Rule In Clayton’s Case - Claims management during CIRP.

Rule In Clayton’s Case - Claims management during CIRP.

Rule In Clayton’s Case - Claims management during CIRP.
This rule, which was laid down in the famous case, Devayanas Vs. Noble by an English Court in 1816, states the rule of appropriation in running accounts like cash credit and overdraft accounts. As per this rule, each withdrawal in a cash credit account is considered as a new loan and each deposit as a repayment of the loan in the order in which it is made. The first debit in the account is considered to have been discharged or reduced by the first item in the credit side and accordingly other entries follow suit in chronological order.

It is to avoid application of this rule, the bankers stop operation of the account in case of death / insolvency of a partner / guarantor / joint account holder.

Section 61 of the Indian Contract Act, 1872 states that, “Where neither party makes any appropriation, the payment shall be applied in discharge of the debts in order of time, whether they are or are not barred by the law in force for the time being as to the limitation of suits. If the debts are of equal standing, the payment shall be applied in discharge of each proportionally”.

In Indian context, the ratio laid down in Clayton’s case has been approved in the case of Gurpreet Singh v. Union of India [Civil Appeal 4570 of 2006] by Hon’ble Supreme Court of India’

Clayton’s Case.
“Mr Clayton had an account with a banking firm, a partnership named Devaynes, Dawes, Noble, and Co. One of the partners, William Devaynes, died.
The amount then due to Clayton was £1,717.
The surviving partners, thereafter paid out to Mr Clayton more than that amount while Clayton himself, on his part, made further deposits with the firm.
The banking firm subsequently went bankrupt. And Mr Clayton also claimed the money.
Sir William Grant Master of the Rolls, in Devaynes v Noble [(1816) 35 ER 781] 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 partner’s death.”

From Clayton's case the following rules are derived -
(1) A debtor making a payment has a right to appropriate it to the discharge of any debt due to the creditor,
(2) if at the time of payment there is no express or implied appropriation thereof by the debtor, then the creditor has a right to make the appropriation;
(3) in the absence of any appropriation by either debtor or creditor, an appropriation is made by presumption of law, according to the items of account, the first item on the debit side being the item discharged or reduced by the first item on the credit side.

The Earl of Selborne, L.C., in In re Sherry, London and County Banking Company v. Terry (1884, 25 Ch. D. 692), said:
  • "The principle of Clayton's case, and of the other cases which deal with the same subject, is this, that where a creditor having a right to appropriate moneys paid to him generally, and not specifically appropriated by the person paying them, carries them into a particular account kept in his books, he prima facie appropriates them to that account, and the effect of that is, that the payments are de facto appropriated according to the priority in order of the entries on the one side and on the other of that account.

A situation may arise that Insolvency proceedings have been initiated against the CD by some operational / financial creditor (FC) , whereas the CD is a corporate guarantor (CG) of the accounts of some other company (CD-2) with the (same or other) financial creditor (FC-2). The accounts (cash credit or overdraft) of CD-2, with the financial creditor are operational. In such a situation, the Creditor (FC-2's) claim against corporate guarantor (CD/CG), gets fixed on the date of commencement of insolvency of the CD [section 5(8)(i)]. Thus with the operation of “Rule in Clayton’s case” the liability of the corporate debtor/guarantor (CD/CG) will continue to get reduced by the amount of credits in the accounts (cash credit or overdraft) of the CD-2 with the financial creditor after the date of commencement of insolvency of the CD.

Now let’s look at the provisions of the Code for the definition of “Claim” & “Financial Debt” with related case law.

# Section 3. Definitions.-
(6) “claim” means –
  • (a) a right to payment, whether or not such right is reduced to judgment, fixed, disputed, undisputed, legal, equitable, secured, or unsecured;
  • (b) right to remedy for breach of contract under any law for the time being in force, if such breach gives rise to a right to payment, whether or not such right is reduced to judgment, fixed, matured, unmatured, disputed, undisputed, secured or unsecured;

# Section 5. Definitions. -
(8) “financial debt” means a debt alongwith interest, if any, which is disbursed against the consideration for the time value of money and includes–
  • (h) any counter-indemnity obligation in respect of a guarantee, indemnity, bond, documentary letter of credit or any other instrument issued by a bank or financial institution;
  • (i) the amount of any liability in respect of any of the guarantee or indemnity for any of the items referred to in sub-clause (a) to (h) of this clause;

Filing Claim in Corporate Guarantor’s Insolvency (Creditor’s double dip)
NCLT (PB) New Delhi, (23.01.2018) in the matter of ICICI Bank V/s CA Ritu Rastogi,[ CA 366 (PB)/2017 and (IB)-102(PB)/2017]. In another matter, CIRP were going on against the principal debtor as well as the guarantor separately. ICICI Bank filed its claim with RP of the principal debtor as well as with the RP of the guarantor (both). RP of the guarantor rejected the claim of ICICI since the same had already been admitted by RP of the principal debtor and if such claim is admitted then the recovery amount may exceed the total claimed amount of ICICI which may be prejudicial to others. However, NCLT allowed the said claim since it falls within the definition of financial debt and RP is not allowed to raise objection contrary to the provisions of the guarantee agreement.

Filing Claim in Corporate Guarantor’s Insolvency. (Maturity of claim - invocation of guarantee)
The question here was whether a creditor can file a claim in the CIRP of Corporate Guarantor, without invoking guarantee, in other words when the claim has not matured. It was held that maturity of claim or default of claim or invocation of guarantee for claiming the amount has no nexus with filing of claim, pursuant to public announcement made under Section 13(1)(b) r/w Section 15(1)(c) or for collating the claim under Section 18(1)(b) or for updating claim under Section 25(2)(e).

NCLAT (13.07.2018) in Andhra Bank Vs. M/s. F.M Hammerle Textiles Ltd. [Company Appeal (AT) (Insolvency) No.61 of 2018], Facts of the case - IRP rejected claims of the bank since the same were not matured at the time of commencement of CIRP against the CD. Thereafter, NCLT reaffirmed the decision of IRP. In appeal, the NCLAT held that any person, who has a right to claim payment under Section 3(6) of IBC, can file its claim irrespective of the fact whether the same is matured or not at the time of commencement of CIRP & held as under:-
  • # 9. It is not necessary that all the claims are submitted by the Creditor should be a claim matured on the date of initiation of Resolution Process / admission, even in respect of debt, which is due in future on its maturity, the ‘Financial Creditor’ or ‘Operational Creditor’ or ‘Secured Creditor’ or ‘Unsecured Creditor’ can file such claim. Therefore, the definition of ‘Claim’ as defined under Section 3(6) is to be read along with Section 13 read with Section 15 of the ‘I&B Code’.

NCLAT (14.08.2018) In Export Import Bank of India and Ors. Vs. RP JEKPL Pvt. Ltd. and Ors. [CA No. 304 of 2017, 16 of 2018 and 302 of 2017] Facts of the case - JEKPL had given counter corporate guarantee in favour of EXIM Bank, which invoked guarantee on 30 March, 2017. The RP rejected to consider EXIM Bank as a FC in the CIRP of JEKPL. The AA vide order dated 27 November, 2017 affirmed the decision of the RP.
The NCLAT held that default of debt has nothing to do with the claim of a person. It observed:
  • # 53 ……….. Any person who has the right to claim payment, as defined under Section 3(6), is supposed to file the claim whether matured or unmatured. The question as to whether there is a default or not is not to be seen.”
  • # 54. Therefore, stand taken by the respondents that the claim has not been matured cannot be ground to reject the claim.
  • # 55……………The matter can be looked from another angle. It is only in case of ‘debt’ and ‘default’, a ‘Financial Creditor’ or ‘Operational Creditor’, may file applications under Section 7 or 9. The ‘Corporate Applicant’ has also right to file an application under Section 10 for initiation of Corporate Insolvency Resolution Process against itself, if it has defaulted to pay the ‘debt’. It does not mean that the persons whose debt has not been matured cannot file claim. The ‘Financial Creditors’ or ‘Operational Creditors’ or ‘secured or unsecured creditors’ all are entitled to file claim.
  • # 56. Therefore, we hold that maturity of claim or default of claim or invocation of guarantee for claiming the amount has no nexus with filing of claim pursuant to public announcement made under Section 13(1)(b) r/w Section 15(1)(c) or for collating the claim under Section 18(1)(b) or for updating claim under Section 25(2)(e)

Corollary; Thus the IRP/RP while admitting the claim of a financial creditor, where “ Rule in Clayton’s Case” is operational, must flag the claim amount for re-verification, to account for the credits in the operational accounts of the principal borrower, at the time of settlement of the claim.

References;-
1. Insolvency and Bankruptcy Code, 2016.
2. Indian Contract Act, 1872.
3. eBook "Claims of Creditors" by Arvind Mangla, a publication of Amazon Kindle Store.

Disclaimer: The sole purpose of this blog is to create awareness on the subject and must not be used as a guide for taking or recommending any action or decision. A reader must do his own research and seek professional advice if he intends to take any action or decision in the matters covered in this blog.
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Arvind Mangla
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