Session Coverage

• Meaning of Creation of charge on Security
• Type of Security Charges
• Lien 
• Hypothecation
• Pledge
• Mortgage 
• Other Misc.

 Introduction &  Overview of Credit Management

 Credit Process Framework

• Pre-Sanction Appraisal
• Processing & Appraisal
• Sanction
• Documentation
• Disbursement
• Monitoring & Follow-up
• Recovery of Loans

 Introduction &  Overview of Credit Monitoring

A debt contract is one where a borrower, be it a small farmer or the promoter of a large petrochemical plant, raises money with the promise to repay interest and principal according to a specified schedule. If the borrower cannot meet his promise, he is in default. In the standard debt contract through the course of history and across the world, default means the borrower has to make substantial sacrifices, else he would have no incentive to repay.

Security Charge - Meaning

• A security interest is a legal right granted by a debtor ( borrower) to a creditor (bank ) over the debtor's property (usually referred to as the collateral) which enables the creditor to have recourse to the property if the debtor defaults in making payment or otherwise performing the secured obligations.
• This  is created by way charge on the security i.e. property, goods ,receivables, financial securities etc.
• Example of security charge is Hypothecation, Pledge, Assignment, Mortgage, Lien , Right of set-off etc

 Type of Security Charge

• Lien
• Hypothecation
• Pledge
• Mortgage
• Other charges

 Hypothecation

As per SARFAESI Act, 2002, HYPOTHECATION means a charge in or upon any moveable property ,existing or future created by borrower in favour of a secured creditor, without delivery of possession of the moveable property to such creditor , as a security for financial assistance and includes floating charge and crystallization of such charge into fixed charge on immovable property  

Legal philosopher , H.L.A. Hart describes hypothecation as ‘ a charge against property for an amount of debt where neither ownership nor possession is passed to the creditor.’

Therefore main characteristics of Hypothecation are 1) Moveable assets 2) In possession of borrower 3) Can be of floating nature  

Type of Facility :- Cash Credit against goods & Book Debts

Hypothecation is resorted to in the following cases:

• When loan is to be raised for working capital requirement to complete the operating cycle
• Loan for Vehicles 
• Lending to shopkeeper for inventory

 Drawbacks of Hypothecations

• Control on the charged goods is NIL. Possibility of fraud is more in such cases.
• Realization of hypothecated stocks may be used elsewhere.
• Possibility of same stocks may be hypothecated to other banks 
• Realization of dues in case of default from the sales of stocks is cumbersome and very difficult.

 Precautions to be taken in  Hypothecations

• An undertaking from the borrower that it is not enjoying and will not enoy the hypothecation facility from any other bank/NBFC/FI
• In case of Vehicle necessary registration of charge is registered with RTO
• Insurance of goods contains Bank clause
• In case of company registered under companies act , such charge is registered with ROC

Pledge

Under Section 172 of Contract Act 1872, Pledge means bailment of goods for the purpose of providing security for payment of debts or performance of promise.

As per above , there are three requirements :-

• There must be bailment of goods( bailment means delivery of goods)
• Bailment must be , by or on behalf of the borrower 
• The bailment must be for the purpose of providing security for the payment of a debt or performance of promise.
• The person whose goods are pledged is known as Pawnor and person whose is taking the pledge is known s Pawnee

 Legal Implications of a Pledgee

• The ownership of the property is with Pawnor.
• Essential requirement of pledge is actual or constructive delivery of the goods to the pawnee.
• Goods may be delivered in one of the following way :
• By handing over the keys of the godowns in which the goods are kept.
• By attornment, i.e. if goods are in public warehouse, the warehouseman acknowledges to the pawnee that he will hold the goods thereafter on behalf of the pawnee 
• Handing over the documents of title to goods , such as railway receipt, bill of lading , warehouse receipts etc.
• Even if the goods are in possession of the pawnor , he may acknowledge that he holds them thereafter for and on behalf of the pawnee. 
• Pledge can be created only in the case of existing goods which are in the possession of the pawnor himself.
• Pledge is lost if the possession of the goods is lost

 Who can create a pledge

• Owner of the goods
• A mercantile agent, provided the following are satisfied 
  • He should in the possession of the goods, or the documents of title of goods with the consent of the borrower
  • The goods must have been entrusted to him in his capacity as a mercantile agent
  • The mercantile agent should create the pledge in the ordinary course of his business as such agent.
• A pawnee can repledge the goods, but it is valid only to the extent of his interest in such goods.

 Rights of Pawnee

• Right of Retainer
• Rights to claim extraordinary expenses
• No right to retain in respect of the other debts
• Pawnee’s right where Pawnor makes default in payment
  • He may sue the pawnor upon the debt or promise
  • He may retain the pawned goods as collateral security or 
  • He may sell it after giving the pawnor reasonable notice of the sale

 Duties of Pawnor

• Disclosure of any material default or extraordinary risks in the goods
• Reimbursement of any expense required for preservation of the goods
• In force sale if he amount of realization is less than the amount due, borrower is liable to make good of the balance

 Mortgage

• It is the transfer of an interest in specific immovable property for the purpose of securing the payment of money advanced or to be advanced by way of loan, an existing or future debt or the performance of the agreement which may lead to a pecuniary liability. The borrower is called the 'mortgagor' and the lender the 'mortgagee'. 
• Forms of mortgage: As per Sec. 58 of the Transfer of Property Act, there are six types of mortgages: 
• Simple mortgage                 
• Mortgage by conditional sale 
• Usufructuary mortgage         
• English mortgage 
• Anomalous mortgage
• Mortgage by deposit of title deeds/ equitable mortgage 

Generally only two types of the mortgage are preferable by the  banks

 Simple Mortgage; according to section 58 (b) of the Transfer of Property Act, 

A simple mortgage is a transaction whereby without delivering the possession of the mortgaged property, the mortgagor binds himself personally to pay the mortgage money and agrees, expressly or impliedly, that in case of default the mortgagee shall have a right to cause the mortgage property to be sold by a decree of the court. 

 Equitable mortgage or Mortgage by deposit of title deeds:

• According to section 58(f) of Transfer of Property Act, where a person delivers the documents of title to the immovable property to the creditors with an intention to create a security thereon, the transaction is called equitable mortgage.
• The essential features of the equitable mortgage are as under:
• Delivery of the documents title to the immovable property to the creditor
• Intention of the mortgagor to create a security thereon in favor of the creditor.
• The delivery of the title deeds must be by the owner of the  property or his / her authorized agent only.       
• The owner of the property must be either our borrower or a guarantor.

 Priority of Mortgages

• Indian Law of priorities is provided in Section 48 of the Transfer of Property Act. The rule is based on the maxim ‘he has a better title who was first in point of time.’ 
• How the rule of priorities operates in respect of different instruments creating mortgages.
• Priority among registered instruments
• Section 47 of the Registration Act, 1908 provides that a registered document operates, not from the date of its registration, but from the time of its execution. Thus, a document executed earlier, though registered after than another, has priority over the documents executed later.
• Priority between registered and unregistered instruments
• Let us now deal with the exceptions to the rule, that priority is determined by order of time, which either have been created by statute or owe their origin to the ancient rule of Hindu Law, which required delivery of possession in the case of a security of land. There are also some exceptions recognized in the Indian System founded upon those general principles of justice and equity, which in the absence of any express enactment, Indian judges are bound to administer, and which, have been mostly borrowed, from theEnglish Law.
• The first exception is that contained in Section 50 of the Registration Act, which under certain circumstances allows a registered mortgage priority over unregistered mortgage. However, it may be noted that prior mortgage by deposit of title deeds is not affected by subsequent registered mortgage as the same need not be registered. This is provided in Section 48 of Indian Registration Act.

 Assignment  

• Assignment means transfer of a right of an actionable claim, existing or future. 
• 'Actionable claim' means a claim to any debt, other than a debt secured by mortgage of immovable property, by hypothecation or pledge of movable property, or to any beneficial interest in movable property in possession, either actual or constructive, of the claimant, which the Civil Courts recognise as affording grounds for relief, whether such debt or beneficial interest be existent, accruing, conditional or contingent. 
• Section 130 describes the manner in which actionable claims can be transferred, as follows: 
• The transfer of an actionable claim, whether with or without consideration, shall be effected only by the execution of an instrument in writing signed by the transfer or his duly authorized agent, shall be complete and effectual upon the execution of such instrument, and thereupon all the rights and remedies of the transfer, whether by way of damages or otherwise shall vest in the transferee, whether such notice of the transfer is hereinafter provided be given or not. 

Lien 

• Lien is the right of a creditor to retain in his possession the goods and securities owned by the debtor until the debt has been discharged, but has no right to sell the goods and securities so retained. Lien is of two types, particular and general. 
• Banker's right of lien: Banker has a right of general lien against his borrowers. Section 171 of the Indian Contract Act, 1872 confers the right of general lien on the bankers as "Banker 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." 
• Bank's right of general lien includes Right of sale. Therefore, it is said that a banker's lien tantamount to an implied pledge. 
• The banker's right of lien is not barred by law of limitation. The Limitation Act only bars the remedy and does not discharge debt. As such, bankers have a right of lien against time barred debt also. When a banker exercises this right, property of goods remains with the owner even though the same is in possession with the bank. 

 Negative Lien

• The borrower may sometimes be having non‑encumbered assets which are not charged to the bank as security. The borrower is thus free to deal with these assets and may even sell them if he so desires. To restrict this right of the borrower, the bank may request him to give an undertaking to the effect that he will neither create any encumbrance on these assets nor sell them without due permission from the bank so long as the advance continues. This type of an undertaking obtained by the bank is known as 'Negative Lien'. Negative lien is in the form of a personal assurance or undertaking which has binding effect but confers no right on the bank to proceed against the property itself and thus creates no encumbrance or charge on the property.

 Right of set-off

• Right to apply the credit balance in customer's account towards liquidation of debit balance in another account of the customer provided both the accounts are maintained by him in the same capacity.
• The right of set-off is a statutory right which enables a bank to combine several accounts of a customer in his own right unless there is any agreement expressed or implied to the contrary. Before exercising the right of set-off a reasonable notice should be given to a customer to avoid dishonoring of cheques drawn by the customer being unaware of the situation. Though the right of set-off is available to a banker as a legal right, banks take a letter of set-off from the customer. It helps the bank to overcome future legal complications and it dispenses with the need for notice. 
• The right of set off can be applied by the bank only if the following conditions are met: 
  • The liability of the borrower is for a sum which is certain.
  • The repayment of debt is due.
  • Both the accounts are held by the customer in the same capacity.