This section is from the book "The Law Of Contracts", by William Herbert Page. Also available from Amazon: Commercial Contracts: A Practical Guide to Deals, Contracts, Agreements and Promises.
In some jurisdictions the general rule that payments from a fund must be applied so as to exonerate such fund, is affected by the knowledge or the ignorance of the creditor to whom such payment is made, of the fund or source from which such payment is made. If the creditor knows of the source of the payment or of the fund from which it is made, it is said in many jurisdictions that he can not apply such payment in any other way except to the exoneration of such fund or source even with the consent of the debtor who makes the payment, as long as other persons would be prejudiced by any other application of such payment.1 If a materialman or a subcontractor knows that a payment which is made to him by the principal contractor is made from funds which were paid to the principal contractor by a property owner under a specific contract, such subcontractor or materialman must apply such payment to the discharge of indebtedness growing out of such contract.2 If a third party whose property is subject to a lien to secure a certain debt furnishes the debtor with money to discharge such debt, and the creditor knows of the source of such fund, such payment can be applied only to the debt which is secured by such lien.3
3 R. Haas Electric & Mfg. Co. v. Springfield Amusement Park Co., 236 111. 452, 23 L. R. A, (NS) 620, 86 N. E. 248.
4 Thorp v. Croto, 79 Vt. 390, 10 L. R A. (NS.) 1166, 65 Atl 562.
5 St. Louis & San Francisco By. Co. v. Ravia Granite Ballast Co., - Okla. - , 174 Pac 252.
6 Sioux City Foundry & Mfg. Co. v. Merton, 174 la. 332, L R. A. 1916D, 1247, 156 N. W 367; Mills v Olsen, 43 Mont. 129, 115 Fac. 33; Crane Bros
Mfg Co v. Keck, 35 Neb. 683, 53 N. W. 606; Lee v Storz Brewing Co, 75 Neb. 212, 106 N. W. 220; Boyer-Van Eursn Lumber & Coal Co v Colonial Apartment House Co, 94 Neb 180, 142 N. W 519.
1 Mills v. Olsen, 43 Mont. 129, 115 Pac. 33; Lee v. Storz Brewing Co., 75 Neb 212, 106 N. W 220; Crane Co. v Pacific Heat & Power Co. 36 Wash. 95, 78 Pac 460; Farr v. Weaver, - W. Va. - , 99 S. E 395.
In some jurisdictions, however, it seems to be held that the knowledge of the creditor is immaterial, and that if the fund which is paid by the debtor is the property of the debtor and not merely a trust fund for the property of another, such payment is subject to the ordinary rules of appropriation of payments as between the debtor and the creditor without reference to the fund or the source from which the payment is made.4 Where this view prevails, a principal contractor to whom a payment under a contract has been made by the property owner, may apply such money to the payment of his debts as he chooses, without regard to the interests of the property owner.5 In some of the jurisdictions, however, in which this view has been expressed,6 it has subsequently been disapproved.7
If the creditor to whom the payment is made is ignorant of the fund or the source from which such payment is made, it is held in some jurisdictions that such payments are governed by the ordinary rules of appropriation of payments as between the debtor and the creditor; and that in such case it is not necessary that such payment should be so appropriated as to exonerate the fund or the source from which such payment comes.8 Where this view prevails, a subcontractor or materialman who does not know the source of the fund from which the principal contractor makes a payment, is not bound to make investigation; but he may treat such payment as the property of the principal contractor and he may appropriate it to the payment of some debt other than the debt growing out of the contract under which such contractor had received such fund from the property owner.9
2 Mills v. Olsen, 43 Mont. 120, 115 Pac. 33; Lee v. Store Brewing Co., 75 Neb. 212, 106 N. W. 220; Crane Co. v. Pacific Heat & Power Co., 36 Wash. 05, 78 Pac. 460.
3 Farr v. Weaver, - W. Va. - , 99 8. E 395.
4W. FT. Pipkorn Co. v. Evangelical Lutheran St. Jacobi Society, 144 Wis. 601, 129 N. W. 516.
5W. H. Pipkorn Co. v. Evangelical Lutheran St. Jacobi Society, 144 Wis. 501, 120 N. W. 516.
6 Paget Sound State Bank v. Gal-lucci, 82 Wash. 445, 144 Pac. 698.
7 B. F. Sturtevant Co. v. Fidelity & Deposit Co., 92 Wash. 52, L. R. A. 1917C, 630, 158 Pac. 740.
8 Chicago Lumber Co. v. Douglas, 89 Kan. 308, 44 L. R. A. (N.S.) 843. 131 Pac. 563; George H. Sampson Co. v. Commonwealth, 208 Mass. 372, 94 N. E. 473; B. F. Sturtevant Co. v. Fidelity & Deposit Co., 92 Wash. 52, L. R. A. 1917C, 630, 158 Pac. 740.
In other jurisdictions the interests of the person who furnishes the fund from which the debt is paid eventually, or who has a financial interest in a fund or in property by which such debt is secured, are regarded as of paramount importance, even though the creditor to whom the payment is made is ignorant of the fund or of the source of payment.10 If a surety furnishes money to the principal debtor for the discharge of the debt, it is held that the creditor must apply it to such debt, even if he does not know of the source of such payment.11 If a contractor has made a general payment to a subcontractor or materialman out of funds paid him under a given contract by the property owner, and if the subcontractor or materialman in ignorance of the source of such payment has applied it to a debt of the contractor arising out of a different building contract, and if he has released the lien for the debt to which he has appropriated such payment, it is held that the property owner by whom such payment was made to such contractor may insist upon its appropriation to debts due to subcontractors and materialmen incurred in the performance of such contract, so as to relieve such property from mechanics' liens.12
Sec. 2846. Appropriation, when immaterial In the absence of facts differentiating debts, it has been held that the law will apply payments pro rata.1 If no practical difference exists in legal effect between an appropriation made without legal authority and one made in accordance with law, the law will not interfere to change the appropriation as made. Thus if two notes are secured by a mortgage, application by the creditor of a payment to the last to fall due instead of to the first is not prejudicial to the debtor, where, even if such payment had been applied to the first note, a balance would be due thereon, which, by the terms of the mortgage, would make the second note due and payable at the option of the mortgagee.2 If the debtor owes two notes of equal amounts to the same payee, secured in the same way and indorsed to two different holders, and he directs a payment due to him from the indorser to be applied on one of such notes, the application of such payment to the other note is in no way prejudicial to the debtor and is binding.3
9 Crane Co. v. Wichita Union Terminal Ry., 08 Kan. 336, 158 Pac. 59; B. F. Sturtevant Co. v. Fidelity ft Deposit Co., 92 Wash. 52, L. R. A 1917C, 630, 158 Pac. 740; Farr v. Weaver, - W. Va. - , 99 S. E. 395.
10 Sioux City Foundry A Mfg. Co v. Merten, 174 Ia. 332, L. R. A. 1916D, 1247, 156 N. W. 367.
11 Columbia Digger Co. v. Rector, 215 Fed 618
12 Sioux City Foundry ft Mfg Co. v. Merten, 174 Ia 332, L. R. A. 1916D, 1247, 156 N W. 367.
1 Turner v Hill, 58 N J Eq 293, 39 Atl 137; Swisher v. McWhinney, 64 O S. 343, 60 N E. 565; Wetmore ft Morse Granite Co. v. Ryle, - Vt. -, 107 Ail. 109.