VARIOUS TYPES OF CHARGES

WHAT IS A CHARGE & WHAT IS ITS PURPOSE Charge is a right on tangible assets. Charging a security means making it available as a cover for an advance. In order to have a valid charge on securities, the securities must be good and the method of charging should be legal and perfect. It should be complete and all the necessary formalities for charge-creation must be complied with so that in case of default by a Borrower, the charged security will be available to the Banker. However, the Banker does not become the absolute or exclusive owner of the assets, he has only certain defined rights until the debt due to him is repaid. The purpose of charge is to reduce risk and to ensure safety. Charge may be floating or fixed charge. There are 2 ways for creation of charge. By act of Parties By operation of Law

FEATURES
Creation of charge does not imply necessarily existence of a debt; Charge is a security for payment of money; Charge holder does not get transfer of interest on charged property; A charge may create a liability in perpetually.

A banker therefore, will have to be selective in accepting the securities offered to him. He has to ensure that the security offered conforms to the following attributes of good security: Easy marketability; Capable of easy ascertainment of Value; Has stability of Value; Storability is easy/convenient; Is transportable; Is durable (as distinguished from perishable)

TYPES OF SECURITY
Personal Tangible Primary Collateral. The following are the methods usually resorted to by the banker for the purpose creation of charge. The method to be selected amongst other is also dependent on the nature of the securities offered :

1. 2. 3. 4. 5. 6. 7.

Pledge Hypothecation Lien Set off Appropriation Assignment Mortgage.

MODE OF CHARGES
LIEN : It is the right to retain all securities of the customer in respect of the general balance due from him (Section 171 of Indian Contract Act). The ownership of such securities is not transferred to the Bank. The Bank gets the right to retain the securities handed over to it in its capacity as Banker. Lien is of 2 types Particular Lien and General Lien. A Particular Lien is the right to retain goods in respect of which the debt was incurred. In case of General Lien, the right of retainer is not only for the debt incurred for particular goods, but also for any general balance due. LIEN PARTICULAR AND GENERAL : PARTICULAR LIEN : (Section 170 of the Indian Contract Act) Definition : Where the bailee has in accordance with the purpose of bailment rendered any service involving exercise of labour or skill in respect of goods bailed, he has in the absence of a contract to the contrary, a right to retain such goods until he receives due remuneration for the service he has rendered in respect of them. Ingredients : 1. 2. 3. Essentials : A. B. Possession acquired in the ordinary course of business The owner has a lawful debt or an obligation to discharge. A right to retention of goods till debt due is paid off Does not require any specific agreement Arises in the ordinary course of business.

GENERAL LIEN : (Section 171 of the Indian Contract Act) Definition : Bankers, wharfingers, Attorneys of High Court and Policy brokers may in the absence of a contract to the contrary retain as security for 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 a contract to that effect.

Ingredients
a) b) c) d) Extends to general balance of accounts (by combining all accounts); Also extends to prior transaction; Is a right of defense, not a right of action; Extends to properties/securities which a banker has come in possession of in ordinary course of business viz. cheques deposited for collection Securities/goods held for special purpose are not subjects of General Lien For example, i. ii. iii. iv. Money/Security Kept in Safe Custody; Trust Money, not the property of the customer; Title Deeds casually left after refusal of credit facilities; Deposit to secure a particular debt.

e)

A Bankers lien is more extensive than a general lien, it is considered an implied pledge and he has the right to sell the securities in certain circumstances, by giving reasonable notice.

MODE OF CHARGES
NEGATIVE LIEN The Banker does not get any right to retain any asset of the Borrower. The Borrower gives a declaration that the assets are free from any charge, encumbrance, agreeable to undertake not to create any charge over the assets or to dispose them of without Banks permission usually, the arrangement is drafted in the form an agreement. In case of a Ltd. Co. the declaration and undertaking are incorporated in a resolution of the Board and a certified true copy of it is given to the Bank. SET- OFF A set-off is a right which, in absence of any agreement to the contrary, enables a creditor to adjust wholly or partly a debit balance in the debtors account with any credit balance lying in

his favour. It means the total or partial merging of a claim of one person against another in a counter-claim by the latter against the former. It is in effect the combining of accounts between a debtor and a creditor so as to arrive at the net balance payable to one or the other. It may be a statutory right or may be by an agreement, express or implied from a course of dealings. The right of set-off enables a banker to adjust wholly or partly, as circumstances permit, a debit balance in a customers account with any balance lying at his credit, unless there is an express or implied agreement to the contrary. This principle will apply even if a customer has more than two accounts in credit or debit. Essentials of Set-off 1. Claims should be for known amounts; 2. Claims should be in the same rights; 3. Debts are due immediately; 4. No agreements to the contrary. Appropriation The Rules are contained in Sections 59,60 and 61 of the Indian Contract Act. These sections give specific directions/right to the creditor as to how to appropriate any payment received by him from his debtor. Section 59 deals with cases where the borrower indicates his intentions expressly or by implication. Section 60 deals with case where the borrower has not intimated his intention either expressly or by implication and Section 61 deals with case where neither party makes and appropriation. In practice, a banker would not arbitrarily and without notice, exercise his right of set-off unless he had an agreement to that effect with the customer. ASSIGNMENT It means transfer of a right, property or a debt existing or future-to another person. The transferor is called the assignor and the transferee the assignee. In banking, the usual subject of assignment is actionable claims, which means a claim to any debt other than a debt secured by mortgage of immovable property or by hypothecation or pledge of movable property or to any beneficial interest in movable property not in the possession, either actual or constructive, of the claimant, which the civil courts recognise an affording grounds for relief, whether conditional or contingent. The borrower may assign to the Banker : (1) the book debts (2) money due from Government department or Semi-Government Organisations and (3) Life Insurance Policies.

MODE OF CHARGES
Assignments are of two types : (1) Legal assignment and (2) Equitable assignment. In legal assignment, there is an absolute transfer of actionable claim and it must be in writing, signed by the assignor, who informs the debtor in writing intimating, the assignees name and address. The assignee (Bank) also serves a notice on the debtor of the assignor and seeks a confirmation of the balance so assigned. If all these requirements are not fulfilled, the assignment is called an equitable assignment. Equitable assignment is of doubtful value as security and even when a legal assignment has been accepted as a security, the following safeguards should be taken : (1) The borrower should give an irrevocable letter addressed to the person who owes the money to him with a request to pay the same to the Bank. In case of advance against supply bills, an irrevocable power of attorney in Banks favour should be obtained. (2) The Bank will forward this letter promptly along with a notice to the borrowers debtor for registration stating that the debt has been assigned in Banks favour with a request to acknowledge the same and to confirm the amount of debt and also the fact that he has not received any earlier assignment and has no right of set-off against the assignor. (3) An assignment should be for the whole of a debt and not a part of it.

PLEDGE
Section 172 of Indian Contract Act defines pledge as Bailment of goods as security for payment of a debt or performance of a promise. In case of pledge, the ownership lies with the borrower, but the possession is with the bank. Two important aspects are : (a) Bailment of goods. Bailment means delivery-physical and constructive - (handing over key of the godown or endorsement of document to the title of goods). Section 148 defines bailment as delivery of goods from one person to another for some purpose or condition that the goods will be returned back when the purpose is accomplished. So, delivery of goods and its return are the two important requisites of bailment. (b) Objective is to hold the goods as security for payment of a debt or performance of a promise. Bailment should be on behalf of a debtor or an intending debtor. A pledge may be in respect of goods, stocks, shares, documents of title to goods and any other movable property, safe custody is not pledge, even though there is bailment of goods. WHO CAN PLEDGE THE GOODS ? (1) (2) (3) The owner of the goods himself; The mercantile agent of the owner; Joint owner with the consent from other co-owners.

RIGHTS / OBLIGATION OF PLEDGOR : 1. 2. 3. 4. 5. 6. Right to redeem the security; Right to surplus in case of forced sale; Disclosure of material faults or extra-ordinary risks involved in the goods; Reimbursement of any expenses for preservation of security; In case of shortfall-pledgor should make good the shortfall; Defects in Title-Pledgor is responsible.

MODE OF CHARGES
RIGHT OF A BANKER AS PLEDGEE 1. Right to retain the goods pledged. This right is applicable only in case of a particular debt for which the goods are pledged, in absence of an agreement to the contrary (Section 174). The pledgee can also claim any extraordinary expenses incurred for preservation of the security. Bankers right to retain goods even if the pledgor has violated any provisions of the law in respect of the goods pledged Bank. Govt. of Bihar Vs. Govt. of Bihar, I.R., 1971, S.C.1210). In case of default by the pledgor

2.

(a) Right to file a suit for amount due and retain the goods as collateral security. Or (b) Right to sell the goods pledged after giving due notice of sale to the pledgor (Section 176). These are alternative rights and not concurrent rights. (Haridas Mundon Vs.N & G Bank 167) 3. The pledgor is bound to disclose to the pledgee the faults, if any, in the goods and if any loss is suffered by the pledgee, the pledgor is responsible; The pledgor is responsible for any loss suffered by the pledgee if the pledgor has a defective title to the goods; In case of fraud or misrepresentation by the pledgor, the contract is void able at the option of the pledgee; The pledgees right is not limited to his interest in pledged goods, he has all remedies that the owner of the goods may have against a 3rd party for deprivation of goods or injury to them.

4.

5.

6.

DUTIES OF THE BANKER AS PLEDGEE

1. The Banker is bound to return the goods on payment of the debt according to the direction of the pledgor as soon as the obligation to repay the amount is discharged; The Banker is responsible for any loss, destruction etc. if the goods are not returned in proper time; The pledged goods must be used according to the agreement between the pledgor and the pledgee; The pledgee is also bound to return any profit or increase which may have accrued from the goods bailed in absence of an agreement to the contrary (Section 163). The pledgee is bound to take as much care of the goods pledged as a man of ordinary prudence would, under similar circumstances, take of his own goods of the same bulk, quantity and value as the pledged goods (Section 151). If the pledgee has done so, he is not responsible for the loss, destruction or deterioration of goods pledged (Section 152), in absence of a special contract between them. (Balkrishnan I.Dayma Vs. Bank of Jaipur 1971, 42 Com.Case 557).

2.

3.

4.

5.

SPECIAL CARE TO BE TAKEN BY THE BANKER AS PLEDGEE

1. Obtaining letter of access from the owner of the premises if the pledged godown is rented; Ensuring that the stocks are moving and no goods are remaining idle First in first out principle is to be observed.

2.

MODE OF CHARGES
HYPOTHECATION In case of hypothecation, there is no definition in the relevant acts, only a mention in Section 3 of Transfer of Property Act, 1982. It is described as a charge against property for an amount of debt where neither ownership nor possession is passed over to the creditor (Hart). The goods remain in possession of the borrower and are equitably charged to the creditor under an agreement with a binding to give possession of the goods to the Banker when called upon to do so. After the possession is handed over to the Banker, the charge is converted from hypothecation into pledge. Hypothecation is now the most popular form of charge over movable assets when transfer of possession is inconvenient or impractical. For the sake of convenience of the debtor, the goods are allowed to be held by him in trust for the purpose of carrying out his business. A floating

charge is thus created over the goods. If the borrower defaults or violates terms of the agreement, the bank may take over possession of the goods. However, while taking over possession, the Bank will take a letter from the borrower stating that he has voluntarily handed over possession of the goods. Care should be taken that the possession is not forcible which may result in (a) allegation of trespass, (b) breach of peace and (c) endangering personal safety. PRECAUTION FOR HYPOTHECATION : The facility should be granted only to the person of good reputation; The borrower must submit periodical statement of stocks hypothecated; Periodical Inspection of stocks must be carried out; Full insurance cover of stocks with prescribed risks must be obtained; Display of Banks hypothecation board at a prominent place in the business premises for public notice; Registration of Banks hypothecation charge with a appropriate authorities, where necessary. RBI GUIDELINES AGAINST RISK OF DOUBLE FINANCING Enquiry to other banks, credit institutions etc. before entertaining the borrower; Obtaining written application along with declaration and undertaking regarding nonborrowing and non-encumbrance of stocks; Inspection at the pre-sanction and post-sanction stages; Maintenance of various books and registers for the purpose of verification by the Bank. MORTGAGE It is a charge in respect of an immovable property. Section 58 of Transfer of Property Act defines mortgage as transfer of an interest in specific immovable property for the purpose of securing payment of money, advanced or to be advanced by way of loan, existing or future debt or performance of an engagement which may give rise to a pecuniary (financial ) liability. CHARACTERISTICS OF MORTGAGE 1. 2. It is a transfer of interest in the specific immovable property and not transfer of ownership; If there are more than one co-owners, every co-owner can mortgage his share; The property to be mortgaged must be specific i.e. it is described and identified by its location, size, boundaries etc.;

MODE OF CHARGES
The object of mortgage must be to secure a loan existing or future or to ensure performance of an engagement may resulting in monetary obligation.; Actual possession of the property is not always transferred to the mortgagee;

Mortgagee gets the right to recover the amount of loan out of sale proceeds of the mortgaged property; On repayment of the loan together with interest, the mortgagor is re-conveyed with the interest in the mortgaged property.

FORMS OF MORTGAGE
There are 6 forms of mortgage (1) Simple (2) Mortgage by Condition Sale (3) Usufractuary (4) English (5) Equitable (6) Anomalous Section 58(b) States that 2 fold security in involved (a) Personal obligation (b) Property itself. Features : Possession remain with mortgagor Mortgagee has a right to sell the property After sale, deficiency can be met through decree. But for practical purpose, we discuss only two types of mortgage, namely, Simple Mortgage and Equitable Mortgage.

Simple Mortgage In this form the mortgager binds himself personally to pay the mortgage money, without delivering possession of the property, and agrees, expressly or implied, that if he fails to pay as per contract, the mortgagee will have a right to cause the mortgaged property to be sold and the sale proceeds to be applied in payment of the mortgage money to the extent necessary. Thus, in case of default by the borrower, the bank shall have to seek the courts intervention for selling the mortgaged property.

The Bank thus has two options : To apply to the court for permission to sell the mortgaged property, or To file a suit for recovery of the whole amount without selling the property. According to Section 59 of Transfer of property Act, 1882, a mortgage is to be registered if the mortgaged money is Rs.100/- or more. Thus, the mortgage deed is to be executed and appropriately stamped advalorem with two best available witnesses.

Equitable Mortgage
By delivering the documents of the title to the immovable property to the creditor with an intention to create an equitable interest of the mortgagee in the property. It means that legal title is not passed on to the mortgagee, but the mortgagor gives his assent orally (which is recorded by the Bank) for creation of equitable interest and also to execute a legal mortgage in case he fails to pay the mortgage money. The mortgagee is thus empowered to apply to the court to convert the equitable mortgage to legal mortgage in case of default by the borrower. MODE OF CHARGES

Essentials A debt existing or future; Delivery of original Title Deed; Expressed intention to create security on debt; No registration / no documents; Immovable Property : Characteristics Definitely identifiable; Clean and marketable title; Free from encumbrances.

ADVANTAGES OF EQUITABLE MORTGAGE No registration is necessary thus the borrower saves stamp duty and registration charges; Information regarding mortgage is confined to the Bank and the borrower thus the borrowers reputation is not affected; On repayment of the loan, the documents are simply returned to the customer, who can redeposit it for effecting another mortgage, if necessary; Mortgage gets the same rights as one conferred in case of simple mortgage.

PRECAUTIONS IN CASE OF EQUITABLE MORTGAGE : 1. No equitable mortgage on copies of revenue receipts, copies of last sale deed, assessment receipt or tax receipt, and receipt of deed from Registrar of assurances. Original title deed is necessary to create equitable mortgage; The documents must be carefully retained in possession of the bank and under no circumstances, the documents once deposited should be returned to the borrower unless the loan is repaid in full.

2.

Effects
No difference between Equitable and Legal Mortgage in India; Equitable Mortgage prevails against a subsequent registered Mortgage of same property Creates a right in them and not liable to the defeated by subsequent purchaser for value without Notice. SUB-MORTGAGE The mortgagee may himself like to sub-mortgage the property mortgaged to him. Such submortgages are accepted by banks in circumstances when a customer is unable to furnish any better security to the Bank. The precautions to be taken are as under : 1. a notice should be given to the mortgagor who will confirm the amount due from him to the mortgagee; the bank will direct the mortgager not to make payment to the mortgagee, but to the Bank, being the sub-mortgagee; the bank should take the original mortgage deed and the title deed from the mortgagee; the sub-mortgage shall be subject to the terms & conditions of the original mortgage deed and hence the bank should scrutinize these terms very carefully before submortgage is created in its favour.

2.

3.

4.

MODE OF CHARGES
LIABILITY OF MORTGAGOR 1. 2. Implied Liability which may be varied by a special contract to the contrary Liability for active waste.

RIGHTS OF MORTGAGOR
1. 2. 3. 4. 5. 6. 7. 8. Redemption : After payment mortgagor is entitled to get back his property; To compel the mortgagee to transfer to 3rd person instead of retransference to the mortgagor; To inspect and make copies of all documents in mortgagees possession; To recover possession of property and deed / all documents; To get all accession to the property during mortgage; To be entitled to all improvements in mortgaged property; To get benefit of renewal of lease by mortgagee; To grant a lease of mortgaged property where mortgagor is in possession.

RIGHTS OF MORTGAGEE 1. 2. 3. 4. 5. 6. 7. 8. Right to foreclosure - right to institute a suit for a decree that the mortgagor be absolutely debarred of his right to redeem. Right to suit for sale. Right to sue for mortgage money. Right to sell without Courts intervention i.e. English Mortgage Party not Hindu / Mohammedan / Buddhist i.e. Mortgagee Govt. and such power is expressed in deed. Right to spend money. Right to insure property. Right to proceed of revenue sale. Right to compensation on acquisition.

COMPARATIVE STATEMENT BETWEEN SIMPLE & EQUITABLE MORTGAGE 1. Mortgagor binds personally himself to notified repay on certain date. 2. Absolute transfer of the Property to the mortgagee. 3. Absolute transfer subject to promise that upon payment the mortgagee to Re -convey the mortgaged property mortgagor. 4. Requires to be registered. 1. Deposit of original title deeds in towns by mortgagor or his agent to the mortgagee or his agent. Deposit with interest to create or security thereon. No writing necessary. No registration required. Title deeds must show some interest or . No title , No mortgage. Redelivery of title deeds will extinguish mortgage.

2. 3. 4. 5. 6.

REMEDIES 1. Right to sale subject to Sec.69 of Transfer of Property Act. 2. Right to appoint Receiver. 1. Suit for sale.