Subject: Principles of Insurance and Banking

Course Code: FM-306 Author: Dr. B.S. Bodla

Lesson: 4 Vetter: Dr. Karam Pal

Modes of creating charge

STRUCTURE

4.0 Objectives
4.1 Introduction
4.2 Modes of creating a charge
4.2.1 Lien
4.2.2 Pledge
4.2.3 Hypothecation
4.2.4 Mortgage
4.3 Summary
4.4 Keywords
4.5 Self assessment questions
4.6 References/Suggested readings

4.0 OBJECTIVES

After reading this lesson, you should be able to-

• Understand how the banks ensure safety of the funds
advanced by them;
• Know about the legal provisions regarding the modes of
creating charge over the tangible assets;
Describe the rights and duties of a banker as a pledgee, unpaid seller and mortgagee.

4.1 INTRODUCTION

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 A sound banking is based on safety of funds lent by a banker to
his customers. A banker lends his funds to persons of means, engaged in
some business, trade, industry or in any profession or vocation. The first
and the most important criterion to judge safety of funds is the capacity
of the borrower himself to repay the amount of the loan after having
achieved success in the productive activity for which the loan is taken.
The banker, therefore, relies primarily on the character, capacity and
capital of the borrower in ensuring the safety of his funds. The viability of
the project and the honesty and capability of the borrower ensure to a
large extent the safety of funds lent by the banker.

Secured advances are those advances, which provide absolute

safety to the banker by means of a charge created on the tangible assets
of the borrower in favour of the banker. In such cases, the banker gets
certain rights in the tangible assets over which a charge is created.

4.2 MODES OF CREATING A CHARGE

There are several modes of creating a charge, e.g., lien, pledge,

hypothecation and mortgage.

4.2.1 Lien

The Indian Contract Act confers the right of general lien on the
banker (Section 117). The banker is empowered to retain all securities of
the customer, in respect of the general balance due from him. The
ownership of such securities is not transferred from the customer to the
banker. The latter gets the right to retain the securities handed over to
him in his capacity as a banker. A banker's lien is considered
tantamount to an implied pledge and he gets the right to sell the
securities in certain circumstances.

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 Negative Lien- Negative lien is to be distinguished from lien. Under
the negative lien, the banker does not get the right to retain any asset of
the borrower. The borrower gives a declaration to the banker that his
assets mentioned therein are free from any charge or encumbrance. He
also gives an undertaking that he shall not create any charge over them
or disposes them of without the permission of the banker. The borrower
cannot dispose of the assets or create any charge thereon without the
consent of the banker. The banker, on the other hand, is not entitled to
realise his dues from the said assets of the customer. His interests are
thus partly safe by securing a negative lien.

4.2.2 Pledge

According to section 172 of the Indian Contract Act, 1872 pledge is

defined as “bailment of goods as security for payment of a debt or
performance of a promise”. The person who offers the security is called
the 'pawner' or 'pledger' and the bailee is called the 'pawnee' or the
'pledgee'. Thus, in case of a pledge-
(i) there should be bailment of goods; and
(ii) the objective of such bailment should be to hold the goods as
security for the payment of a debt or the performance of a
promise. In other words, the bailment should be on behalf of
a debtor or an intending debtor.

1. Bailment of goods- Section 148 defines bailment as the

“delivery of goods from one person to another for some purpose upon the
contract that the goods be returned back when the purpose is
accomplished or otherwise disposed of according to the instructions of
the bailor”.

2. Bailment of security for payment of debt- It is essential

that the bailment of the goods is done with the object to secure the

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payment of a debt or the performance of a promise. If the goods are left
with the banker for safe custody or for any other purpose, it does not
constitute a pledge. Banks, therefore, take a declaration in case of pledge
to safeguard their interests.

Who can pledge the goods?

Goods can be pledged by any one who is in legal possession of the

same, namely,
1. The owner of the goods himself.
2. The mercantile agent of the owner- According to Section 178,
“where a mercantile agent is, with the consent of the owner,
in possession of goods or the documents of title to goods,
any pledge made by him, when acting in the ordinary course
of business of a mercantile agent, shall be as valid as if he
were expressly authorised by the owner of the goods to make
the same, provided that the pawnee acts in good faith and
has not, at the time of pledge, notice that the pawner has no
authority to pledge”.
3. Joint-owner with the consent of other co-owner- If the
interest of the pledger in the goods is to a limited extent only,
he can pledge the same to the extent of his limited interest.
But in such cases the rights of an innocent third party are
well protected, if a second pledge is made to him.
4. If a person obtains possession of the goods by fraud,
misrepresentation, coercion or undue influence, such
contract is voidable at the option of the lawful owner.
However, the former can create a valid pledge on such goods
provided the following conditions are fulfilled:
(a) The contract has not been rescinded before the
contract of pledge is entered into.

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 (b) The pledgee acts in good faith and without notice of
the defective title of the pledger.
5. If a buyer leaves the goods or documents of title to goods
after sale in the possession of the seller, the latter may make
a valid pledge of the goods provided the pledgee acts in good
faith and he has no notice of the sale of goods to the buyer.

Rights of a banker as a pledgee

1. The pledgee has the right to retain the goods pledged for the
payment of the debt or the performance of the promise and also for the
amount of interest due on the debt and the necessary expenses incurred
by him in connection with the possession or for the preservation of the
goods pledged (Section 173). This right is applicable only in case of
particular debt for which the goods are pledged, in the absence of an
agreement to the contrary (Section 174). The pledgee can also claim any
extra-ordinary expenses incurred by him for the preservation of the
security.

The banker is entitled to this right of the pawnee in case of cash

credit arrangements, even if the customer (pledger) has violated any
provisions of the law in respect of the goods pledged.

This right of the pledgee is not affected even if he allows the

pledger to retain possession over the goods pledged. In Bank of India vs.
M/s Binod Steel Limited and Another (A.I.R. 1977 M.P. 188), the Bank of
India permitted the company to retain possession of the movable
machines pledged to it as security for loan, for and on behalf of the bank.
Subsequently the Additional Tahsildar attached the movable machines
for the recovery of the amount of wages due to the workers of the
company. The High Court held that-

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 “The legal possession and custody of the machinery and other
movables of the company, which were under a pledge, must be held to be
in the bank itself. The physical possession may be with the company but
in the eyes of law the company must be deemed to be in possession of
the same for and on behalf of the bank, the pledgee”.

The court held that the bank was a secured creditor and since the
right to possess the movables and machinery as pledgee was vested in
the bank, no one could touch the pledged property until the claim of the
bank was satisfied.

2. In case of default by the pledger to make payment of the

debt, the pledgee has the right either-

(a) to file a civil suit against the pledger for the amount due and
retain the goods as a collateral security; or

(b) to sell the goods pledged after giving the pledger reasonable
notice of sale (Section 176).

The pledgee can resort to these steps only when the pledger
defaults in making payment of the debt and not earlier. In case of loans
repayable after a fixed period, default takes place if the loan remains
unpaid after the expiry of the stipulated period. In case of a loan
repayable on demand, default takes place if, on receipt of a notice from
the creditor demanding the repayment of the loan by a specified date, the
debtor fails to do so within the period allowed by the creditor.

The question whether the pledgee can exercise the right to sue and
the right to sell the pledged goods or securities concurrently was decided
in Iaridas Mundra vs. National and Grindlays Bank (67 G.W.N. 58). In
this case the Bank, being the pledgee of the shares, filed a suit for the
recovery of the loan. During pendency of the suit the Bank served a

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notice on the customer demanding payment of its dues failing which the
shares would be sold by the bank. The customer pleaded that the right of
the pawnee under section 176 to sue for the debt or the promise is
alternative to his right to sell and that he cannot sell the articles after he
files a suit on the debt. The Court held that the right to retain the article
pawned and the right to sell it are alternative and not concurrent rights.
The pawnee has the right (i) either to sue on the debt or the promise
concurrently with his right to retain the pawn or (ii) to sell it. However,
the court observed that the institution of a sit upon the debt or promise
does not reduce the pledge to a passive lien and destroy the pawnee's
right to sell the article pawned and that right to sell is necessary to make
the security effectual for the discharge of the pawner's obligation and the
right continues in spite of the institution of the suit. This means that the
banker is not denied the option for the second right, i.e., to sell, if he had
already filed a suit in the Court. If he sells the goods after giving due
notice and his claim is met in full, the suit filed becomes ineffective.

But the pledger cannot force the pledgee to sell goods without
clearing debts even if value of the goods pledged deteriorated during the
pendency (Bank of Maharashtra vs. M/s Racmann Auto (P) Ltd. (AIR
1991 Delhi 278). In this case, the Delhi High Court further held that if
the value of the goods had deteriorated due to passage of time, no relief
can be obtained by the pledger against the pledgee as the former was
legally bound to clear the debt and obtain the possession of the pledged
goods from the bank, before the pledged goods were sold during the
pendency or the suit.

It is also essential that a clear and specific notice of sale is issued

to the pledger before the pledgee exercises his right of sale, not
withstanding the presence of a specific term in the agreement of pledge
authorising the pledgee to sell the security without notice to the pledger.

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 The sale made by the pledgee without giving a reasonable notice to
the pledger cannot be set aside, but the pledgee will be liable to the
pledger for the damages.

It must be noted that after giving notice of sale, the pledgee retains
the right to sell or not to sell the goods pledged. It is not obligatory for
him to sell the goods within a reasonable time after the notice of sale is
served. If the sale proceeds are insufficient to meet the claim of the
pledge, the pledger remains liable to pay the balance. If the sale proceeds
exceed the amount due, the pledgee has to return the excess amount to
the pledger.

3. The pledger is bound to disclose to the pledgee the faults, if

any, in the goods pledged which are within his knowledge, and which
materially interfere with the use to those goods or expose the pledgee to
extraordinary risks. If the pledgee suffers any damage as a result of non-
disclosure of such fault by the pledger, the latter shall be responsible for
it.

4. If the title of the pledger to the goods pledged is defective and

the pledgee suffers any loss due to this fact, the pledger shall be
responsible for such loss.

5. If the pledgee has given his consent as a result of

inducement by fraud or misrepresentation in this regard or in regard to
pledger's interest in the goods, the contract would be voidable at the
option of the pledgee.

6. A pledgee's rights are not limited to his interest in the

pledged goods but he would have all the remedies that the owner of the
goods would have against a third person for deprivation of goods or
injury to them. In Morvi Mercantile Bank Ltd. Vs. Union of India, the
Supreme Court held that the bank (pledgee) was entitled to recover the

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full value of the consignment from Railways, namely, Rs. 35,000 and not
only the amount due to it from the customer, namely, Rs. 20,000.

Duties of the pledgee

1. The pledgee is bound to return the goods on payment of the

debt. It is the duty of the pledgee to restore the goods to the pledger or to
deliver the goods according to the directions of the pledger as soon as the
obligation to repay the amount is discharged.

2. The pledgee is responsible to the pledger for any loss,

destruction or deterioration of the goods, if the goods are not returned by
the pledgee at the proper time (Section 161).

The banker remains liable to the pledger even if the goods are
delivered to a wrong party without the negligence of the banker. In UCO
Bank vs. Hem Chandra Sarkar (1991) 70 Comp. Case P119, S.C., the
goods were delivered by the bank to some impostor who produced an
artfully forged order. The Supreme Court held that a banker takes charge
of goods, articles, securities etc., as bailee only and any inference of a
fiduciary relationship was unwarranted and unjustified. It further held
that if the property is not delivered to the true owner, the banker cannot
avoid his liability in conversion. In its opinion, where the bank delivers
the goods to the wrong person, whereby they are lost to the owner, the
liability of the bank is absolute, though there is no element of negligence
just as where delivery is obtained by means of an artfully forged order.

3. The pledgee is bound to use the goods pledged according to

the agreement between the two parties. If he violates any of the
conditions of the pledge, the contract would be voidable at the option of
the pledger. He is also liable to make compensation to the pledger if he
suffers any damage due to the unapproved use of the goods pledged
(Section 153).

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 4. The pledgee is also bound to deliver to the pledger any
increase of profit which may have accrued from the goods bailed in the
absence of an agreement to the contrary (Section 163). In M.R. Dhawan
vs. Madan Mohan and Others (A.I.R. 1969 Delhi 313), the borrower
pledged certain shares with the banker. The right of the pledgee to the
dividends and the rights and bonus shares issued in respect of pledged
shares was disputed by the pledger. Declaring that the pledgee has no
right, in the absence of a contract tot eh contrary, to the accretion to the
goods pledged, the Delhi High Court observed that-

“The primary purpose of a pledge, which is a kind of bailment and

security, is to put the goods pledged in the power of the pledgee to
reimburse himself for the money advanced, when on becoming de it
remains unpaid, by selling the goods after serving the pledger with a due
notice. The pledgee at no time becomes the owner of the goods pledged.
He has only a right to retain the goods until his claim for the money
advanced thereon has been satisfied. The pledgee acquires a right, after
notice, to dispose of the goods pledged. This amounts to his acquiring
only a 'special property' in the goods pledged. The general property
therein remains in the pledger and wholly reverts to him on the payment
of the debt or performance of the promise. Any accretion to the goods
pledged will, therefore, be, in the absence of any contract to the contrary,
the property of the pledger”.

4.2.3 Hypothecation

Hypothecation is another method of creating a charge over the

movable assets. Under hypothecation neither ownership nor possession
of goods is transferred to the creditor but an equitable charge is created
in favour of the latter. The goods remain in the possession of the
borrower, who binds himself, under an agreement, to give the possession
of the goods to the banker, whenever the latter requires him to do so. The

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charge of hypothecation is thus converted into that of a pledge and the
banker or the hypothaecatee enjoys the powers and rights of a pledgee.
In M/s Gopal Singh Hira Singh vs. Punjab National Bank (A.I.R. 1976,
Delhi 115), the Delhi High Court observed that in case of hypothecation,
“The borrower is in actual physical possession but the constructive
possession is still of the bank because, according to the deed of
hypothecation, the borrower holds the actual physical possession not in
his own right as the owner of the goods but as the agent of the bank”.
The High Court, therefore, concluded that in law there was no difference
between pledge and hypothecation with regard to the legal possession of
the banks- the hypothecated goods are also not only constructively but
actually in the possession of the bank. But to enforce its claim it is
essential for the bank to take possession of the hypothecated property on
its own or through the Court. The bank can enforce the security by filing
a suit to this effect. If the banker fails to do so, and chooses to seek a
simple money decree, the bank would be deemed to have waived its right
as hypothecatee. In Syndicate Bank vs. Official Liquidator, Prashant
Engineering Co. Pvt. Ltd. (1986) 59 comp. Cases 301, the Bank filed a
suit for the recovery of money and failed to make a claim on the security.
It was held that the Bank ranked as an unsecured creditor along with
other creditors of the company.

Hypothecation is a convenient device to create a charge over the

movable assets in circumstances in which transfer of possession is either
inconvenient or impracticable. For example, if a borrower wants to
borrow on the security of raw materials or goods-in-process, which are to
be processed into finished products, transfer of possession will impede
the functioning of the borrower’s business. By hypothecating such
stocks, the borrower may use the same in any manner he likes, e.g., he
may take out the stock, sell it and replenish it by a new one. A floating
charge is thus created over the movable assets of the borrower on the

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confidence reposed by the creditor. Hypothecation is thus only an
extended idea of pledge; the creditor permitting the debtor to retain
possession either on behalf of or in trust for himself. The creditor
possesses the right of a pledgee under the Deed of Hypothecation.

According to a recent judgement of the Andhra Pradesh High Court

it is open to the bank to take possession of the hypothecated property on
its own or through the court as per the hypothecation agreement. Where
there is any specific clause in the hypothecation agreement empowering
the hypothecatee to take possession of the goods and sell the same in the
event of default in payment, the Court (State Bank of India vs. SB Shah
Ali: (Unreported judgement of High Court dated 9.3.94).

If the hypothecated vehicle is involved in an accident and the

passengers of the other vehicle are injured, the bank will not be liable for
the compensation to the victims. In Bank of Baroda vs. Babari
Bachubhai Hirabhai and Others (A.I.R. 1987 Gujarat), the Gujarat High
Court held that the hypothecating bank had no title over the vehicle, it
had merely a right to recover its dues by the sale of that vehicle and so
long as there was no default in the payment of the loan amount, it could
not exercise that special right to sell the vehicle for the realisation of its
dues.

The relative rights of unpaid seller and the hypothecatee

In case of Punjab National Bank vs. M/s Lakshmi Card Clothing

and Manufacturing Ltd. And Another 1978 T.N. Law Notes Journal p.
89), the Madras High Court considered the question of relative rights of
the unpaid seller and the bank as hypothecatee. In this case the
manufacturer of textile machines sold to a textile mill some machinery
on the condition that the transfer of the property in the goods was to
take place only after the purchaser had paid full value thereof. The

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purchaser failed to pay the full value and hence the seller wanted to take
back the goods. But as all the movables in the mill of the purchaser were
under hypothecation with the Punjab National Bank, the machinery
could not be restored to the seller. The seller, therefore, filed a suit for
the machinery or the payment of its price. The purchaser contended that
the contract of sale has been repudiated and it was willing to return the
items supplied by the manufacturer.

But the Punjab National Bank contended that the purchaser had
obtained overdraft facilities from its Mount Road branch after executing
deeds of hypothecation and pledge. As the goods stood transferred to the
Bank, its charge over the same was protected under Section 30(2) of the
Sale of Goods Act, 1930. The seller pleaded that the bank had the
knowledge of the property in the goods not having passed to the buyer
because the documents relating to the machinery were presented at its
Mylapore branch.

Precautions to be taken by Banker- The position of the banker

under hypothecation is not as safe as under a pledge. If the borrower
fails to give possession of the goods hypothecated, or sells the entire
stock or borrows from another banker on the security of the same goods,
the banker shall have to resort to legal proceedings in a Court of Law for
the recover of the amount lent. The advances on hypothecation basis are
as risky as clean advances. The banker should, therefore, take the
following precautions to safeguard his own position:
(i) The facility of loans on the basis of hypothecation of goods
should be sanctioned only to person or business houses of
high reputation and sound financial standing.
(ii) The banker must periodically inspect the hypothecated
goods and the account books of the borrower should be
checked to ascertain the position of stocks under

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 hypothecation. Care should be taken to see that unsaleable
stocks are not being maintained by the borrower.
(iii) The borrower should be asked to submit a statement of
stocks periodically giving correct position about the stocks
and its valuation and declaration that the borrower
possesses clear title to the same.
(iv) Stocks should be fully insured against fire and other risks.
(v) A name plate of the bank, mentioning that the stocks are
hypothecated to it, must be displayed at a prominent place
in the business premises of the borrower for public notice.
This is essential to avoid the risk of a second charge being
created on the same stocks.

4.2.4 Mortgage

Section 58 of the Transfer of Property Act 1882 defines mortgage

as “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 an
engagement which may give rise to a pecuniary liability”. The transferor
is called ‘mortgagor’; the transferee ‘mortgagee’; the principal money and
interest thereon, the payment of which is secured are called the
‘mortgage money’ and instrument if any, by which the transfer is effected
is called a ‘mortgage deed’. The main characteristics of a mortgage are as
follows:
1. A mortgage is the transfer of an interest in the specific
immovable property and differs from sale wherein the
ownership of the property is transferred. Transfer of an
interest in the property means that the owner transfers some
of the rights of ownership to the mortgagee and retains the

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 remaining rights with himself. For example, a mortgagor
retains the right of redemption of the mortgaged property.
2. If there are more than one co-owners of an immovable
property, every co-owner is entitled to mortgage his share in
the property [Debi Singh vs. Bhim Singh and Others (A.I.R.
1971, Delhi 316)].
3. The property intended to be mortgaged must be specific (i.e.,
it can be described and identified by its location, size,
boundaries, etc.). A mortgagor must mention which of his
properties is intended to be mortgaged.
4. The object of transfer of interest in the property must be to
secure a loan or to ensure the performance of an
engagement which results in monetary obligation. Thus the
property may be mortgaged to provide security to the
creditor in respect of the loans already taken by the
mortgagor or in respect of the loans which he intends to take
in future. An existing overdraft can also be secured by the
mortgage of the property. But if a person transfers his
property for a purpose other than the above, it will not be
called a mortgage, e.g., a transfer of property in discharge of
a debt is not a mortgage.
5. The actual possession of the property need not always be
transferred to the mortgagee.
6. The mortgagee gets, subject to the terms of the mortgage
deed and the provisions of the Transfer of Property Act,
1882, the right to recover the amount of the loan out of the
sale proceeds of the mortgaged property.
7. The interest in the mortgaged property is re-conveyed to the
mortgagee on the repayment of the amount of the loan along
with interest thereon.

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Rights of a mortgagee

The rights of a mortgagee as specified in the Transfer of Property

Act, 1882, are as follows:

1. Right to foreclosure or sale- The mortgagee has a right to

obtain from the Court a decree that the mortgagor shall be absolutely
debarred of his right to redeem the property or a decree that the property
be sold. The former is called a suit for foreclosure. This right can be
exercised by the mortgagee at any time after the mortgagee money has
become due to him and before a decree has been made for the
redemption of the mortgaged property and in the absence of a contract to
the contrary. The right of foreclosure may be exercised by (i) a mortgagee
by conditional sale, or (ii) a mortgagee under an anomalous mortgage,
which authorises the mortgagee to exercise such right. A usufructuary
mortgagee or a mortgagee by conditional sale is not authorised to file a
sit for sale.

The right of the mortgagee is absolute and cannot be postponed in

preference to other debts of the principal debtor. In State Bank of India
vs. Regional Provident Funds Commissioner (A.I.R. 1965, M.P. 40), the
Madhya Pradesh High Court held that the property mortgaged to the
Bank would be sold only subject to the mortgage in favour of the Bank,
even if the mortgagor was in default of the payment of employer’s
contribution to the Employees Provident Funds. The demand for the
latter would not have any priority over other secured or unsecured debts
of the employers. The Court held that the Employees Provident Funds
Act, 1952 merely provides the manner of recovery of the employers’
contributions, i.e., to recover the same in the same manner as arrears of
land revenue. It does not have the effect of converting the arrears into
arrears of land revenue, nor did it create any charge over any property of
the employer or give a priority in the matter of payment of the amount.

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 2. Right to sue for mortgage money- Under Section 68, the
mortgagee has a right to sue for the mortgage money in the following
cases:

(i) where the mortgagor binds himself to pay the money, or

(ii) where the mortgaged property is wholly or partially destroyed
or the security is rendered insufficient and mortgagor has
failed to provide further security to render the whole security
sufficient, or
(iii) where the mortgagee is deprived of the whole or a part of his
security by or in consequence of the wrongful act or default
of the mortgagor, or
(iv) where the mortgagee being entitled to possession of the
mortgaged property, the mortgagor fails to deliver the same
to him.
3. Right of sale without the intervention of the Court- Under Section 69, the
mortgagee has the power to sell the mortgaged property or a part thereof without the
intervention of the Court in the following cases:
(i) where the mortgage is an English mortgage; and
(ii) where the power of sale without the intervention of the Court
is expressly conferred on the mortgagee by the mortgage
deed and that mortgagee is the government or the mortgaged
property or any part thereof was, on the date of the
execution of the mortgage deed, situated within the towns of
Calcutta, Madras, Bombay or in any other town or area
which the State Government may specify in this behalf.
4. Right to the accession to mortgaged property- Section 70 enables the mortgagee
to hold, for the purpose of security, any accession to the mortgaged property, which
occurs after the date of the mortgage, if a contract to the contrary does not exist.

5. Right to sue and Right to realise the security are distinct

rights- A mortgagee possesses the right to sue the mortgagor and also to
sue for the realisation of his security. In Bihar State Electricity Board

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and Another vs. Gaya Cotton & Jute Mills Ltd. (A.I.R. 1976, Patna 372)
the High Court considered the question whether the mortgagee was
bound to sue for the realisation of his security in a suit to enforce the
personal covenants given by the mortgagor to pay the mortgage debt.

6. Right in case of renewal of mortgaged lease- When the

mortgaged property is a lease and the mortgagor obtains renewal of the
lease, the mortgagee, in the absence of a contract to the contrary, shall,
for the purposes of the security, be entitled to the new lease (Section 71).

7. Right to recover money spent on mortgaged property- Under

Section 72 a mortgagee may spend such money as is necessary for the
following purposes and may add such money to the principal money, in
the absence of a contract to the contrary. Interest on such money shall
be payable by the mortgagor at the rate payable on the principal and, if
no such rate is fixed, at the rate of 9% per annum:
(i) for the preservation of the mortgaged property from
destruction, forefeiture or sale;
(ii) for supporting the mortgagor’s title to the property;
(iii) or making his own title thereto good against the mortgagor;
and

4.3 SUMMARY

A sound banking is based on safety of funds lent by a banker to

his customer. The first and the most important criterion to judge safety
of funds is the capacity of the borrower himself to repay the amount of
loan. Secured advances provide absolute safety to the banker by means
of a charge created on the tangible assets of the borrower in favour of the
banker. The modes of creating charge include lien, pledge, hypothecation
and mortgage.

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 The right of general lien empowers the banker to retain all
securities of the customer in respect of the general balance due from
him. The banker is, however, not entitled to realise his ….. from the said
assets of the customer. Under pledge, the banker as a pledgee has the
right to retain the goods pledged for the payment of the debt or the
performance of the promise. The pledgee can also claim any extra-
ordinary expenses incurred by him for the preservation of the security.
The pledgee has the duty to return the goods on payment of debt and is
also responsible to the pledger for any loss of goods, if the goods are not
returned by him at the proper time.

Hypothecation, which is another method of creating a charge over

the moveable assets, neither transfer ownership nor possession of good
to the creditor but an equitable charge is created in favour of the latter.
The goods remain in the possession of the borrower, who binds himself,
under an agreement, to give the possession of the goods to the banker,
whenever the latter requires him to do so. Another mode of creating
change is mortgage. The right of a banker as mortgagee is to obtain from
the court a decree that the mortgager (borrower) shall be absolutely
debarred of his right to redeem the property or a decree that the property
be sold.

4.4 KEYWORDS

CRR: The cash which banks have to maintain with the RBI as a
certain percentage of their demand and time liabilities.

Bailment: Section 148 defines bailment as the “delivery of goods

from one person to another for some purpose upon the contract that the
goods be returned back when the purpose is accomplished or otherwise
disposed of according to the instructions of the bailor”.

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 Pledge: According to section 172 of the Indian Contract Act, 1872
pledge is defined as “bailment of goods as security for payment of a debt
or performance of a promise”.

Hypothecation: Hypothecation is another method of creating a

charge over the movable assets. Under hypothecation neither ownership
nor possession of goods is transferred to the creditor but an equitable
charge is created in favour of the latter. The goods remain in the
possession of the borrower, who binds himself, under an agreement, to
give the possession of the goods to the banker, whenever the latter
requires him to do so.

Mortgage: Section 58 of the Transfer of Property Act 1882 defines

mortgage as “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 an engagement which may give rise to a pecuniary liability”.

4.5 SELF ASSESSMENT QUESTIONS

1. What is meant by the statement “Banker’s lien is

tantamount to an implied pledge? Bring out the distinction
between a lien, a hypothecation, a pledge and a mortgage.
What is the difference between an Equitable Mortgage and a
Legal Mortgage?

2. Discuss the characteristics of a mortgage, a pledge and a

lien. As a banker which of these would you prefer as security
and in what circumstances?

3. (a) Define a fixed charge and a floating charge.

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 (b) A charge is created by a public limited company on its
stock-in-trade in favour of your bank to secure a cash
credit limit. What would be the effect of failure to
register the charge under Section 125 of the
Companies Act?

4. Define ‘Pledge’. What are its essential ingredients? Who can

create a valid pledge? What are the rights and obligations,
respectively, of the pledger and the pledgee?

4.6 REFERENCES/SUGGESTED READINGS

Geoffrey Lipscombe and Keith Pond, The Business of Banking, New Age International
(P) Ltd. Publishers, 1st Indian Ed., 2005.Amin, V. (1994), Banker's’ Securities- A
Practical and Legal Guide, CIB Books.
• Chawla, R.C., Garg K.C. and Suresh V.K., Mercantile Law,
Kalyani Publishers, New Delhi, 2000.
• Downes, Patrick: The evolving Sale of Control Banks, IMF
Publication, Washington, D.C. 1991.
• Dr. Gopal Swaroop: Laws and Practices Related to Banking,
Sultan Chand and Sons, New Delhi, Second Rev. Edition,
2003.
• Dutt, A.C., Indian Contract Act (Act IX of 1872, with notes
and commentaries), Eastern Law House Pvt. Ltd., Calcutta.
• K.P.M. Sundharam and P.N. Varshney: Banking Theory, Law
and Practice, Sultan Chand and Sons, New Delhi.
• M.C. Vaish: Money, Banking and International Trade, 8th
edition, New Age International Pvt. Ltd., New Delhi.
• P.N. Varshney: Banking Law and Practice, Sultan Chand &
Sons, New Delhi, 20th edition, 2003.
• Panda, R.H., Principles of Mercantile Law, N.M. Tripathi
Private Ltd., Bombay.

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Reserve Bank of India: 50 Years of Central Banking, RBI, Mumbai, 1997.

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