S.Y. B.

Com (Sem- III)

Banking Law & Practice
Dr. Richu M. Juneja
Definition of a Banker by Sir John Paget
“That no person or body corporate or otherwise can be a banker who does
not,
i. take deposit accounts,
ii. take current accounts,
iii. issue and pay cheques,and
iv. collect cheques crossed and uncrossed for his customers.”

Sir Paget further adorns his definition by adding that, “one claiming to be a
banker must profess himself to be a full time banker and the public must
accept him as such and his main business must be that of banking from
which, generally, he should be able to earn his living”.
Definition of a Customer by Sir John
Paget
“To constitute a customer, there must be some recognisable course or habit
of dealing in the nature of regular banking business”.
This definition lays emphasis on the duration of the dealings between the
banker and the customer and is, therefore, called the “Duration Theory”.

According to the new view, following points must be considered to be called

as a Customer:
i. A person who has an account in a bank in his own name and for whom a
banker undertakes to provide facilities as a banker, is considered to be a
customer.
ii. Secondly, the dealings between a banker and a customer must be related
to the business of banking.
iii. A customer of a bank need not necessarily be a person, i.e. A firm, joint-
stock company, a society or any separate legal unit may be a customer.
Main Characteristics of Banker-Customer
Relationship

Characteristics of Banker-Customer
Relationship

General Special
Characteristics characteristics
1) Debtor and Creditor Relation
 A banker when deals with his customer, is primarily in the position of a
debtor to his creditor.
 The depositor is only a creditor, and there is no entrustment to the bank for
any particular purpose.
 The bank is liable to refund the money when demanded.
 Unless demanded, bank is entitled to use the money as it likes.

“A Banker is a Privileged Debtor and a Customer is an Unsecured

Creditor.”
 The customer remains a creditor upto the time there is a balance to his
credit.
 The moment customer has overdrawn from the account, the bank will
become a creditor and the customer is a debtor.

But, there is a difference between the banker-customer relationship and the

ordinary commercial debtor-creditor relationship.
 Banker’s Debt Vs. Ordinary Commercial Debt
Sr. No. Banker’s Debt Ordinary Commercial Debt
1. Banker is a privileged debtor The ordinary commercial debtor’s
because a creditor has to demand duty is to seek out the creditor and
for payment to the banker. pay the money.
2. This demand must be made at the The debtor can pay the money to the
branch where he has opened an creditor at any place.
account.
3. The demand for repayment of a Time is not essential element in this
banker’s debt should be made only commercial debt.
during the specified banking hours
of business.
4. The banker is able to get the This is not possible for an ordinary
deposit money without giving any debtor.
security to the customer. (i.e. He is
a dignified borrower.)
5. Banker cannot close the account of An ordinary debtor can close the
his creditor at any time without account of his creditor at anytime.
getting his prior approval.
2) Banker’s Right of Set-Off
 The right of set-off means combining of two or more accounts (say
overdraft and fixed deposit), one of which is in debt and the other in credit
(in the same branch or in a different branch) subject to certain conditions.
 A banker like other debtors, possess the right of set-off which enables him
to combine two accounts in the name of same customer and adjust the
debit balance in the account with the credit balance in the other.
Example,
Suppose A has taken an overdraft from his banker to the extent of Rs
9,000 and he has credit balance of Rs 7000 in his savings bank account.
The bank can combine both of these accounts and claims the remainder
amount of Rs 2000 only.

 This right of set-off can be exercised by the bank if there is no agreement

contrary to this right and afterwards a notice is served on customer,
intimating the customer about the banker’s intention to exercise right of
set-off.
 Points to be Remembered for a Banker to Exercise the
Right of Set-off
1) The right can be exercised only after sending a prior notice to the customer.
2) The accounts to be set-off must be in the same name.
3) The accounts must be in the same capacity/right. Example, The personal
account and the account as partner are the account in different capacities and
hence cannot be combined.
4) The amount of debts must be certain.
5) The right may also be exercised in the absence of an agreement to the contrary.
6) The right of set-off can be exercised in respect of debts due and not in respect
of future debts.
Example, If a loan given to a customer is repayable on demand or at a future
date the debt becomes due only when the banker make a demand or on the
specified date and not earlier.
7) The banker may exercise this right at his discretion. Customer cannot compel
or pursue the banker to exercise the right and to pay the credit balance at
another branch.
8) The banker has right to exercise this right before the garnishee order is made
effective for the lawful debt which is due.
3) Banker is Not Simply a Trustee of the Money
of the Customer
Banker acts as a trustee in certain cases, while in certain cases it is not a
trustee but a debtor.
Example, When bank accepts securities and valuables from a customer for
safe custody, the position of the banker is that of a trustee and he is liable to
return them to customer when demanded. But when bank accepts deposits
in the customer’s account it becomes a debtor and ceases to be a trustee.
Thus, banker is not simply a trustee of the money of the customer.

4) Banker as an Agent of the Customer

In the business of banking, bank act as an agent of the customer and
provides many services such as:
i. Buying and selling securities on customer’s behalf.
ii. Collection of cheques, dividends, interest and bills on customer’s
behalf.
iii. Acting as a trustee, attorney, executor or representative of a customer.
In such situations banker is an agent and customer is a principal.
5) Banker as a Bailee
 A banker becomes a bailee when he receives gold, ornaments and
important documents for safe custody.
 Here, bank does not get the ownership of the articles and so cannot make
use of them and he is bound to return the identical articles on demand.
 Bank does not allow any interest on the articles kept in custody of the
bank.
 Moreover, customer has to pay rent for the lockers provided by banks.
 Banker acts as a bailee when he receives articles for safe custody and not
when he receives money on deposit account.

 Here, Banker is a “Bailee” and the Customer who handovers the items
to the banker for security is known as “Bailor”.
 The agreement made between a bailee and a bailor is known as
“Bailment”.
6) On Collecting the Deposit Banker can Lend and
Invest
 As per the bank rules, depositors are given interest on their deposits,
looking to the duration of the deposits.
 When the deposits has been made for a fixed period, the banker can
use the deposited money to give loans to individuals, companies, and
others as per his discretion, at a rate of interest which is higher than
the interests given to the depositors.
 This difference of interest becomes the earning of the bank or the
banker.
1) Banker’s Obligation to Honour Cheques
 The deposits from the customers are accepted by a banker and these
deposits are liabilities repayable on demand or otherwise.
 The banker is under a statutory obligation to honour his customer’s
cheques whenever they are presented by self or the bearer.

As per Section 31 of the Negotiable Instruments Act, 1881, it is said

that “The drawee of a cheque having sufficient funds of the drawer in
his hands, properly applicable to the payment of such cheques must
pay the cheque when duly required to do so and in default such
payment must compensate the drawer for any loss or damage caused
by such default.”
The Banker is Bound to Honour his Customer’s Cheques
Provided the Following Conditions are Fulfilled

Conditions to be Fulfilled for

Honouring Cheques
Sufficient Cheque
Cheque Cheque Cheque
funds of should be
should be should be should be
the Cheque written
presented presented honoured
drawer in should be only after
at a at a upto the
the hands written the
proper proper limit of
the of properly sufficient
time place bank
drawee fund in
overdraft
the
account
2) Banker’s Obligation for the Secrecy of
Accounts
 In addition to implied contract between bank and customer not to
disclose the affairs of the customer, Section 13 of the Banking
Companies (Acquisition & Transfer of Undertakings) Act, 1970,
specifically requires a banker not to disclose any information relating
to the affairs of the constituents, except in circumstances in which they
are in accordance with law and practice and usage customary among
bankers.
 Hence, the banker should not disclose balance of the accounts,
financial position of the customer and details of dealings in customer’s
account.
 If these facts are disclosed, it may harm the reputation of the
accountholder and bank may be made liable.
 Duty to Maintain Secrecy of Customer’s Account is
Related to the Following Main Points

1) Banker’s duty of secrecy is a legal one and not moral one. It arises out
of implied terms of the contract.
2) Obligation of secrecy is not for a particular account of the customer. It
extends to all the transactions that go through the account and securities
offered in that respect.
3) Duty is not discontinued even when customer is dead or account is
closed.
4) Obligation is extended to the information obtained from various sources
regarding customer’s account or financial position.

The banker is thus under an obligation not to disclose deliberately or

intentionally any information regarding his customer’s account to a
third party and also to take all necessary precautions and care to ensure
that no such information leaks out of the account books.
There are certain situations when general rule of secrecy of accounts may be
dispensed. Following are the circumstances:
Precautions to be Taken by a Banker While Disclosing the
State of his Customer’s Account
If the banker is careless in disclosing the state of customer’s account, then he is
liable for the damages to the customer who suffers damage because of
unreasonable disclosure or to a third party who incurs loss relying upon the
information which is misleading and vague.
Following are the precautions the banker should have about disclosing the
customer’s account:
1) The banker should not be negligent in giving information.
2) He should strictly give only general information and should not disclose the
actual state of account.
3) Information should be given only after getting the express consent of the
customer.
4) He should not speak too favorably or unfavorably of a customer.
5) The information should be given with a note of remarks.
6) As far as possible the banker should supply the information only to a fellow
banker.
7) On no account should banker disclose to the holder of a cheque the exact
balance in a customer’s account.
3) Banker’s Lien
Lien has been defined as the right of a creditor to retain the
possession of the goods and securities owned by the debtor until the
debt has been paid.

Lien is available on goods and securities only.

Example, bills, cheques, promissory notes, share certificates, bonds and
debentures, etc.

Types of Lien

1. General Lien 2. Particular Lien

Particular Lien: A particular lien confers to a right to retain the goods in
connection with which a particular debt arose i.e. A particular lien applies to
one transaction or certain transactions only.
Example, A tailor has the right to retain the clothes made by him for his
customer until his tailoring charges are paid by the customer.

General Lien: A general lien gives the right to the creditor to retain the
possession till all amounts due from debtor are paid or discharged. This is
available to bankers, intermediaries, wharfingers, attorneys of high court and
police brokers only.
A banker is given the general lien against his borrowers. Under the banker’s
lien, the banker is authorized to retain securities etc. in respect of the general
due by their owner to the banker. The banker can retain all the properties
which have been received from the owner legally.
 Conditions for Right of General Lien
A banker can exercise his right of lien, if the following conditions are
fulfilled:

1) There must not be any agreement inconsistent with the right of lien.
2) The property must come into the hands of a banker in his capacity as a
qua-banker.
3) The possession should be lawfully obtained in his capacity as a banker.
4) The property should not be entrusted to the banker for a specific
purpose.
5) The goods or other securities must be in the name of the borrower only
and not jointly with other.
 Circumstances Under which the Banker cannot
Exercise the Right of Lien

1) When there is any contract inconsistent with this right between banker
and customer.
2) When the goods and securities are entrusted to the bank as a trustee or
as an agent.
3) When the goods and securities are entrusted for some specific purpose.
4) When the loan is granted to one person and the goods and securities are
owned by more than one person.
5) When goods and securities are handed over for safe custody.
6) When the bills of exchange or other documents have been handed over
by the customer with specific instructions to utilize their proceeds for
the specific purpose.
7) In case of shares which are given to bank for selling them in future and
apply the sale proceeds for a specific purpose.
8) When the securities are given to bank to secure a loan, but that has not
been granted as yet.
9) When some documents or variables are left in bank’s possession by the
customer by mistake or negligence.

4) Banker’s right to claim incidental charges

Banks in India resort to this practice of claiming incidental charges on an
increasing scale.
These incidental charges take the form of:
i. Service charges
ii. Processing charges
iii. Ledger folio charges
iv. Penal charges
However, these service charge regulations are not strictly followed by all banks
and the charges may vary from bank to bank.
Banks have a tendency to manipulate the service charge regulations so as to
attract more and more customers.
5) Banker’s Right to Collect Compound
Interest
 As a creditor, a banker has the implied right to charge interest on the
advances granted to the customer.
 Bankers usually follow the practice of debiting the customer’s account
periodically with the amount of interest due from the customer.

6) Law of Limitation
 Article 59 and 60 of the Indian Limitation Act, 1918 define the law of
limitation.
 Article 59 originally provided a period of 3 years for the recovery of
money lent under one agreement and payable on demand from the time
when the loan was made.
 Article 60 originally provided the same period for “money deposited
under an agreement”.
 These articles 59 and 60 of Indian Limitation Act, 1908 have become
articles 21 and 22 respectively, under the Limitation Act, 1963.
 Later on, an amendment was made in Article 60, in which the words,
“including money of a customer in the hands of his bankers so
payable” have been added after the words “payable on demand”. The
effect of the amendment is to make an express demand a necessary
condition for a cause of the action to recover a debt due for a banker.

 Further, according to article 22 of the Law of Limitation Act, 1963, the

period of 3 years will be calculated from the date of demand for
repayment of the banking debt and not from the date of deposit.
Practically when the demand is made, the banker will return the
money immediately and so this Law does not apply to a banking debt.
Garnishee Order
Garnishee Order is an order issued by a court on the request of a creditor
known as the Judgement Creditor for attachment of funds of the debtor
available with his bank.

The debtor is called Judgement Debtor and banker (i.e. judgement debtor’s
debtor) on whom this order is issued is called Garnishee.

Effects of Garnishee Order

 The relationship between the bank and customer is suspended
temporarily.
 A garnishee order, normally does not mention the amount. But if the
amount is specified the order will apply for that specified amount only.
Stage of Implementation of Garnishee Order
i. Order Nisi: Through order nisi, court seeks the bank to advise as to why the
funds in the account of judgement debtor should not be attached for meeting the
obligation towards the judgement creditor. On receipt of order nisi, bank stops
honoring customer’s cheque and customer is advised about the order
immediately to avoid dishonoring of cheques issued by them. At this stage, bank
recovers its own dues first and subsequently informs the court about remaining
balance available for attachment.

ii. Order Absolute: After receiving the explanation from the bank, the court may
issue the absolute order. This order attaches amount of judgement creditor
deposited with the Garnishee bank. On receipt of this order, bank remits funds
of Judgement debtor to the court, without production of any passbook or issuing
any receipt.
 Capacity

Type of Deposit
Accounts

Amount not
Withdrawn

Order on Head Office

Joint Account

Firm’s Account
 Marked Good for Payment

Specific Sum

Cash Credit/Overdraft A/C

Cheques Presented in Clearing

Amount Deposited After Order

Different Name in Order

Joint Accounts

Single Partner

Payment Already Made

Assigned Amounts

Trust Account

Funds in Other Capacities

CLAYTON’S CASE
(DEVAYNES VS. NOBLE-1816)
Facts:
Mr. Clayton had an account with a banking firm, Devaynes, Dawes, Noble,
and Co., that was a partnership firm of five partners rather than a joint stock
company as modern banks almost always are. The bank's partners were
therefore personally liable for the debts of the bank. One of the
partners, William Devaynes, died in 1809 and senior partners carried on the
banking firm under the same name. The executives of the deceased partner
objected to the continuance of the name of Devaynes in the firm’s name. The
amount then due to Clayton was £1,713. After Mr. Devaynes' death, Clayton
made further several payments and deposits with the bank reducing the
balance of his account to £453 and the surviving partners paid out to Mr.
Clayton more than the £1,713 on deposit at the time of Mr. Devaynes' death.
The firm went bankrupt in 1810 and various classes of creditors of the firm
placed their claims against the state of Devaynes, the deceased partner.
Clayton was one of those creditors.
Judgement:

Sir William Grant, Master of the Rolls, 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. The
ruling was 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, the first sum paid 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.
Example, 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 a final balance to be recovered from the debtor by the creditor.
The rule is only a presumption, and can be displaced. The rule is one of
convenience and may be displaced by circumstances or by agreement.
The rule has special application in relation to partnerships upon the death or
retirement or insolvency of a partner. Where the firm has a debit balance, the
old account should be stopped by the banker to fix the liability of the estate of
the deceased or retired or insolvent partner and new account must be opened in
the name of reconstituted firm to avoid the operation of the rule in Clayton's
case.

Conclusion:

Devaynes vs. Noble (1816), best known for the claim contained in Clayton's
case, created a rule, or more precisely 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 determine the effect of
payments from an account, and normally applies in English Law 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. The same
clause is incorporated in Section 61 of the Indian Contract Act, 1872.
RIGHT OF APPROPRIATION OF PAYMENT
RULES IN CLAYTON’S CASE APPLICABILITY
IN INDIA
In India the Rule in Clayton’s case has been followed subject to the provision
of the Indian Contract Act, 1872.
The Rules relating to the appropriation of payments made by a debtor, who
owes a number of distinct debts to his creditor are contained in Sections 59 ,
60 and 61 of the Indian Contract Act, 1872.
These rules are:-

1. Where The Debtor Intimates Or Express Mention By

Debtor (Sec. 59):
i. Appropriation of payment is a right primarily of the debtor and for his
benefit. If the debtor expressly intimates at the time of actual payment
that the payment must be applied towards the discharge of a particular
debt, the creditor or banker must do so.
ii. If there is no express intimation by the debtor, the Law will look to the
circumstances attending on the payment for appropriation. There is an
established maxim that when money is paid, it is to be applied
according to the express will of the payer, not to the receiver. [Craft Vs.
Lumlay]
Example,
X owes two distinct debts of Rs. 350 and Rs. 396. He pays Rs. 396. It
will be presumed that it is the payment of the latter debt as it is revealed
from the amount of the second debt.

2. When The Debtor Does Not Intimate And The

Circumstances Are Not Indicative Or Omission By
Debtor To Intimate (Sec. 60):
i. When the debtor does not expressly intimate or where the circumstances
attending on the payment do not indicate any intention, the creditor may
apply his own discretion to any lawful debt actually due and payable to
him from the debtor.
ii. The creditor may also, until he has declared appropriation to the debtor,
alter the appropriation. [Simson Vs. Ingham]
iii. He cannot, however, apply the payment to a disputed and unlawful debt,
but he may apply it to a debt, which is barred by the law of limitation.

3. When The Debtor Does Not Intimate And Creditor Fails

To Appropriate Or Not-appropriation By Any Party (Sec.
61):
Where the debtor does not expressly intimate and where the creditor fails
to make any appropriation, the payment shall be applied in discharge of
the debt in chronological order, i.e., in order of time.
If the debts are of equal standing, the payment shall be applied in
discharge of each proportionately.
Example:
X owes Y three loans- (1) Rs. 1,000 taken on 1st April, (2) Rs. 700 taken
on 1st May, and Rs. 1,200 taken on 1st July. If he pays Rs. 2,000, the
payment shall be appropriated towards the 1st and 2nd loans in full and
the rest Rs. 300 towards the third one.
In the popular case of Devaynes vs. Noble (1816) all the above points of
appropriation of payments have been included in the court judgement. This
case is known as Clayton’s case.

Note to remember:
Regarding part-payment, the general principle, subject to any contract to the
contrary, is that the payment should first be applied to the interest and after
the interest is fully paid off, to the principal. [Rubia Devi Vs. Raghunath
Prasad]