csAFmi in

BANKER’S RIGHT OF
SET - OFF
 CHAPTER III

BANKER’S RIGHT OF SET - OFF

If a customer has two or more accounts in the same right at the same
bank, one loan account and others deposit accounts, the banker can
appropriate the credit balances in the deposit accounts to the debit balance
in the loan account provided the customer has failed to pay off the loan
account on the due date. The loan should be due for repayment and the
deposit (if fixed deposit) should also be matured. If it is a current or savings
bank account the banker can immediately transfer the credit balances from
these accounts to the loan account when it is due for repayment. This right
of the banker to combine the accounts of the customer in credit and debit
balances is the right of set - off. General lien is the right of the banker to
retain the goods of the customer until a debt of the customer is paid,
whereas set - off is the right of the banker to adjust cash balance in the
deposit account of the customer to the loan account of the customer. In
short, lien indicates goods; set - off is in relation to money.

Definition

Set - off is the combining of debit and credit accounts so as to arrive

at a partial or full repayment of a debt. A banker has the right to set - off
different accounts in the name of the same customer provided that he has
not agreed to keep them separate and provided that the accounts are in the
same right1.

1 Dictionary of Banking - F.E. Perry & G.Klein, 3rd Edn, 1988, p.288
 55

In law, set - off consists of the total or partial merging of a claim of

one person against another in a counter - claim by the latter against the
former. While set - off may be given by agreement it is essentially a
statutory right or a right created by Rules of Court2.

Set - off is the debtor’s right to reduce the amount of a debt by any
sum the creditor owes the debtor; the counterbalancing sum owed by the
creditor3.

Set - off signifies the subtraction or taking away of one demand from
another opposite or cross demand, so as to extinguish the small demand and
reduce the greater by the amount of the less; or, if the opposite demands
are equal, to extinguish both. It was also, formerly, called stoppage, because
the amount to be set - off was stopped or deducted from the cross demand4.

Cash as Security

Cash is the finest type of banking security available. There are no

problems of valuation, depreciation or realisation when cash is held to cover
a banking security and, providing the charge over it is complete, no
difficulty can arise when it is needed to liquidate the indebtedness.

2 Thomson’s Dictionary of Banking - F.R. Ryder & D.B.Jenkins, 12th Edn,

1974, p.531
3 Black’s Law Dictionary - 7th Edn. 1999, p.1376

4 A Treatise on the Law of Set - off, Recoupment, and Counter Claim -

Thomas W.Waterman, 2nd Edn, 1872, p.l
 56

Cash may be held as security in two distinct ways:

1. When cash is deposited by a third party expressly to secure

the indebtedness of the borrower.

2. When the banker relies on credit balances of a customer as

security by way of set - off to cover the overdraft of the same
customer.

Any express arrangement for collateral cash security has to be

evidenced in writing and a special agreement or letter of set - off will
normally be executed by the depositor detailing the transaction. The cash
will be held as security for all sums due from the borrower, either solely or
jointly with any other person on any account, and the bank will usually be
empowered to credit moneys in reduction or repayment of the customer’s
indebtedness at any time without notice to the depositor. In practice, a
bank would not seize the collateral moneys without discussing the position
with depositor, but it is advisable to obtain full rights to act without
reference to meet extreme cases where the depositor declines to co-operate
when the security has to be applied in reduction or repayment of the
principal debt.

In some cases, a guarantee is taken instead from the depositor and

the bank relies on the lien clause included therein to catch the cash
deposited in the name of the guarantor as collateral security. In effect, the
bank has a guarantee supported by cash. But some people will be unwilling
 57

to sign a guarantee with its innumerable clauses. The problem can easily
be solved by the preparation of a special agreement or letter of set - off
which may be relatively short and simple in its terms.

Direct Set - off

Between debtor and creditor there is an undoubted right to set - off

amounts due to and from each other in the ordinary course of business.
When X buys cotton from Y at a cost of Rs. 1500/- and later supplies Y with
machinery worth Rs.1000/- he is perfectly entitled to set - off the cost of the
machinery against his liability for the cotton and to pay only Rs.500/- to Y
in settlement of the net indebtedness. The implied right of the banker to
set - off at any time the balances on the accounts of the same customer in
order to ascertain the net amount then due to and from the customer is,
however, subject to several restrictions and it does not always follow
automatically that credit moneys are valid security for the indebtedness of
the same customer on other accounts.

While lien signifies the right of a creditor in possession of goods or

securities belonging to a debtor to retain them until a debt due from the
latter is paid, set - off is the right of the debtor to take into account a debt
owing to him by a creditor when claiming a debt due from him to the
creditor. In the case of a banker, the right of set - off enables him to adjust
the debit balance in a customer’s accounts with any balance standing to his
credit in the books of the bank. In other words, the banker can adjust his
claim from the amount payable to his customer. The right to set - off is a
 58

statutory right and can also arise out of agreement between the parties
concerned. In practice, the banker will not arbitrarily exercise his right of
set - off without giving due notice to the customer unless there is an
agreement to that effect.

The concept of set - off has been enunciated under Order VTII Rule ("
6 of the Code of Civil Procedure, 1908.

The Andhra Pradesh High Court in Mis. Durga Pharma

Distributors, Hyderabad v Geoffrey Manners & Co Ltd5 held that the
right to set - off dealt with by Order VIII, Rule 6 of the Code of Civil
Procedure, 1908 is a legal set - off. Its characteristics are that the sum of
money is ascertained and both the parties fill the same character as they
fill in the suit.

A bank can transfer amount deposited in current account to its loan

account for set - off. Debtor cannot object on the ground that the transfer
of amounts from the current account will result in negation of petitioner’s
activities6.

Combination of Accounts

The right of set - off is also known as the right of combination of

accounts. In many cases a customer maintains more than one account with
his bank. Thus, a customer may use one account for personal purposes and

5 AIR 2000 AP 242

6 Canara Bank, Hyderabad v Taraka Prabhu Publishers Pvt Ltd AIR 1991
AP 258 (DB)
 59

another one for his business. Similarly, a customer who has several
enterprises may decide to maintain a separate account for each of them. In
other cases, a customer may open some special type of account, such as loan
account or savings account, in addition to his current account. Furthermore,
some professionals are required to open special accounts for their business.
Thus, solicitors are required to maintain clients’ accounts.

The bank seeks to combine the customer’s accounts for its own
purposes. If the customer is unwilling to pay an amount due in respect of
an overdraft or of a loan, the bank can, of course, sue him for the debt. If,
however, the bank is able to set - off against the overdraft in account A
credit balance in account B, it obviates the inconvenience and expense
involved in legal proceedings. Furthermore, it avoids the risk of
deterioration in the customer’s financial affairs during the period of
litigation.

The main problems involved are the bank’s right to combine accounts
where there is an agreement or manifestation of intention to the contrary;
the question of whether the bank is obliged to give notice before it resolves
to combine the accounts; whether the bank either is under the duty or has
the authority to combine the accounts in the customer’s interest.

Essential Features of Set - Off

For set - off to apply, there should be mutual debts and the debts
should be for sums certain. The claim and cross - claim should be both for
determined amounts. If a customer has stood as a guarantor to another
 60

party, the credit balance cannot be set - off against the borrower’s dues till
the exact liability under the guarantee is determined. For the purposes of
set - off all the branches of a bank are treated as one entity.

The set - off can be applied only to those debts which are due and
recoverable on the date of exercising the set - off. Adjusting an overdue bill
to the available credit balance in the account is an example. For adjustment
the debt should be immediately payable and a debt accruing due cannot be
set - off against a debt already due. In the absence of some special
agreement, a bank is not entitled to retain a customer’s credit balance to
secure itself against a contingent liability on bills which it has discounted
for the customer7.

Another important essential of set - off is that the indebtedness

should arise in the same rights. A solicitor’s personal account which is
overdrawn cannot be combined with his client’s account. A personal debt
cannot be combined with the credit balance in the trust account maintained
by the individual. Where a bank has notice that an account contains money
held by a customer on trust, the bank will have no right to set - off this
money against a debit balance on another account8.

In cases where a customer opens No. 2 or No.3 account and gives any
indication that the funds to be paid into the account are trust moneys, the
bank should record this information and never regard the balance on the

7 Bower v Foreign and Colonial Gas Co. Ltd; Metropolitan Bank, Garnishees
(1874) 22 W.R. 740
8
Barclays Bank Ltd v Quitclose Investments Ltd (1968) 3 All'E.R. 651
 61

new account as being available to set - off against a debit balance on the
customer’s other accounts. Likewise a deceased’s credit account and an
executor’s debit account cannot be combined.

The right of set - off can be excluded by means of an express or

implied agreement between the bank and the customer. The banker and
customer are at liberty to agree on an express right of set - off, unless the
customer is holding the money, which to the banker’s knowledge is held on
trust.

Automatic set - off arises in the following cases : ^

r

1. On the death, insanity or insolvency of the customer.

2. On the insolvency of a partner of a firm or on the winding up

of a company.

3. On the receipt of a garnishee order

4. On receiving notice of assignment of a customer’s credit

balance and

5. On receiving notice of second mortgage over the security

charged to the bank
 62

Combining of Separate Accounts of a Customer

Sometimes some customers open separate accounts for the sake of

convenience in different branches or in the same branch. In such cases, a
question will arise whether such accounts can be combined, which they have
opened for specific purposes and with intention to have them separately.

In Greenhalgh and Sons v Union Bank of Manchester9, it was

stipulated that when a bank agrees with its customer to open more than
one account, then it cannot, without the customer’s consent, move either
assets or liabilities from one account to the other; the basis of the
agreement being that the accounts will be kept separate.

In Buckingham and Co. v London and Midland Bank Ltd10,

the banker transferred the credit of £ 160 of a customer in current account
to his secured debt of £ 600 and suddenly informed this action to the
customer. As a result of this, various cheques of the customer had to be
dishonoured. The banker had to pay damages for this to the extent of £ 500.
To avoid situations like this, bankers feel safer to give notice to their
customer of their intention to exercise their right of set - off or in the
alternative a letter of set - off is taken in all cases where a customer has
two or more accounts, one or more in credit and the other(s) in debit. A
letter of set - off is thought of dispensing with the giving of notice to the
customer and may be a proof that the banker’s right of set - off manifests
and is not waived.

(1924) 2 K.B. 153

10
(1895) 12, T.L.R. 70
 63

In Garnett v McKewann, regarding the combining of two accounts

in two different branches, the banker’s right to combine was upheld, there
being no special contract or usage to keep the accounts separate or to give
notice before combining the accounts. This case has received further support
in Barclays Bank v Okenarhe12. Despite these favourable decisions for
the banker, bankers, as abundant caution, take a letter of set - off from the
customer in case where he has two or more accounts.

There may remain a surplus amount with the banker after adjusting
a particular loan by the sale or realisation of securities held as cover for the
said loan. According to Section 176 of the Indian Contract Act, 1872, such
surplus should be paid to the pledgor. In order to circumvent this, bankers
usually take a letter of set - off - cum - lien authorising them to apply the
sale proceeds not only for the adjustment of the particular debt but also to
the satisfaction of any other debts of the customer.

We shall refer to the observations of Lord Denning in Halesowen

Presswork Assemblies Ltd v Westminster Bank Ltd13 regarding the

distinction between lien and set - off.

11 (1872) L.R., 8 Ex 10

12 (1966) 2 Lloyd’s Rep 87

13 (1971) 41 Comp. Cas. 239

 64

"Seeing that the banker’s lien (as applied to combination of accounts)

is no true lien, in order to avoid confusion, I think we should discard the
use of the word "lien" in this context and speak simply banker’s right to
combine accounts or a right to set - off one account against the other.

Using this phraseology, the question in this case is : suppose a

customer has one account in credit and another in debit, has the banker a
right to combine the two accounts? So that he can set - off the debit against
the credit and be liable only for the balance? The answer to this question
is : Yes, the banker has a right to combine the two accounts, whenever he
pleases, and to set - off one against the other, unless he has made some
agreement, express or implied, to keep them separate".

Set - off is the legal right by which a debtor is entitled to take into
account a debt owing to him by a creditor when the creditor demands
repayment of the debt owing to him by the debtor. The right can be
exercised under the following conditions :

i) that the debts are sums certain

ii) that debts are due by and to the same parties

iii) that the debts are in the same right

iv) that there is no contract, express or implied, to the contrary.

 65

Rule of English Law

The rule of English Law that the Bank has a lien or more
appropriately, a right to set - off against all moneys of his customers in his
hands has been accepted as the rule in India. According to this rule when
moneys are held by the bank in one account and the depositor owes the
bank on another account, the banker by virtue of his lien has a charge on
all moneys of the depositor in his hands and is at liberty to transfer the
moneys to whatever account the banker may like with a view to set - off or
liquidate the debt.

In this regard, it is submitted to refer Devendra Kumar Lai

Chandji v Gulab Singh14. The defendant had a loan account as well as
a deposit account with the plaintiff, a banker. The plaintiff transferred a
Siam of Rs.265.5 anna from the deposit account to the loan account without
any authority from the defendant. It was held by the trial court that the
plaintiff had no right to do so but the Nagpur High Court allowed the
revision and held that a lien was available to the banker not under Section
171 of the Indian Contract Act, 1872 but by virtue of the general law on the
subject. This case is a clear case of banker’s right to set - off a customer’s
deposit account against a bank loan advanced to him.

hAIR 1946 Nagpur 114

 66

Set - off in Joint Accounts

The question before the court was whether set - off can be exercised
in the case of joint accounts of the customer. The suit was for the recovery
of dues from the defendant on the overdraft account. The defendant pleaded
that his debt should be set - off against certain deposits with the bank - a
fixed deposit in the names of himself and his brother and two provident
deposits in the names of himself and his wife, all repayable to ‘either or
survivor’. There was no evidence that the brother or wife was dead. No
demand had been made on the bank for the repayment of deposits. It was
held by the Calcutta High Court in Nath Bank Ltd (in liquidation) v
Sisir Kumar Sirkar15 that the defendant was not entitled to the set - off.

The court referred to the English case Wolstenholm v Sheffield

Union Banking Co16 where Lindly L.J. observed :

"Prima facie a separate debt cannot be set - off against a joint debt
either at law, in equity or under the mutual credit clauses of the
Bankruptcy Act. There is no authority for the bankers having a general lien
in such case as the present".

15 (1954) 24 Comp. Cas 306

16 (1886) 54 L.T. 746

 67

In Simla Banking Co. v Bhagwan Kuar17, the bank had issued

a Fixed Deposit receipt in favour of A and his wife, B payable to either or

survivor. In a suit by B against the bank to recover the deposit, the bank
claimed to retain the moneys and asserted a lien thereon on the ground
that A was severally indebted to the Bank. This defence was negatived and
it was held that the bank could not appropriate the amount of the fixed
deposit against the debt severally due from A either in law or in equity.

The Patna High Court in Radha Raman Choudhary v Chota

Nagpur Banking Assn Ltd18 has held that the bankers have a right to
combine one or more accounts of the same customer. But a banker cannot
combine a customer’s personal account with the joint account of the
customer with another person.

The facts and circumstances of the case "S.K. Panicker v

Travancore National and Quilon Bank Ltd19 throw some peculiar
light on set - off in joint accounts.

The applicant claimed that loan due and payable by him to the bank
should be set - off against the balance on the current account with the bank
in the joint names of himself and his wife. The applicant alleged that his
salary was being credited to the account, that the balance represented the
withdrawn salary and that the money belonged to him. He also alleged that

17 AIR 1928 Lah. 316

18- (1945) 15 Comp. Cas. 4

19 (1942) 12 Comp. Cas 72

 68

for convenience of operation of the account and to facilitate drawings of the

amount in the account by his wife in the event of her surviving him, he
made it joint ‘either or survivor’ account. The wife also gave an affidavit
saying that the balance on the account represented her husband’s salary.
The liquidator of the bank did not controvert the statements but contended
that no right of set - off should be allowed since the deposit account was a
joint account and the debt was owed to the bank by the husband alone. His
contention was rejected by the Madras High Court.

In England, when a husband pays money into a banking account in

the name of his wife or in the joint names of himself and his wife, there is
presumption that he has made a gift of the money to his wife. This
presumption can however be removed by evidence to the contrary. The
evidence in the present case clearly proved that the money belonged to the
husband though deposited with the bank in the joint names of the husband
and wife. Hence the balance on the account could be set - off against a debt
to the bank from the husband alone.

Accounts in Different names

In Uttamchandani v Central Bank of India20 the defendant

bank sought to set off accounts held in different names on the ground that
in each case the accounts were ‘nominee’ accounts and in each case the
customer was in reality a Mr.Vaswani. The Court of Appeal, affirming the
decision of Hobhouse J, held that the bank had no such right. Lloyd U
said:

20
(1989) NLJ 222
 69

"Now the banker’s right of set - off between accounts is well

established part of our law of banking. But so far as I am aware, set - off
has never been allowed save where the accounts are of the same customer,
held in the same name, and in the same right. Even then, the right of
set - off may be excluded by agreement express or implied. What is unusual
about the present case is that the bank is seeking to set - off accounts held
in different names, on the ground that in each case the accounts are so -
called ‘nominee’ accounts, and in each case the customer is in reality Mr.
Vaswani".

The bank had relied not on the ordinary banker’s right of set - off at
common law, but on set - off in equity. Having examined the authorities,
Lloyd L.J said : ‘As I understand the old cases on this topic, set - off in
equity was never allowed save where a court of equity could see that the
person claiming to rely on set - off was the beneficial owner of the debt in
question, either on the face of it, or by distinct admission, or otherwise
without the need for any further enquiry’. Accordingly, the Court of Appeal
dismissed the bank’s appeal.

Existence of Mutual Debts

It was held in State Bank of India v Javed Akhtar Hussain &

Others21 that the right of a bank to apply a deposit to the indebtedness
due from the depositor, result from the right of set - off, which obtains
between persons occupying the relation of debtor and creditor, and between

21
AIR 1993 Bombay 87
 70

whom there exist mutual demands. Mutuality is essential to the validity of

set - off, and in order that one demand may be set - off against another, •
both must mutually exist between the same parties.

Account’s Containing Trust Money

Very often the title of an account indicates that it contains moneys

belonging to other people e.g. John Jones, ‘Tennis Club Account’, or
Benjamin L.Gross, "Police Account" or John Smith, Sole Executor of William
Robinson. In Re Gross, Ex parte Kingston22, it was held that the bank
is not entitled to set - off a credit balance on such accounts against the debit
balance on the customer’s private account. Similarly, professional men often
maintain separate banking accounts for client’s moneys. Where it is known
to a bank that a particular account is used for this purpose, no right of
set - off can arise. A bank cannot have any recourse or right, whether by
way of set - off or otherwise, against moneys standing to the credit of such
accounts.

O.RM. O.M. SP (Firm) v P.L. N.KM. Nagappa Chettiar13: On

the death of one of the brothers who were jointly carrying on their family
business, the assets of the family were partitioned. It was agreed under the
partition agreement that the business would be continued by the surviving
brother. In terms of the arrangement, one of the sons of the deceased made
a contribution of Rs. 11,250/- towards capital for certain charities for which
some amount had been credited in the books of the firm before partition.

22 (1871) 5 Ch App 632

23
(1941) 11 Comp. Cas. 231
 71

The contribution was in the form of hundis drawn by the son (plaintiff here)
on his account with the appellants, a firm of bankers. The hundis were
handed over to the plaintiffs uncle who took them to the bankers who
credited the amounts to accounts in the name of the charities. It would
appear that the plaintiff had authorised his uncle to invest the trust funds
in his own business. After three years, the balances to the credit of these
accounts were appropriated by the bankers towards the dues from the
plaintiffs uncle on an overdraft account. The uncle was subsequently
adjudicated insolvent and thereafter the planitiff sought to make the
bankers liable to refund to the charities the moneys appropriated as
aforesaid. The PRIVY COUNCIL held that the planitiff must succeed and
dismissed the bank’s appeal since there was no authority of the plaintiff to
his uncle to invest the trust funds in his own business. This was in breach
of trust on the part of the banker to appropriate the money towards the
dues of the plaintiffs uncle since the money was actually belonging to the
trust.

Money standing to the credit of an account maintained by a customer

in a fiduciary capacity of which the banker has or is deemed to have notice
cannot be set - off against a debt due from the customer in his personal
capacity. In this case the money in question was credited by the banker to
accounts in the names of charities, and the Privy Council had no difficulty
in holding that the bank could not set - off the funds against the personal
overdraft of the customer. In the opinion of the Privy Council, the authority
given to the customer by his nephew to invest the charity funds in his
(customer’s) business did not cover utilisation of the moneys to repay his

overdraft.
 72

Set - Off on Partnership Accounts

A case on this point in Jaikishan Das Jinda Ram. (Firm) v

Central Bank of India Ltd24. There were two partnership firms
functioning under two different names but comprising the very same
. partners. Firm No. 1 deposited a sum of Rs.15,000/- with the bank for
remittance to a company. The company did not accept the remittance and
the money was returned to the remitting office of the bank. Thereafter the
bank credited the amount to the overdraft account with it in the name of
Firm No. 2. Firm No. 1 contended that the bank had no right to combine
the accounts of Firm No. 1 (in credit) and Firm No. 2 (in debit). The Punjab
High Court rejected this contention and affirmed that the bank had right
to make the adjustment.

This decision is based on the proposition that the partnership firm is

not a legal entity distinct from the persons constituting it under Indian
Law, partners are jointly and severally liable for the debts and obligations
of the firm. Thus, the balance due to the bank on the overdraft account of
a partnership firm is a joint and several debt owed by the partners to the
bank. Against such a debt, as was held in the present case, can be set - off
money in the hands of the bank belonging to the same set of partners,
though functioning as a different partnership, provided the money is not
subject to any trust or fiduciary obligation with which set - off would be
inconsistent. In the present case, the money appropriated against Firm

24
AIR 1960 Punjab 1
 73

No. 2’s overdraft had been entrusted to the bank for a specific purpose, but
since that object could not be accomplished, it was held that the set - off
could be exercised.

Set - off and Guarantor’s Liability

The case Punjab National Bank Ltd v Satya Pal Virmani25

clarifies when set - off can be exercised by the bank against the credit
balances in the guarantor’s account. Certain government securities held as
security for a loan were sold by the bank with the borrower’s consent. After
appropriation towards the loan, there was surplus left out of the sale
proceeds. When the borrower claimed the surplus, the bank refused to pay
on the ground that it had a lien thereon in respect of his liability as joint
guarantor of certain advances granted to a third party. The Punjab High
Court held that the bank had such lien. On the basis of the evidence, the
court held that an agreement had been concluded between the bank and the
borrower in respect of the loan on the lines of the bank’s standard format
of agreement which contained the following clause :

"And it is further agreed that the bank shall have a lien on all such
stocks, shares and securities or on the proceeds after sale thereof (if sold)
as security for or in part payment of any other debt due or liability then
incurred or likely to be incurred by me / us to the said bank".

25 (1956) 26 Comp. Cas. 135

 74

This decision supports the widely accepted view that when the
banker sells the security furnished to him by a borrower in respect of a
specific advance, any surplus out of the sale proceeds can be set - off by the
banker against any other debt owing by the borrower to the banker except
where there is notice of intervening charge on the security in favour of
another creditor. In the present case the loan agreement clearly allowed the
banker such a right of set - off.

Money owed by the banker to the customer cannot be set - off against
the customer’s contingent liability, such as that under a guarantee to the
banker, except in the event of the customer’s bankruptcy. Page Wood V.C
said in Jeffryes v Agra and Masterman ’s Bank Ltd?6, "you cannot
retain a sum of money which is actually due against a sum of money which
is only to become due at a future time". Sometimes, for example, a bank
accepts a foreign currency deposit from another bank for a fixed period, and
subsequently makes a loan in the same currency and to the same bank but
for a different period. If the deposit is due to be repaid on, say, 15
December, the bank holding the deposit is not entitled to retain it against
a loan which is due to be repaid on say 31, December. But once the
contingent liability has crystallised as when the guarantor has become
liable and is called upon to pay, the right of set - off is available and can be
exercised. It is presumed that in the case under comment the guarantor has
become actually liable to the bank. The court held that the guarantor’s
liability was not merely joint but also several and hence the banker could
have the benefit of a set - off.

26
(1866) 35 LJ Ch 686
 75

Set - off Against Time - barred Debt

A banker can exercise his right of set - off in respect of a debt which
is time - barred. Section 3 of the Limitation Act, 1963 only bars the remedy
through a court of law and does not extinguish the right to the debt. The
creditor can recover the debt without resort to filing of suit in a court of

In Thakur Prasad Chaudhari v Official Liquidator, Benaras

Bank Ltd21, a person was having a deposit account with the bank and
also stood as a guarantor for a borrower of the bank. The bank invoked the
guarantee on account of the default committed by the borrower. The bank
exercised its right of set - off against the deposit. The depositor questioned
the action of the bank on the ground that bank’s claim was barred by
limitation.

The Allahabad High Court held that the Law of Limitation does not
extinguish the debt. It merely prohibits filing of suit. Therefore the bank is
entitled to exercise its right of set - off eventhough the bank had lost its
remedy to recover the dues by filing suit. Banker’s right of set - off against
time - barred debt should be used as a shield to protect against loss of
securities by operation of law of limitation and not as a sword to purposely
bypass the effects of the Law of Limitation.

27
(1941) 11 Comp. Cas. 298
 . VJJ1' N

76

In England, a banker is not entitled to set - off a credit balance

against a statute - barred debt28, which is in contradistinction to the law

prevailing in India.

In Radha Raman Choudhary v Chhota Nagpur Banking

Association Ltd29, the banker purported to set - off the customer’s deposit
against a time - barred debt. It was held by the court that right of set - off
could not be exercised against a time - barred debt. This case was wrongly
decided since the right of set - off could be exercised outside a court and the
Law of Limitation could not be a bar.

Decision in the Radha Raman Chaudhary’s case stood automatically

reversed by the Supreme Court’s judgment in Punjab National Bank and
others v Surendra Prasad Sinha30 which settled the law that right of
set - off can be exercised against a time - barred debt.

In the Punjab National Bank case, the bank (appellant) granted a

loan to one D on May 5, 1984 for repayment of which the respondent and
his wife stood guarantee. The respondent and his wife, for this purpose
handed over to the bank a fixed deposit receipt maturing on November 1,
1988 and executed a security bond giving the bank the right to credit the
balance to their savings accounts and adjust the amount due from the
borrower out of the same. In January 1989, the bank intimated the

28 Banker and Customer by S.Evelyn Thomas & Maurice Megrah, 5th Edn,
1947, p.384

29 (1945) 15 Comp. Cas. 4

30 AIR 1992 SC 1815

 77

respondent that the amount due on the loan had been adjusted out of the
proceeds of the fixed deposit and the balance credited to the savings account
of the respondents with the bank. The respondent filed a complaint alleging
criminal misappropriation by the bank on the ground that, since recovery
of the debt was barred by limitation on May 5, 1987, the liability of the
guarantors also stood extinguished on the date and the bank ought to have
credited the entire amount in fixed deposit on maturity in the respondent’s
accounts. The magistrate issued process and this was confirmed by the High
Court. The bank preferred an appeal before the Supreme Court.

The Supreme Court held as follows :

The rules of limitations are not meant to destroy the rights of parties.
Section 3 of the Limitation Act, 1963 only bars the remedy, but does not
destroy the right. The right to the debt continues to exist notwithstanding
that the remedy is barred by limitation. Though the right to enforce the
debt by judicial process is barred under Section 3 read with relevant Article
in the schedule, the right to debt remains. The time - barred debt does not
cease to exist by the reason of Section 3. That right can be exercised in any
other manner than by means of a suit. The debt is not extinguished, but the
remedy to enforce the liability is destroyed. What Section 3 refers to is only
the remedy but not the right of the creditors. Such debt continues to subsist
so long as it is not paid. It is not obligatory to file suit to recover the debt.
It is settled law that the creditor is entitled to adjust, from the payment of
a sum to a debtor, towards the time - barred debt. It is also equally settled
law that when the creditor is in possession of an adequate security the debt
due could be adjusted from the security in his possession and custody.
 78

Undoubtedly, the respondent and his wife stood as guarantors to the

principal debtor, jointly executed the security bond and entrusted the fixed
deposit receipt as security to adjust the outstanding debt from it at
maturity. Though the remedy to recover the debt from the principal debtor
is barred by limitation the liability still subsists. In terms of the contract,
the bank is entitled to appropriate the debt due and credit the balance
amount to the savings bank account of the respondent. Thereby the
appellant bank did not act in violation of any law, nor converted the amount
entrusted to them dishonestly for any purpose. Action in terms of the
contract, expressly or impliedly, is a negation of criminal breach of trust
defined in Section 405 and punishable under Section 409 of the Indian
Penal Code. It is neither dishonest nor a misappropriation.

The complaint does not make out a case, much less a prima
facie case, of a condition precedent to set cirminal law in motion.
The magistrate, without adverting as to whether the allegation in the
complaint prima facie makes out the offence charged, obviously, in a
mechanical manner, issued process against all the appellents. The High
Court committed a grave error in declining to quash the complaint on the
finding that the bank acted prima facie high - handedly.

It is submitted that judicial process should not be an instrument of

oppression or needless harassment. The complaint was laid impleading the
Chairman, the Managing Director of the bank by name and a host, of
officers. There lies the responsibility and duty on the magistry to find
whether the concerned accused should be held legally responsible for the
offence they are charged with. Only on being satisfied that the law casts a
 79

liability or creates an offence against a juristic person or the persons

impleaded, should process be issued. At that stage, the court should be
circumspect and judicious in exercising discretion and should take all
relevant facts and circumstances into consideration before issuing process
lest it be an instrument in the hands of the private complainant as vendetta
to harass persons needlessly. Vindication of majesty of justice and
maintenance of law and order in the society are the prima facie
objects of criminal justice but it would not be the means to wreak
personal vengeance. Considered from any angle, we find that the
respondent has abused the process of court and laid a complaint against all
the appellants (bank) without any prima facie case to harass them for
vendetta.

The appeal of the bank is, accordingly, allowed and the complaint is
quashed.

Set - off and Fundamental Rights

There is an interesting and leading case in Canara Bank v Taraka

Prabhu Publishers (Pvt) Ltd and others31 decided by the Andhra
Pradesh High Court.

The appellant, a nationalised bank, filed a suit for recovery of loans

from the respondent - company, and transferred certain sums standing to
the credit of the company in current account to the loan account. The
company filed a writ petition under Article 226 of the Constitution of India

31
AIR 1991 AP 258
 80

against the action of the bank contending that, if the bank were not
restrained from transferring the amount deposited in current account to
loan account, the company would have to close down, and this was denial
of the fundamental right guaranteed by Articles 14 and 19 (1) (g) of the
Constitution, and also prayed that the bank be directed to consider the
proposal for reviving the company. An interim order was passed restraining
the bank from transferring amounts deposited in the company’s current
account to the loan account. The bank filed an appeal against the interim
order.

The High Court held, allowing the appeal and dismissing the writ
petition, that the petitioners had taken loans from the bank which they had
failed to repay consequent upon which the bank was trying to exercise the
right of set - off in terms of the contractual obligations undertaken by the
petitioners by transferring the amounts deposited by them in the current
account to the loan account. The matter fell within the domain of the law
of contract and the right of set - off claimed by the bank could not be
denied. Nor could the claim of the bank to set - off, for the purpose of
realising its dues, which in the final analysis, was in public interest, be
characterised as arbitrary or mala fide.

It is submitted to refer to the following observations of the High

Court :

The counsel appearing for the petitioners relying on Olga Tellis v

Bombay Municipal Corporation, AIR 1986 SC 180 contended that the
action of the first respondent bank in transferring the amount deposited by
 81

the first petitioner in its current account to its loan account for set - off is
in flagrant violation of the fundamental rights of the petitioners guaranteed
under Article 19 (1) (a) of the Constitution of India, as also it affects the
fundamental rights of the petitioners under Article 21 of the Constitution
of India. The principle decided by the Supreme Court in the above said case
is that there can be no estoppel against the Constitution which is the
paramount law of the land and the source and sustenance of all laws. It
was further held that no individual can barter away the freedoms conferred
upon by the Constitution. In the above said decision, the Supreme Court
was considering the effect of an undertaking given before the High Court
by the petitioners who were hut and pavement dwellers to the effect that
they did not claim any fundamental right to put up huts on pavements or
public roads and will not obstruct the demolition of the huts after certain
date. It must be stated that it is beyond any shadow of doubt that the
petitioners cannot draw any sustenance from the ratio of the above decision
in so far as the present case is concerned".

In the instant case, the petitioners have borrowed loan from the bank
which they have failed to repay and consequent upon which the bank is
trying to exercise the right of set - off in terms of the contractual obligations
assumed by the petitioners by transferring the amounts deposited by them
in the current account to the loan account. It would be extremely far-fetched
to say that, having borrowed the loans, the petitioners’ current account
cannot be interfered with for the discharge of the loans as it would result
in the deprivation of the rights of the petitioners guaranteed to them under
Article 19 (1) (a) and Article 21 of the Constitution of India as they would
 82

be prevented from carrying on their profession. The correct way to look at

the controversies arising in this case is not as to whether the petitioners
have given up their fundamental rights available to them under the
Constitution by entering into a contract with the respondent banks but to
see whether the respondent - banks have a right to claim set - off of the
amount deposited in the current account by transferring them to the loan
account in order to realise the loans advanced to the petitioners which they
have failed to discharge. We are of the view that this falls within the
domain of the law of contract and the right of set - off claimed by the banks
cannot be denied on the pretext that the transfer of the amount in the
current account will result in the negation of the activities of the petitioners
in publishing the newspapers, weeklies, etc.

The question arising for consideration in this case is whether the

respondents in any manner are acting in an illegal or arbitrary manner or
whether the action taken by them is mala fide, or for a collateral purpose
due to which it can be held that the action of transferring the amounts from
the current account to the loan account by the respondent - bank is vitiated
in the eye of the law. We find it extremely difficult to accede to this
argument of the learned counsel that enforcement of doctrine of set - off for
the amounts to be realised by the bank which is also in the ultimate
analysis in public interest is an action which is arbitrary or an exercise' in
a mala fide manner. A logical extension of this argument would lead
to a somewhat astounding principle wherein it would he open for
persons to wriggle out of their contractual obligation by pleading
that their fundamental rights are affected if the terms of the
 83

contract are enforced against them. We have no hesitation in rejecting

this argument advanced by the learned counsel for the petitioners for the
reasons which we have stated above in extenso.

Set - off and Doctrine of Notice

It is of paramount importance to consider whether a banker can

exercise the right of set - off without giving notice to the customer.

While dealing with doctrine of notice, it is interesting to refer to

Bagg’s Case32 wherein James Bagg, a chief Burgess of Plymouth had been
disenfranchised for unbecoming conduct in as much as it was alleged that
he had told the Mayor, ‘you are a cozening knave. I will make thy neck
crack’ and by ‘turning the hinder part of his body in an inhuman and
uncivil manner’ towards the Mayor, said, ‘come and kiss’. He was reinstated
by mandamus as no notice or hearing was given to him before passing the
impugned order.

In R v University of Cambridge33, Dr. Bentley was deprived of his

degree by the Cambridge University on account of his alleged misconduct
without giving any notice or opportunity of hearing. The Court of King’s
Bench declared the decision as null and void. According to Fortescue, J. the
first hearing in human history was given in the Garden ofEden. His
Lordship observed :

32 (1615) 11 Co. Rep 93 b : 8 Digest 218

33
(1723) 1 Str 757 : 93 ER 698
 84

Even God himself did not pass sentence upon Adam, before he was
called upon to make his defence. ‘Adam’ says God, ‘where art thou? Hast
thou not eaten of the tree, whereof I commanded thee that thou shouldst

not eat?’.

Even if there is no provision in the statute about giving of notice, if

the act in question adversely affects the rights of an individual, the notice
must be given.

Lord Chorley in his Law of Banking, 6th Edition, 1974, page 221
argues that the banker is entitled to exercise his right of set - off without
giving notice to the customer although the contract may provide that such
notice must be given.

The Court of Appeal in Halesowen Presswork Assemblies Ltd v

National Westminster Bank Ltd34 had held that as such notice to
terminate the "Freeze" had not been given by the bank they had no right
to effect the combination. The House of Lords in National Westminster
Bank Ltd v Halesowen Presswork Ltd35 unanimously reversed this
decision pointing out that before any such notice had become operative the
customer would obviously draw out the balance standing to his credit, so
that to imply such an obligation was contrary to any reasonable assessment
of the position. From the point of view of bankers, this is the most
important practical aspect of the Halesowen case.

34 (1970) 3 All E.R. 473

35
(1972) 1 All E.R. 641
 85

Halesowen Presswork case (supra) resolved the doubt that existed of

notice to be given to the customer of the banker’s intention to combine the
accounts. Lord Cross in the House of Lords remarked that on the one hand
a period of notice would enable the customer to defeat the combination by
withdrawing the credit balance, while on the other hand if he had no notice
at all he might continue to pay into his account cheques that he could have
paid into another bank if he had known the true position.

In Garnett v McKewan36, a customer drew cheques against his

credit balance at one branch of a bank. At another branch, he was indebted
to an amount almost as great as the credit balance at the first, and the
bank, without notice to him, combined the balances and dishonoured his
cheques. It was held that they were entitled to do so. There is no legal
obligation on a bank to give notice to the customer of intention to combine
accounts, either from express contract or course of dealing. This case is a
high level authority for the proposition that a banker may set - off different
accounts of his customer without notice, whether such accounts are kept at
the same or different branches.

In Marten v Roche, Eyton and Co37, an auctioneer habitually paid

the proceeds of sale of livestock into his private account at the bank. The
bank knew the nature of the credits and had sanctioned the overdraft limit
of £ 2,500. The bank without notice withdrew the facility and applied the
proceeds of sale in reduction of the overdraft. The plaintiff brought the

36 (1872) 27 L.T. 560

37
(1885) 53 L.T. 946
 86

action against the bank on behalf of all the vendors concerned for the
recovery of the sale proceeds less the auctioneer’s commission. It was held
that auctioneer paid the proceeds of the sale into his private account in the
ordinary course of business and was not guilty of breach of trust in so
doing. The bank was entitled to take the action which it did and the
plaintiff had no remedy against the bank.

In the House of Lords, Lord Cross dealt with the question of notice
in National Westminster Bank Ltd v Halesowen Presswork
Assemblies Ltd33 in the following terms :

"I cannot agree ... that any period of notice was necessary for on
receipt of such notice the company could have defeated the object with
which it was given by at once drawing out the credit balance on the
account. The choice as I see it lies between a notice taking immediate effect
or no notice at all".

In Buckingham & Co v London & Midland Bank Ltd3®, B had

two accounts, one current and other loan, the latter being secured by a
house. After a time, the Bank got the house revalued and decided that the
advance was too high. A notice was given to B that the current account was
closed. He requested the Bank to honour the cheques he had issued before
such notice. The Bank however combined the two accounts and dishonoured
the cheques. B sued the Bank for damages. Held that the course of dealing

38 (1972) 1 All E.R. 641 HL

39 (1895) 12 T.L.R. 70
 87

between the Bank and the customer was that the cheques would be drawn
on current account without reference to the loan account and was entitled
to reasonable notice before closure of the current account.

In Greenhalgh v Union Bank of Manchester*0, Swift J said "If

a banker agrees with his customer to open two or more accounts he has not,
in my opinion, without the consent of the customer, any right to move either
assets or liabilities from the one account to the other; the very basis of his
agreement with his customer that the two accounts shall be kept separate".

The Right of Immediate Set - off

In the event of death, bankruptcy, or insanity of a customer, all

balances due to and from him have to be combined to decide how much is
due net to or from the estate. The same procedure applies upon the failure
of the firm or the liquidation of a Limited Company. The position is also
determined when a garnishee order is served upon the bank. In all such
cases, the immediate need to combine the balances is obvious and the power
to setoff without notice is undoubted. Again, the undoubted right of
set - off arises where the banker as first mortgagee receives notice that a
second charge has been created over the security. In such event the
accounts have to be stopped to determine the amount which can be looked
upon as secured first out of the given security. Any advances made
subsequent to such notice will rank after the second mortgagee and
circumstances may demand the immediate set - off of all accounts to
determine the position.

40
(1924) 2 KB. 153
 88

In the case of ordinary trade debts, the rule is that a creditor may,
without notice to his debtor, set - off a credit balance due to the debtor
against the debt due by him. But the debt owing by a banker to his
customer on current account is not the same as an ordinary debt because
it involves an obligation on the banker’s part to honour cheques drawn by
the customer against the balance outstanding, and because the banker
renders himself liable if the customer suffers damage through the wrongful
dishonour of any cheques so drawn.

Where-notice is required before the right of set - off can be exercised^

notice taking immediate effect is sufficient. Otherwise the customer could
defeat the right by withdrawing the credit balance immediately. Even
where immediate notice is given, the banker would be bound to honour
outstanding cheques drawn in good faith before receipt of such notice.

An agreement to keep the accounts separate may be abrogated by

subsequent developments. The classic case in point is where the customer
becomes insolvent. His bankruptcy or winding up usually abrogates the
agreement, and may restore to the bank its right to combine the accounts
without notice. Thus in British Guiana Bank v OR41 Lord Macnaghten
held that an agreement to keep accounts apart remained in effect only
whilst the accounts were current. It came to an end when they were frozen
by the customer’s insolvency.

41
(1911) 104 LT 754 (JC)
 89

In National Westminstar Bank v Halesowen Presswork

Assemblies Ltd42, the bank agreed to keep the current account and the
frozen account apart for four months provided there was no material
alteration in the customer’s circumstances. Two changes took place. Initially
the customer convened a meeting of creditors, and subsequently, he decided
to wind up voluntarily. The bank had resolved not to combine the accounts
after the first event, but exercised its right without notice after the second
event. Their Lordships were unanimous that the words of the agreement
indicated that it was automatically avoided when the company decided to
wind up. Notice by the bank of its decision to combine the accounts was
therefore not required. Their Lordships indicated, however, that in the
absence of clear language to such an effect, notice would probably be
required. Viscount Dilhorne said that, if the bank had made its decision to
combine the accounts in the wake of the customer’s decision to convene a
meeting of creditors, the bank would have had to give reasonable notice.
Lord Cross of Chelsea said that, ordinarily, a bank would in the very least
have to honour cheques drawn by the customer upto the time he was given
notice of the combination of his accounts.

It is submitted that from a commercial point of view, it is necessary

to take into account two conflicting considerations. On the one hand, the
need of serving notice can do irreparable harm to the bank. Notice would
enable the customer either to draw on his account until the ‘reasonable
time’ given to him had expired or to divert cheques payable to him to some
other bank accounts. On the other hand, it has been shown that the bank
cannot close his customer’s account, and thus terminate the contract
between them, without serving notice.

42
[1972] AC 785
 90

Advance notice of set - off to the customer would provoke him to issue
cheques and wipe off the credit balances in his account. Set - off without
notice may lead to dishonour of cheques of the customer who may move the
Consumer Forum / Civil Court and claim damages for such dishonour
consequent upon set - off without notice.

Thus the banker is sandwitched between devil and deep sea in the
matter of notice on setting off accounts. Conflict of judicial decisions still
aggravates the problem.

There appear to be no leading cases in India touching the aspect of

notice while exercising right of set - off by the banker. The English cases
are the sources for the Indian bankers regarding notice on setting off
accounts.

Set - off is Banker’s Right

The right of set - off is solely the right of the banker. The customer
has no corresponding right. Thus if the customer has a debit balance of
Rs.100/- in one account and a credit balance of Rs. 1000/- in another account
and then draws a cheque for Rs.200/- on the first account, he cannot
demand that the banker should honour his cheque. If, however, the banker
does decide to honour the cheque he has implied authority to debit the
customer’s second account to the extent that is necessary for him to do so.