Banking News

How bankers establish their right over assets of the borrower?


The charge creation means establishment of lender’s right to recover from the specified assets of the borrower, in case the recovery is difficult in normal course. The mode of bank charge on different securities depends upon nature of facility and type of security. Banks grant loan or extend CC facility against marking lien on term deposits of the customer. Loans are granted against Assignment of Life Insurance policies, National Saving Certificates. Cash Credit or overdraft facilities are also extended to customers against hypothecation or pledge of stocks and receivables. Term loans are granted against hypothecation of machinery. Mortgage of land and buildings are the examples of securities held by the bank against term loans and deferred payment guarantees offered by banks and financial institutions. A third party guaranty offered to the bank is also a form of security offered to the bank. As a result, Banks establish their rights over different securities by way of lien, pledge, hypothecation,Assignment/ actionable claim, Trust Receipt etc.

Right of set-off:  The right of set off means where a customer is having one or more accounts with the bank in credit balance. The customer also owes money to banker in another account or other accounts. In the above circumstance, then the banker has the right to reduce the amount which the borrower owes to him from the credit balance available in his other account/s. This right of banker is known as right of set-off or right of combining account. The right of set-off is available to bank only when the money owed to the bank is certain sum, which should be due at the time of set-off and there shall not be an agreement, express or implied to the contrary.

What is the meaning of Lien?

Lien: Lien is akin to bailment. It is the right to retain goods or securities belonging to a debtor until dues are paid fully to the retainer (creditor). No special agreement is necessary for creating the right of lien. However a general lien may be created by special agreement. Section148 of the Indian Contract Act 1872 deals with the definition of bailment.

“A bailment is delivery of goods by one person to another for some purpose, upon a contract that they shall, when the purpose is accomplished, be returned or otherwise disposed, according to the directions of the person delivering them.”

The person who delivers the goods is called the “bailor” and the person to whom they are delivered is called the “bailee”. The goods delivered for the purpose is called “bailed goods”.

The cloth given to tailor for stitching, gold given to goldsmith for making jewellary, Scooter given to mechanic for repair, leaving the cycle at cycle stand and so forth, are some of the common instances which creates the relationship of bailment.

Lien may be either (i) particular lien or (ii) general lien.

In particular lien, the debtor gives the rights to   creditors to retain only those specific securities or goods in respect of which dues are arisen. The general lien confers a right to retain the securities or goods in respect of all the dues payable to the creditors

Banker’s Lien: Banks are conferred with the right to retention of goods or security (  such as cheques, bill of exchange, deposits etc,) ,by way of general lien, until some claim attaching to it, is satisfied or discharged. The lien extends to all such documents under which money will or may be payable to the customer.

Section 171 of the Indian Contract Act 1872 reads “Bankers Lien” as under.

“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 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 express contract to that effect.

Thus, Banks are entitled to exercise a general lien or right of retention over securities belonging to the customer whom the bank holds until all the dues from the customer is fully paid.

Negative Lien: Negative lien is an undertaking obtained by the banker, from the borrower that his assets (e.g land, building, machinery, stocks, etc.) mentioned is free from any charge or encumbrance and he would not create any charge or encumbrance on any of these assets in favour of third parties during the period of bank finance.

No lien letter: No lien letter is an undertaking from the premises owners (in case of rented premise) that he does not have lien on goods hypothecated to bank which is stored in his premises rented out to the borrower, towards his dues like rent receivable etc.

Pledge and right & duties of pledgee:

Pledge is only a special kind of bailment where the object of the delivery of assets/goods is to provide a security for a loan or for the fulfillment of an obligation.

Section 172 of the Indian Contract Act, 1872 defines pledge as “the bailment of goods as security for payment of a debt or performance of a promise.”

Section 148 of Indian contract Act defines Bailment which is summarized below:

I)             There must be delivery of goods either actual or constructive

II)            Delivery of goods should be for some purpose and based on contract

III)           When the purpose is accomplished, the goods must either be returned or disposed off as per the terms of contract.

The essence of pledge is the goods must be delivered to the possession of pledgee, as a security for payment of debt and there should be a contract to return the same goods which were pledged after the debt is repaid. The delivery of goods may be actual or constructive. The delivery of godown keys, where the goods are stored, in case of Key Cash Credit/key loan, is an illustration of constructive delivery of goods.  As the pledge is not a transfer of property, the pledgee bank only retains possession of the goods, but right of ownership remains with the borrower who pledged the goods. In order to constitute a valid pledge, delivery of goods, and release of advance need not be simultaneous. Delivery of goods can be subsequent to making the advance (Case study Laun Parshad Vs Rahamat Ali-SC-1967)

 Rights and duties of Bank as Pledgee under section 173 to 176 of Indian Contract act:

  1. Pledgee can  retain the goods not only for payment of the debt or performance of the promise but also for interest and all necessary expenses incurred in respect of possession and / or preservation of pledged goods (Case study Satyanarayana Vs SBI-AP HC -1975).
  2.  Pledgee can file a suit against the borrower for recovery of shortfall of balance if any, after disposal of pledged goods (Case study Haridas Mundra Vs National Grindlays Bank Ltd.-Calcutta HC-1963)
  3. Pledgee can sell the goods without intervention of Court, after giving due or reasonable notice to the pledger,
  4. Pledgee has a special property in the goods pledged. So long as his claim was not satisfied, no other creditor including Government Authorities has authority to supersede the bank’s right over pledged security. Pledgee Bank has the first charge on goods pledged. (Case study Bank of Bihar Vs State of Bihar-SC-1971).
  5. Pledgee is not entitled to enjoy any accretions on pledged security.Pledgee must re-deliver the goods after the debt is repaid. A pledge cannot retain goods for any debt other than the debt for which goods are pledged. However, if the pledgee is a bank, operation of General Lien (u/s 171) would be applicable unless the bank has expressly agreed to waive its right of general lien.
  6. Pledgee must take same care of the pledged assets, as a man of ordinary prudence would take his own goods. (7).(ix) Goods pledged can be sold by private sale or by public auction.
  7. Any person, who is in valid possession of the goods/security, can create valid pledge. Pledge by an agent or power of Attorney holder is treated on par with pledge by owner of goods provided by existence of agency can be provided/power to pledge is clearly expressed in the power of attorney (U/S.178A).

The documents of title to goods pledged, amounts to pledge of goods, covered by the documents of title. The advancing of loan, execution of the promissory note and endorsement and delivery of the document of title to goods together form one transaction. Their combined effect is that bank would be in control of goods till the debt is discharged (U/S.180). It is advisable to draw the bills in favour of the bank and  give notice of  banks interest in the relative goods to the carrier so that unpaid seller or a fraudulent person cannot take re-delivery of the goods. Bank must exercise extra care while accepting documents like Lorry Receipts, Airway bill because they are not considered as “document to title” under the sale of goods Act. Bank should invariably notify the carrier of its interest in relative goods, (Case study: Canara Industrial & Banking Syndicate Ltd Vs R.G.Prabhu, Mysore HC-1968).

The term “Hypothecation of assets”

The lender’s right under the term “Hypothecation of assets” is not defined in anywhere in the statute. However hypothecation is defined in SARFAESI ordinance as under:

“a charge in or upon any movable property, existing or future, created by a borrower in favour of a secured creditor without delivery of possession of the movable property to such creditor ,as a security for financial assistance and includes floating charge and crystallization such charge into fixed charge on movable property”.

In hypothecation, neither the possession of assets nor the ownership of the assets transferred to the lender (hypothecatee). The asset hypothecated remains under the possession of the borrower and he is free to deal with it. The securities commonly covered under hypothecation are goods, book debts machinery, and furniture. The charge under hypothecation and terms and conditions thereby is created by an agreement commonly known as “Letter of Hypothecation” or hypothecation deed. As the hypothecation deed is not uniformly drafted and varies from bank to bank, the courts while considering the rights of banks as hypothecatee have relied upon the deed executed and given conflicting decision. Some courts have referred to ‘hypothecation as ‘mortgage of movables’

 What is Assignment and actionable claim?

Assignment is when the rights, title and interest in debts due or accruing due to a person are transferred to another person. Actionable claim means any claim other than the debt to mortgage of immovable property or hypothecation or pledge of goods and receivables. Thus the charge by way of assignment can be created on actionable claim by an instrument in writing signed by assignor (Transferor) or through his duly authorized agent. The debts which are sought to be assigned may be present, future, conditional or contingent charge by way of assignment can be created under actionable claim.

Transfer of   Life Insurance Policy, National Saving Certificates, Supply bills etc, to the name of bank for the purpose of borrowing are examples of assignment. The transferor of the security is called assigner and the transferee is called the assignee. The assignee must give a notice to the debtors so as to complete his title, otherwise until debtor receives the notice of assignment, his dealing with the original creditor will be protected.  On full payment of dues to the assignee, the assignor can get the security re-assigned in his name.

Section 3 of the Transfer of Property Act 1882 defines actionable Claim;

“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 possession, either actual or constructive, of the claimant, which the Civil Court recognizes as affording grounds for relief, whether such debt or beneficial interest be existent, accruing, conditional or contingent”

Thus in terms of sec 3 of Transfer of Property Act 1882, the  debt  secured by mortgage of immovable property or by hypothecation or pledge of movable property are excluded from actionable claim. The Charge by way of assignment can be created on actionable claim by an instrument in writing signed by assignor (Transferor) or through his duly authorized agent. The debts which are sought to be assigned may be present, future, conditional or contingent. The arrears of rent, PF credit, life Insurance Policy claim, money due under a will, under a contract, money receivable under sale of property are the example of actionable claim.

Section 130 of Transfer of property act 1882 lays down that the actionable claim can be assigned to anyone except to a judge, a legal practitioner or an officer of the Court of Justice. Thus actionable claim can be assigned. The assignee must give a notice to the debtors so as to complete his title, lest until debtor receives the notice of assignment, his dealing with the original creditor will be protected.

“Trust Receipt” under the contract of pledge

In “trust receipt” under the contract of pledge, the borrower gets his assets/goods released from the pledge, only on full payment of his dues which automatically terminates contract of pledge. However in case of Key cash Credit or Key Loan, if bank desire to release the assets/goods retained under pledge before repayment of dues as a temporary arrangement, the bank obliges so by obtaining a Trust Receipt from the borrower.  Under the trust receipt the borrower acknowledges the receipt of goods or documents of title to goods and undertakes to hold the goods in trust on behalf of the bank. Further the borrower undertakes that he would not encumber on the goods released or dispose-off the goods without the consent of the bank and also promises to return the assets (security) on demand, such portions as shall remain unsold. The borrower also undertakes that the entire transaction will be done separately and remit the sale proceeds directly to the bank.

The purpose of “Trust Receipt” is that allows bankers to maintain the original charge under pledge and if the customer becomes insolvent, the official assigner/receiver cannot claim the goods for the benefit of unsecured creditors. Normally such business contingencies arise while taking delivery of goods from Railways whereas documents are pledged in bank, and later shift the goods to Godown under bank’s lock and key or sometime sold goods to be released from godown/warehouse before receipt of payment.

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