Legal Principles
43Where several separate debts are due from a debtor to a creditor, the debtor may appropriate the money to a particular debt or debts. If a creditor accepts the payment, it must then apply it in the manner directed by the debtor. However, if a debtor does not make an appropriation when the payment is made then the creditor may be allowed to do so : Simson v Ingham .
44For the act of appropriation by a debtor to have occurred, it is essential that the debtor communicates its intention to appropriate to the creditor, so that the creditor knows that its right of appropriation has not arisen: Leeson v Leeson . However, it is not essential that the debtor be explicit that an appropriation is being effected at the exact time that the payment is made; it is enough that it was indicated - through words or conduct - that it is it's intention to appropriate the payment at a prior point in time.
45Intention by a debtor to appropriate can be ascertained from a variety of circumstances and will depend entirely on the particular circumstances of the case.
46An important question that arises is whether an appropriation that is once made can then be reversed through mutual agreement.
47It has long been held that where a debtor owes a creditor a certain amount, both parties cannot contract to reduce the size of the debtors debt. In Penny v Cole (Pinnel's Case), it was found that an agreement to take a lesser sum than that which is owed, of itself, will not amount to a binding obligation.
48The general law of contract is also clear that past performance cannot constitute valuable consideration. As such, a debt which has already been discharged cannot form the basis of the consideration in a new agreement.
49However, ancillary issues arise where there is an entirely new agreement that involves not merely agreement regarding the size or liability of the (previously discharged) debt, but also covers a range of additional matters. In this situation there is a basis for asserting that consideration has passed, as the consideration for the agreement may be found in other promises or sacrifices that the debtor and creditor have made. Here, a similar logic as that which was applied in Pinnel's case would apply, as the court found there that an agreement to reduce the size of the debtors debt would be binding where the monetary reduction was accompanied by some other form of proprietary compensation (the "gift of a horse, hawk, or robe", for example, to quote Sir Edward Coke).
50The exact question of whether a debt can be reversed through contractual negotiations was discussed in Foakes v Beer , which has since been followed in a number of cases: see Kelen v Vitamin Pty Ltd; Monsour Pty Ltd v Amos; Martech International Pty Ltd v Energy World Corporation ; N Ray v Deputy Commissioner of Taxation and Hennessey v Architectus Group Holdings Pty Ltd .
51In Foakes it was established that in an agreement between judgment debtor and creditor, where the debtor promises to pay down part of the judgment debt in return for the creditor not taking proceedings on the judgment the agreement is nudum pactum, or, without consideration.
52Whilst the parties in Foakes had made an agreement to alter the original debt owing, the court found that there was a live question as to whether that agreement was capable of being construed as legally binding. The Earl of Selbourne LC observed that:
"if the question be (as in the actual state of the law, I think it is), whether consideration is, or is not, given in a case of this kind, by the debtor who pays down part of the debt presently due from him, for a promise by the creditor to relinquish, after certain further payments on account, the residue of the debt, I cannot say that I think consideration is given in the sense that I have always understood that word to be used in our law. It might be (and indeed I think it would be) an improvement in our law, if release or acquittance of the whole debt, on payment of any sum which the creditor might be content to receive by way of accord or satisfaction (though less than the whole), were held to be, generally, binding though not under seal; nor should I be unwilling to see equal force given to a prospective agreement, like the present, in writing though not under seal; but I think it is impossible, refinements that practically alter the sense of the word, to treat such a release or acquittance as supported by any new consideration proceeding from the debtor" (emphasis added).
53This reasoning has been applied in numerous subsequent cases, which have distinguished between the ineffective agreement to reduce or extinguish a debt owing and an alternatively binding agreement that purports to extinguish or reduce an existing debt whilst also providing fresh consideration. In Vanhergen v St Edmunds Properties Ltd , for example, the court applied Foakes to state that:
"a creditor cannot bind himself by a simple agreement to accept a smaller sum in lieu of an ascertained debt of larger amount, such as an agreement being nudum pactum. But if there be any benefit, or even any legal possibility to the benefit of the creditor thrown in, that additional weight will turn the scale and render the consideration sufficient to support the agreemen t" (emphasis added).
54The same reasoning has been applied in a range of general (non debt related) situations, where a similar conceptual situation arises: see, for example, Fortune Food Manufacturer Pty Ltd v Young Trading Pty Ltd ; Combins v Jenson and Hewitt v Garder for recent applications of the principle. However, where there are new terms within the agreement, signifying fresh consideration, contracts have been upheld and the original act already done has been subsequently enforced (or, in the case of appropriation of debts, effectively reversed). In Hennessey v Architectus Group Holdings Pty Ltd , for example, Slattery J found that there was in fact a lawful and binding agreement despite the fact that some of the promises made in the agreement had previously been satisfied on the basis that there were also ancillary terms in the agreement providing fresh consideration.
55On this basis, whilst a discharged debt cannot form the basis of consideration in a contract, there is no reason why an agreement that derives its consideration from another promise or set of promises cannot involve enforceable provisions regarding a reappropriation of a previously discharged debt. As long as there is valuable consideration (be it related to the debt or otherwise), the reasoning Pinnel's case and Foakes v Beer and their more contemporary enunciations are satisfied.