Banker's Lien under Section 171 Contract Act and the Right of Set-off

A bank lends money and holds its customer's property, and the two facts meet when the customer defaults. The law gives the banker three devices for that moment: a lien over what it holds, a right to set one account against another, and a set of rules deciding which debt a payment goes to. The third sounds mechanical and is in fact the most litigated, because it decides whether a guarantor remains liable and whether a security still stands.

1. The Banker's General Lien

Section 171, Indian Contract Act, 1872

Bankers, factors, wharfingers, attorneys of a High Court and policy-brokers may, in the absence of a contract to the contrary, retain as a security for a general balance of account, any goods bailed to them; but no other persons have a right to retain, as a security for such balance, goods bailed to them, unless there is an express contract to that effect.

General, not particular: an ordinary lien under Section 170 secures only the charges on the particular goods. A banker's lien is general, securing the whole balance of account, which is what makes it valuable.
A statutory recognition of custom: the banker's lien existed as a usage of bankers long before 1872. Section 171 gives it statutory force, and the words in the absence of a contract to the contrary mean it can be excluded or enlarged by agreement, as the account terms usually do.
An implied pledge: the lien is described as an implied pledge, because the banker may not merely retain the security but may, after notice, sell it and apply the proceeds. An ordinary lien gives only a right to retain.
What it attaches to: securities, bills, cheques, share certificates, bonds and other instruments that have come into the bank's hands in its capacity as a banker.

The conditions for the banker's general lien

Figure 1: The conditions for the banker's general lien

What the lien does not cover

Property held for a specific purpose: securities deposited for safe custody, or money paid in to meet a particular bill, are outside the lien, because the purpose is inconsistent with retention against a general balance.
Property coming in by accident: an article left behind in the branch, or money credited by mistake, does not come to the bank as a banker.
Property of a third person: securities belonging to someone other than the debtor cannot be retained for the debtor's balance, even where the debtor deposited them.
Articles in a safe deposit locker: the bank has no possession of the contents and therefore no lien over them.
Money deposited as a trustee: a trust or client account is held in a different right and is outside both the lien and set-off.
Negative lien: this is not a lien at all. It is an undertaking by the borrower not to create any charge on specified assets without the bank's consent. It gives the bank no proprietary interest, only a contractual claim if the undertaking is broken.

2. The Right of Set-off

The lien and the set-off compared

Figure 2: The lien and the set-off compared

What it is: the right to combine two or more accounts of the same customer and to pay only the net balance. It converts two separate claims into one.
Mutuality: the debts must be between the same parties and in the same right. A sole account may not be set against a joint debt, nor a personal account against money held as a trustee.
Both must be due: the debts must be presently payable. A fixed deposit before maturity is not yet due, so it may not ordinarily be set off unless the contract permits it, and bank account terms usually do.
Certain in amount: a contingent or unascertained claim, such as a liability under a guarantee that has not yet been invoked, cannot be set off until it crystallises.
Notice: although the right is often described as exercisable without notice, the better view, reflected in the codes of fair practice that banks have adopted, is that a bank should give the customer reasonable notice of a set-off, and certainly inform him promptly once it has been exercised.
Automatic set-off: on the customer's death, insolvency, or the winding up of a company customer, and on receipt of a garnishee order or notice of assignment, the accounts are treated as combined at that moment, because the mutuality is fixed then.

⚠ Note

Set-off is a right, not a duty, and its exercise can cause real hardship, as where a bank takes a salary credit to meet an overdue instalment and leaves the customer without money for the month. The contract usually authorises it, but the Reserve Bank's charter of customer rights and the fair practices code require a bank to act reasonably and with notice, and an unreasonable exercise is open to challenge as a deficiency in service.

3. Appropriation of Payments

Section 59, the debtor's right: where a debtor owing several distinct debts makes a payment, with express intimation or in circumstances implying that the payment is to be applied to a particular debt, it must be so applied.
Section 60, the creditor's right: where the debtor makes no such indication, the creditor may apply the payment at his discretion to any lawful debt actually due, including a debt whose recovery is barred by limitation.
Section 61, the law's rule: where neither party appropriates, the payment is applied to the debts in order of time, including time barred debts, and if the debts are of equal standing, proportionately.
Principal and interest: where a debt carries interest, the ordinary rule of practice is that a payment is applied first to interest and then to principal, unless the contract provides otherwise.
Why it matters: the appropriation decides which debt survives. That in turn decides whether a surety remains liable, whether a security is still charged, and whether a claim is still within limitation.

📖 Devaynes v. Noble (Clayton's case), (1816) 1 Mer 572

Facts: Devaynes, a partner in a banking firm, died. The surviving partners carried on the business, and Clayton, a customer with a credit balance at the date of death, kept operating his running account, drawing money out and paying more in, until the firm failed. The question was whether Devaynes's estate remained liable for the balance standing to Clayton's credit at the death, or whether Clayton's later drawings had exhausted it.

Held: In a running account where neither party has appropriated, the sum first paid in is the sum first drawn out: the first item on the debit side is discharged by the first item on the credit side, in short first in, first out. Clayton's drawings after the death exceeded the balance then standing, so that balance had been paid off, the later deposits were debts of the surviving partners alone, and Devaynes's estate was discharged.

Ratio: The rule applies to any current or running account in which the items form a single blended fund, unless the parties agree otherwise or the circumstances show a different intention. In banking it decides whether an overdraft outstanding at the date of a surety's revocation, a partner's death, or the registration of a later charge has been paid off by subsequent credits, which is why a prudent bank breaks the account at that moment and opens a new one.

4. Interest, Charges and Incidental Rights

Interest: the bank's right to charge interest rests on the contract and on banking practice, and the rate and the rests must conform to the Reserve Bank's directions under Sections 21 and 35A of the Banking Regulation Act.
Capitalisation: interest may be charged at periodical rests and capitalised where the contract or established practice so provides, as the Constitution Bench held in Central Bank of India v. Ravindra, (2002) 1 SCC 367. Penal interest may not be capitalised.
No reopening for excess: Section 21A of the Banking Regulation Act bars a court from reopening a transaction between a bank and its debtor on the ground that the rate of interest is excessive.
Penal charges: the Reserve Bank now requires that charges for default be levied as penal charges and not as penal interest added to the rate, so that they cannot be compounded, and that they be reasonable and proportionate.
Incidental charges: the bank may levy service charges disclosed in its schedule, subject to the requirement that they be reasonable and transparently published.
Right to close an account: a bank may close an account on reasonable notice, since the relationship is contractual, but must not do so capriciously, and a public sector bank acting as State must act fairly.

5. Questions Arising

Can a bank sell shares it holds under its lien?

Yes, within limits. The banker's lien is treated as an implied pledge, so the bank may, after giving reasonable notice of its intention, sell the securities and apply the proceeds to the balance due. A sale without notice is wrongful even though the debt is admitted, and the customer may claim the difference between the price realised and the value he could have obtained.

Why does a bank break an account when a guarantee is revoked?

To defeat the rule in Clayton's case. If the account continues to run, later credits are applied to the earliest debits, so the balance the guarantor covered is progressively paid off while new advances take its place, and the guarantor is discharged on the old debt without securing the new. By ruling off the account at the moment of revocation and opening a fresh one, the bank freezes the guaranteed balance and keeps the surety liable for it.

⚠ Key point

Section 171 of the Indian Contract Act, 1872 gives bankers a general lien, in the absence of a contract to the contrary, to retain as security for a general balance of account any goods bailed to them. It is an implied pledge, so the bank may sell after notice. It requires lawful possession as a banker and does not extend to property held for a specific purpose, property of a third person, locker contents or money held as a trustee. A negative lien is not a lien but an undertaking not to encumber. The right of set-off allows the combining of accounts where the debts are mutual, in the same right and presently due, and is treated as automatic on death, insolvency, winding up or a garnishee order. Appropriation follows Section 59 (the debtor chooses), Section 60 (the creditor chooses, including a time barred debt) and Section 61 (in order of time), and in a running account the rule in Devaynes v. Noble (Clayton's case), (1816) 1 Mer 572 applies first in, first out, which is why a bank breaks the account when a guarantee is revoked.

6. Quick Revision

✦ Points worth fixing

Section 171 is the banker's lien, and it is general, not particular.

An implied pledge, so the bank may sell after notice.

Possession as a banker, lawfully, without a special purpose, with a balance due, and no contract to the contrary. The five conditions.

A negative lien is not a lien. It is a promise not to encumber.

Mutual, same right, presently due. The three conditions of set-off.

Section 59 for the debtor, Section 60 for the creditor, Section 61 for the law.

Section 60 lets the creditor appropriate to a time barred debt.

First in, first out is Clayton's case, and breaking the account is the answer to it.

Penal charges, not penal interest. The current regulatory position.

7. Frequently Asked Questions

What is a banker's lien?

The right, under Section 171 of the Indian Contract Act, 1872, to retain as security for a general balance of account any goods bailed to the banker, in the absence of a contract to the contrary. It is general, covering the whole balance rather than charges on the particular goods, and is treated as an implied pledge, so the bank may sell the security after reasonable notice.

What property is outside the banker's lien?

Property deposited for a specific purpose inconsistent with the lien, such as securities left for safe custody; property that came to the bank by accident rather than as a banker; property belonging to a third person; the contents of a safe deposit locker, of which the bank has no possession; and money held in a trust or client account.

When can a bank exercise the right of set-off?

Where the debts are mutual, that is between the same parties in the same right, and both are presently due and certain in amount. A fixed deposit before maturity, a trust account against a personal debt, and a joint account against a sole debt are all outside it. Good practice, reflected in the banks' codes of fair practice, calls for reasonable notice to the customer when the accounts are combined.

What is the rule in Clayton's case?

That in a running account where neither party has appropriated a payment, credits are applied to the earliest debits in order of time: first in, first out. It comes from Devaynes v. Noble (Clayton's case), (1816) 1 Mer 572 and decides whether a balance outstanding at a given moment, such as the revocation of a guarantee or a partner's death, has been discharged by later credits.

How does a bank protect itself against the rule in Clayton's case?

By breaking the account. When a guarantee is revoked, a partner dies or retires, or notice of a later charge is received, the bank rules off the existing account and opens a new one for subsequent transactions. Later credits then go to the new account instead of discharging the old balance, and the surety or the security remains answerable for the frozen amount.

8. Related Topics and Provisions

Nature of the banker and customer relationship
Duties of a banker: secrecy, care and honouring cheques
Garnishee orders, attachment and termination of the relationship
Restrictions on loans and advances (Sections 19 to 21)
Sources of banking law