debt actually due and payable by the debtor.

Such debt may be:

• presently recoverable; or
• even a time-barred debt.

However, the creditor cannot appropriate the payment towards an illegal or void debt.

Example

A owes B ₹10,000, ₹15,000 and ₹20,000 under three separate debts. A pays B ₹10,000 without specifying against which debt the payment is to be adjusted. B may appropriate the ₹10,000 towards any lawful debt actually due and payable to him.

Payment Towards Interest and Principal

Where a debt carries interest and the debtor makes a payment without specifying its appropriation, the normal rule is that the payment is first applied towards interest and thereafter towards the principal, subject to any agreement to the contrary. [Meghraj v. Bayabai, AIR 1970 SC 161].

3. Application of Payment Where Neither Party Appropriates [Section 61]

Section 61 applies where neither the debtor nor the creditor makes any appropriation. In such a case, the law itself determines the appropriation. The payment is applied:

• first to the oldest debt, according to the order of time in which the debts were incurred;
• this applies even if the debt is time-barred;
• if the debts are of equal standing, the payment is applied proportionately among them.

Contracts Which Need Not Be Performed [Section 62-67]

Effect of Novation, Rescission, and Alteration of Contract [Section 62]

Section 62 deals with the discharge of a contract by mutual agreement through:

• Novation
• Rescission
• Alteration

Section 62 provides:

“If the parties to a contract agree to substitute a new contract for it, or to rescind or alter it, the original contract need not be performed.”

The basic principle is that the parties who have created contractual obligations may, by mutual agreement, modify or bring those obligations to an end.

1. Novation

Novation means the substitution of an existing contract by a new contract. When novation takes place:

• the old contract is discharged;
• the parties become bound by the new contract; and
• the original contract need not be performed.

Novation can take place between the same parties, by substantially changing the terms; or by a change in parties, where a new person is substituted for an existing contracting party.

Example

A owes B ₹1,00,000. A, B and C agree that C will pay B ₹1,00,000 and B will accept C as his debtor instead of A. A’s liability to B comes to an end, and the old contract is substituted by the new contract between B and C.

Essentials of Novation

For novation:

• there must be a valid existing contract;
• the parties must agree to substitute a new contract;
• the consent of the parties concerned is necessary; and
• the new agreement must itself be valid and enforceable.

Where novation is by substitution of a new contract, the original contract must generally be subsisting and unbroken. A new contract cannot ordinarily be substituted for an agreement after its breach merely by treating the substitution as novation. Further, where the new agreement itself is invalid or unenforceable, the original contract may continue to bind the parties.

Case: Shanker Lal Damodhar v. Ambalal Ajaipal, AIR 1964 Nag 260

In this case, the Nagpur High Court established that a valid novation under Section 62 of the Indian Contract Act requires a legally enforceable substitute contract. Because the attempted replacement agreement was legally defective due to non-registration, it failed to extinguish the original mortgage deed, leaving the original obligations fully valid and binding.

Case: Union of India v. Kishori Lal Gupta & Bros., AIR 1953 Cal 642

In this case, the Supreme Court of India ruled that a wholesale novation under Section 62 of the Indian Contract Act entirely extinguishes the original agreement along with any arbitration clauses contained inside it. The Court held that when a subsequent settlement contract unconditionally substitutes and completely obliterates the original agreements, the prior contracts legally perish, thereby rendering any embedded arbitration clauses null and void.

2. Rescission of Contract

Rescission means cancellation of the contract. Where the parties mutually agree that the existing contract shall no longer bind them, the contract is rescinded. In rescission, the original contract is cancelled; and no new contract is substituted in its place.

For example, A agrees to sell certain goods to B. Before performance, A and B mutually agree that the contract shall no longer bind them. The original contract is rescinded and need not be performed.

3. Alteration of Contract

Alteration means a change in one or more material terms of an existing contract by mutual agreement of the parties. In alteration, the parties remain the same; but one or more terms of the contract are changed.

Novation vs. Alteration

The distinction can sometimes be narrow because substantial alteration of the terms may itself amount to novation.

Remission of Performance [Section 63]

Section 63 provides:

“Every promisee may dispense with or remit, wholly or in part, the performance of the promise made to him, or may extend the time for such performance, or may accept instead of it any satisfaction which he thinks fit.”

Thus, the promisee has the right to:

• dispense with or remit performance, wholly or partly;
• extend the time for performance; or
• accept any other satisfaction instead of actual performance.

An important feature of Section 63 is that consideration is not necessary for remission by the promisee.

1. Dispensing With or Remitting Performance

To dispense with performance means to waive or abandon the right to demand performance. The promisee may completely waive performance or accept a lesser performance in full satisfaction.

Examples:

1. A promises to paint a picture for B. B subsequently forbids A from painting the picture. A is no longer bound to perform the promise.
2. A owes B ₹5,000. B accepts ₹2,000 in full satisfaction of the entire debt. The whole debt is discharged. Therefore, acceptance of a lesser sum in satisfaction of the whole debt is valid under Section 63.

The promisee may also accept performance from a third person. Once such performance is accepted in satisfaction of the claim, the promisor is discharged to that extent or as agreed.

2. Extension of Time for Performance

Section 63 permits the promisee to extend the time for performance. No fresh consideration is required merely for granting such extension. However, the extension must be based upon the understanding of the parties; a unilateral communication which is not accepted or acted upon does not necessarily amount to an effective extension.

• Case: M/s Venkateswara Minerals v. Jugalkishore (1986) - In this case, it was held that where the promisee grants an extension of time, he becomes bound by that extension.

3. Accord and Satisfaction

Section 63 also permits the promisee to accept any other satisfaction instead of the agreed performance. This is commonly described as the principle of accord and satisfaction.

• Accord means the agreement to accept something different from the original performance.
• Satisfaction means the actual performance of the substituted obligation.

Example

A owes B ₹50,000. B agrees to accept A’s house in full satisfaction of the debt. If B accepts the house in satisfaction, the original monetary obligation is discharged. Similarly, where the amount of a debt has not been ascertained, the promisee may accept a particular sum in full satisfaction of the debt.

Waiver of Contractual Rights

Waiver means the intentional abandonment of a known contractual right. A party may waive a contractual right by words or conduct, but the intention to waive must be clearly established.

The Supreme Court has emphasised the need for clear evidence of waiver. [Case: Sham Singh v. State of Mysore, AIR 1972 SC 2440]

Restoration of Benefit Under a Voidable Contract [Section 64]

Section 64 deals with the consequences of rescission of a voidable contract. When a person at whose option a contract is voidable rescinds it:

• the other party need not perform the promise in which he is the promisor; and
• the party rescinding the contract must restore any benefit received under the contract, so far as may be, to the person from whom it was received.

Example

Suppose a person rescinds a loan agreement on the ground of undue influence after receiving the loan amount. The person must restore the amount received, subject to the applicable legal principles.

Obligation to Restore Advantage Under a Void Agreement or A Contract That Becomes Void [Section 65]

Section 65 provides:

“When an agreement is discovered to be void, or when a contract becomes void, any person who has received any advantage under such agreement or contract is bound to restore it, or to make compensation for it to the person from whom he received it.”

Section 65 therefore deals with restitution.

The provision covers two situations:

1. an agreement is subsequently discovered to be void; or
2. a contract which was initially valid becomes void.

The person who has received an advantage must restore it or make compensation for it.

1. Agreement Discovered to Be Void

An agreement may appear valid initially but later be discovered to be void.

• For example, A pays B ₹1,000 in consideration of B promising to marry C, A’s daughter. C is already dead at the time of the promise. The agreement is void, but B must repay ₹1,000 to A.

2. Contract Becomes Void

A contract may be valid when made but subsequently become void because its performance becomes impossible or unlawful. In such a case, any benefit received under the contract may have to be restored.

• For example, A contracts to sing for B at a concert for ₹1,000, which B pays in advance. A becomes too ill to sing. A is not bound to compensate B for the loss of profits B would have made if A had been able to sing, but A must refund the ₹1,000 received in advance.

The benefit to be restored must be a benefit received under the agreement or contract.  For example, a deposit given as security for performance may stand on a different footing from an advance payment made as consideration under the contract.

Case: Faqir Chand Seth v. Dambarudhar Bania, AIR 1987 Ori 50

An advance was made for the supply of paddy, but the agreement was discovered to be void because it violated the applicable law. The advance was held refundable. Thus, Section 65 may apply where the parties were unaware, at the time of entering into the agreement, that it was void.

Communication of Rescission [Section 66]

Section 66 provides that the rescission of a voidable contract may be:

• communicated, or
• revoked

in the same manner and subject to the same rules as apply to the communication or revocation of a proposal. Thus, rescission must be properly communicated to the other party. The usual method is to give notice of the intention to rescind. Where direct communication is not possible, communication may, depending upon the circumstances, be made through an appropriate public notice or other legally recognised means.

Effect of Neglect of Promisee to Afford Reasonable Facilities [Section 67]

Section 67 provides:

“If any promisee neglects or refuses to afford the promisor reasonable facilities for the performance of his promise, the promisor is excused by such neglect or refusal as to any non-performance caused thereby.”

Thus, a promisee cannot prevent or obstruct performance and then hold the promisor responsible for the resulting non-performance. The promisor is excused to the extent that the non-performance is caused by the promisee’s neglect or refusal.

For example, A contracts with B to repair B’s house. B neglects or refuses to point out to A the places in which the house requires repair. A is excused for the non-performance caused by B’s neglect or refusal.