4. Payment Obligations and Commercial Paper: Payment of Debts

Question 1

How may debts be extinguished?

Answer 1

Debts may be extinguished by:

1) Performance
2) Novation
3) Delegation
4) Negative Prescription
5) Compensatio — known as settle.

Question 2

What is novation?

Answer 2

Novation is where the debtor and the creditor agree that an old debt should be extinguished and replaced with a new debt. It is an express discharge that the old contract has come to an end and an express agreement that a new contract has been established.

Question 3

What does novation require?

Answer 3

Novation requires the active participation of the debtor and the creditor.

Question 4

When does novation arise in practice?

Answer 4

An example concerns the channel tunnel.

The tunnel was operated by a company which for many years was in financial troubles - it was very indebted. The company operating the tunnel were unable to pay the banks on a regular basis the amounts due. Accordingly every now and then they would propose to the bank, why don’t you agree to extinguish some of the debts that have been entered into previously and replace them with new debts. Why would the bank agree?

The reason the bank would agree is that the bank knew that the only asset that the company had was a tunnel so that if the company went bust the only asset they could sell would be a tunnel which would not raise enough to pay all the debts. So the banks think acknowledge that it may be advantageous to extinguish the old debts and replace them with lesser debts so that they at least receive some return.

So in this example what happened was a ‘debt to equity conversion’ whereby the loans were reduced in exchange for the bank getting some shares in the company so that when the company started to make money the banks would share in the profits so they would get some return - this would be better than getting nothing at all/ very little in terms of liquidation. The way in which this debt was structured was in terms of novation.]

1. Debt Restructuring
2. So when you agree that certain liabilities of the debtor should be extinguished.

Question 5

Why is novation often not attractive in practice?

Answer 5

Both parties do not always benefit. This is only worth doing if there is something in it for the debtor and the creditor (or it is unlikely they’ll agree to it). Otherwise, why would they give up a right to payment which they have against the debtor.

Question 6

Special type of novation: delegation

Answer 6

One special type of notation is where it isn’t the original parties that enter the agreement but a new party comes in and the agreement is taken with them - the creditor agrees to the extinction of the old debt and a new debtor is created - this special type of novation is called delegation.
- New debtor substituted

Question 7

What does delegation of a debt depend on?

Answer 7

Like novation generally, delegation is dependent on the agreement of the parties - the decision cannot be made unilaterally. A new debt is created and a different debtor takes over the debt.

Question 8

When does delegation arise in practice?

Answer 8

Delegation typically arises in practice where there are groups of companies (e.g. parents and subsidiaries) which may want to shift debt from one company to another as part of company restructuring. In this case the creditor usually will be happy to allow the new debt to be taken over by another member of the group as long as the other member of the group has assets etc.

Question 9

What is negative prescription?

Answer 9

Negative prescription is the process whereby debts are extinguished by passage of time.

The rules in relation to negative prescription are found in ss 6, 7, 9 and 10, and schs 1 and 2 of the Prescription and Limitation (Scotland) Act 1973.*** [must know].

Question 10

What are the types of negative prescription?

Answer 10

There are two types of negative prescription
⁃ Short negative prescription (5 years)
⁃ Long negative prescription (20 years)

Question 11

How do you determine if a debt is covered by sort or long negative prescription?

Answer 11

Obligations which arise under a contract or delict tend to be subject to short negative prescription and obligations which relate to land tend to be long negative prescription. It is a case of being familiar with the provisions above**.

To determine whether a debt is covered by short negative prescription one must look at Schedule 1.
⁃ Look up when schedule 2 is relevant?

Question 12

What is Compensatio?

Answer 12

(compensation or set-off)
This is where payments which are due are balanced against each other. e.g. A owes B £5000 and B owes A £4000, overall A owes B £1000.
⁃ The reason for this doctrine is so that only one court process would be necessary to sort all the debts between two parties.
- They are balanced together so we can adjust it so that only one of them owed money to the other.
- This idea of set-off is what underpins compensatio.

The Compensation Act 1952

Question 13

What are the four requirements for compensation to apply?

Answer 13

4 requirements for compensation to apply (or set off is not allowed):

1) Concursus crediti et debiti
It must be the same creditor and debtor in the same capacity as creditor and debtor.
⁃ A owes B money. B in his capacity as a trustee owes A money as a beneficiary under the trust. In this situation these two debts could not be set-off. For concursus crediti et debiti to apply the creditor and debtor have to be both creditor and debtor in the respective obligations in the same capacity on both sides of the transaction (so it is the same patrimony that is affected).

2) The obligations are of the same kind
If A owes B £10k and B is under an obligation to transfer to A 100 widgets, these obligations cannot be set-off against each other.
i.e. Not to buy oats. They are usually about two liquid sums of payment.

3) The debts must be certain and liquid
This means that if there is a breach of contract where there is an outstanding damages claim and quantification of the damages hasn’t taken place, this debt is not sufficiently certain to allow it to be compensated.

This typically only arises from a contractual obligation where you have fixed sums which are due. The debts have to be due now.

4) The matter is raised before decree
After decree has been given it is too late to have compensatio. So it can be raised as a defence to an action (that the sum should be reduced because an amount could be compensated) but once the decree is given you have missed your chance to raise it.

By balancing the debts it can serve to extinguish them.

Question 14

Can parties specify how they want payment to be made? What happens if the contract is silent?

Answer 14

Where a contract has been entered into, the creditor can specify how they want payment to be made (so the parties can agree that payment is to be made in a particular way.)

If the contract is silent e.g. the creditor has not specified what they require for payment then the only thing that the debtor can require the creditor to take is legal tender. They creditor cannot refuse this.

Question 15

What is legal tender in the Scottish context?

Answer 15

Only coins (however not all coins are legal tender for all debts) under the Coinage Act.
⁃ 1p and 2p coins are legal tender for debts up to 20p
⁃ 5p and 10p coins are legal tender for debts up to £5
⁃ 20p and 50p coins are legal tender for debts up to £10 [£1 or £2
⁃ £1 and £2 and any higher denomination coins are legal tender for everything else.

[So bus driver is legally entitled to refuse coins up to 20p etc.]

Physical money in the legal sense is Legal tender

Question 16

Are bank notes legal tender in Scotland?

Answer 16

Bank notes in Scotland and England are only promissory notes. So Scottish bank notes are not legal tender in Scotland.

Question 17

Does the creditor have to accept banknotes?

Answer 17

In practice the creditor does not have to accept cash at all.

You are not obliged to accept banknotes
“No creditor is bound to receive payment of a debt due to him by cheque or otherwise than in the current coin of the realm. A creditor may even refuse to accept Scottish banknotes”
Glasgow Pavillion v Motherwell (1903) 6 F 116

Question 18

What form of payment will the creditor accept in practice?

Answer 18

By agreement of the creditor the debtor can satisfy the debt by paying the debtor using an equivalent to legal tender.
⁃ Physical form – negotiable instruments (see later)
⁃ Non-physical form, such as bank giro credit, standing order, direct debit, or other automated form of transfer. However, little authority on the nature of these arrangements.
⁃ Key idea here: is that where you are not using cash one debt is “paid” by another debt. Think about this.
- Money is paid from the bank into the shop’s bank account. The bank account is a contractual right against the bank.

⁃ Electronic payment mechanisms (most common in practice and also little authority on this.) [Crerars chapter 10].
⁃ Credit transfer (where funds are moved from payer to payee – following instructions given by payer to debit his account and credit payee’s account) (Bank Giro Credit/CHAPS/Standing order)
⁃ Debit transfer[ E.g. direct debit - the process is initiated by the creditor.]: creditor gives instruction to bank to obtain payment from debtor’s account (instructing creditor’s bank to demand payment from debtor’s bank)
⁃ Debit cards – used within EFTPOS system
⁃ Credit cards – consider description in **Re Charge Card Services Ltd [1988] Ch 497 at 509
⁃ There are a number of contractual relationships at work (in both debit and credit card transactions) which regulate the way in which payment is made:
⁃ 1) There is a relationship between the seller and the buyer (a contract for sale or supply of goods or services).
⁃ 2) There is then a relationship between the seller and the buyer bank or card provider whereby the buyer’s bank or card provider will make payment of the appropriate sum if they sign / present card and insert pin number in the appropriate way.
⁃ 3) There is also a relationship between the seller and the bank or card provider. This is an agreement between them that the seller will accept payment using that type of card.

Question 19

**Re Charge Card Services Ltd [1988] Ch 497 at 509

Answer 19

[ Look this up - it summarises the contractual relationships which are in place.] (per Browne-Wilkinson, VC) [must read this!!]**

Question 20

How can you prove payment has been made?

Answer 20

Until August 1995 you could only prove this by written documentation from the creditor that the debt had been received or the creditor testifying on oath to confirm that the debt had been received. If you didn’t have a written receipt confirming that payment had been made the creditor was unlikely to testify that they’d received the money.
⁃ Since August 1995 you have been able to use any evidence to prove that you paid the debt (e.g. bank account record which shows that money was transferred from your bank account to the creditor).
- You can use parol evidence

Question 21

What is clayton’s case?

Answer 21

Clayton’s case is an English case in relation to payment which represents a general rule which applies where there are payments to a running account (typically an overdrawn bank account).
- Rule in the law of banking called Clayton’s case.

Question 22

What is the general rule of Clayton’s case & appropriation of debts?

Answer 22

• Must remember: “earliest credit pays earliest debit”. The £200 goes in and pays £100 debt off from day 1 and £!00 of day 2 debt, which means there is still £50 outstanding from day 2 debt. £100 owed to the bank comprises two separate debts. This rule comes up repeatedly**. Must just be aware of it at this stage.
• See Crerar’s banking law case.

Example:
⁃	Bank account:
⁃	Day 1. A withdraws £100
⁃	Day 2. A withdraws £150
⁃	Day 3. A withdraws £50
⁃	Day 4. A receives £200
⁃	Day 5. A withdraws £100
⁃	Day 6. A receives £50

⁃ The total indebtedness at the end of day 3 is £300.
⁃ On day 4 when £200 gets paid into the account, what does this £200 pay? (Since each overdrawn amount in the debit column is a debt that is owed by the customer to the bank.) The rule is that the credited £200 pays of the earliest debt that is outstanding - the earliest credit meets the earliest debit. So the £200 pays off the £100 debt from day 1 and £100 of the £150 debt from day 2. So the total indebtedness in the account now is £100 (comprising £50 of debt from day 2 and £50 of debt from day 3).
⁃ When more money is withdrawn on day 5 the total indebtedness is now up to £200.
⁃ When £50 is paid in on day 6 this goes to pay off the earliest debt (the £50 remaining from day 2).

**See notes and do a table in the exam

Question 23

Why does the Clayton principle matter?

Answer 23

⁃ In the law of insolvency, one of the doctrines which applies is something called unfair preference. This is where a bankrupt or insolvent company has in a period immediately before insolvency granted a security in relation to an outstanding debt. This security being granted to a party therefore diminishes the amount which is available to other creditors. This is not fair to the other creditors so this security can be struck down. But if the security is granted for a new debt then the security is valid.
⁃ Sometimes a security is granted in relation to an overdrawn bank account, which means that what you get is a mix of old debts and new debts, and you need to be able to characterise and identify how much of the old debts are going to be struck down and how much of the security applies to new debts for which it is valid.