DOCUMENTATION PROCEDURE IN LOAN ACCOUNTS

It is of utmost importance to obtain appropriate and correctly executed security documents before disbursing an advance to borrowers. In case the borrowers fail to repay, the recovery of Bank’s dues, banks will mainly depend upon the enforcement of the security. Banks should, therefore, take necessary care and precaution while obtaining security documents in advance accounts and scrupulously adhere to the instructions/guidelines laid down in this regard. It should be borne in mind that if the Bank is faced with a situation of remedying any defects or irregularities in the security documents at the time of filing a suit, it would be difficult to get the co-operation from the borrowers and guarantors, if any, and the Bank’s action against them might be in jeopardy.

WHAT IS DOCUMENTS ?

As per Sec.3 of Indian Evidence Act 1872, document means any matter expressed or described upon any substance by means of letters, figures or by more than one of these means intended to be used or which may be used for the purpose of recording that matter with an intention of producing the same as evidence.  

In common usage Documents are related to written record created for the purpose of evidence while lending the bank funds. Banking relationship is a contract between the Bank & the Customer. Customer should be legally capable of entering into a valid contract.

Need & Importance of Documents: Documents are necessary to be obtained for the following purpose;

• It identifies borrower, guarantor,
• It identifies security, nature of charge
• For creation of Bank’s charge on security.
• Written evidence of transaction & hence cannot be disputed by the executant in future.
• It is accepted as an evidence of fact in court of law in any legal proceedings against defaulter. Documentary evidence (Section 64 of the Indian Evidence Act).
• Recording happening of an event/incident.
• Helps Bank to safeguard its interest by incorporating protective clauses as & when felt necessary.
• Under Negotiable Instruments Act 1881, Banker acquires a right to file a money suit based on Demand Promissory Note executed by the borrower.
• Deciding period of limitation.

DIFFERENT TYPES OF DOCUMENTS

Bank obtains different types of documents during opening of accounts and financing an advance to borrower. Documents obtains during an advance can be broadly classified as three types. 

1. Demand Promissory Note (DPN): DPN is an important loan documents. It is an unconditional promise to repay the loan on demand with agreed rate of interest where no fixed period of time mentioned. Section 4 of the Act defines, “A demand promissory note is an instrument in writing containing an unconditional undertaking, signed by the maker, to pay a certain sum of money to or to the order of a certain person, or to the bearer of the instruments”. An instrument to be a promissory note must possess the following elements:

• It must be a promise to repay a certain sum of money along with agreed rate of interest,
• It is paid on demand, no time frame for repayment mentioned,
• Promise to pay must be unconditional,
• The promise should be to pay in money and money only,
• It should be signed by the borrower,

2. Agreements: It is defined in the Indian Contract Act 1872. Every promise and every set of promises, forming the consideration for each other, is an agreement. An agreement enforceable by law is a contract. All the terms and conditions are mentioned in the agreements. The loan amount, rate of interest, margin, repayment period, moratorium period, details of securities offered are included in the agreement. The agreement attracts a stamp duty as per Indian Stamp Act. During documentation, bankers use different forms of agreements such as term loan agreement, Hypothecation agreement, pledge agreement, guarantee agreement etc.

3. Forms: Forms are neither a promise nor an agreement. It is obtained for the purpose of the intention of the borrower. Application for request of a loan by the borrower is also a type of forms. When a loan is granted against the security of a fixed deposit standing in the joint names, one of the depositors gives an authorization to the other to raise a loan on the deposit, such an authorization is taken in a form. If a letter from the borrower authorizing the bank to pay the proceeds by means of drafts, is taken by means of a form. All these forms are used as part of documentation to prove the intention of the borrowers.

STEPS AND PROCESS OF DOCUMENTATION

The following are the precautions, which should be taken care of both by the borrower as well as banker, at the time of preparation, execution and registration of loan documents etc. The systematic process of documentation are as follows; 

1. Selection of proper set of documents and formats;
2. Stamping;
3. Filling Up;
4. Execution or signing;
5. Checking & Vetting Recording;
6. Registration;
7. Keeping documents in force.

1)   Selection of proper set of documents and formats: Selection of proper set of documents is important steps of documentation. Selection of full set of documents depending upon the nature of facility, types of security and type of person who will execute the documents. Some documents are common for most of the loans, but some particular documents are relevant for particular credit facility. Documents also depends upon the types of borrowers. Banker needs to be conversant with legal provisions of various Acts. Documents must be in proper format and vetted by the legal department. 

2)   Stamping: The next important steps is stamping of documents. The loan documents should bear proper type of stamps i.e. adhesive, embossed etc. Further value of stamp duty should be adequate, keeping in view the laws of the State in which the documents are executed. The Non Judicial Stamp papers, if used, should bear the date, prior to its execution and also the date should not be earlier than six months. The text of the agreement may be written on the Stamp papers itself and plain papers (additional sheets) may be used, if required in addition to Stamp papers.

Statutory Requirement: Stamp duty is a form of tax that is levied on documents. Let us understand stamping duty provisions, starting with the Indian Stamp Act 1899. Any instrument which creates, transfers, extends, extinguishes, limits or amends a right or liability is required to be stamped as per the Indian Stamp Act. This extends to the whole of India, except Jammu and Kashmir.

Stamp Duty: Central Government Stamps applicable on the instruments including Demand Promissory Note, Usance Bill of Exchange, Bill of lading, Letter of Credit, Share Transfer Form, Insurance Policy, Money Receipts, the stamp duty will remain the same throughout India.

State Government Stamps applicable on Mortgage, Hypothecation, Guarantee, Pledge, Power of Attorney, Partnership Deed, Agreements etc. Stamp duty in respect of other items (not in union list), the State Government can amend or enact a new Act and prescribe the duty.

Stamping Norms: Section 17 of Indian Stamp Act states that the documents should be stamped before or at the time of execution. Value of stamp will be decided as per the State Act. In the event of doubt, the Collector will decide. All security documents should be properly and adequately stamped before execution. Appropriate stamp refers to using revenue stamps, adhesive stamps or special adhesive stamps or non-judicial stamp paper wherever applicable. Stamp duty is payable on the instrument.

Effect of non-stamping or under-stamping: Documents including promissory note, usance bill of exchange and acknowledgement of debt, if unstamped or inadequately stamped, cannot be validated. They will not be admitted in the court of law as evidence. They cannot be validated even after payment of duty. In case of documents like hypothecation agreement, pledge agreement and so on; the difference in stamp duty together with penalty can be paid. However, such payment should be before filing of suit so that it may be admitted as evidence.

Stamp duty on documents executed at different place: If documents executed outside India, then after reaching to India again stamping is required within 3 months.

It should be stamped as per state act where it is executed first then to be send to other state, difference to be paid if duty is more in second state. If documents are signed in one state and to be enforced in other state difference to be paid within 3 months of receipt of document.

Cancellation of Stamps: The adhesive stamp which is the revenue stamp on Demand Promissory note and acknowledgement of debt can be cancelled by the executant. This should be done by writing across the stamp so that the stamp cannot be used again.

The special adhesive stamps affixed on top of the hypothecation agreement, pledge agreement and other bank documents need to be cancelled. The cancellation will be done either by the stamp office or by the Chief Incumbent of the branch or authorised person as per state government notification before or at the time of execution.

Effect of Non-cancellation: Any instrument bearing adhesive stamps that have not been cancelled will be treated as unstamped. Such an instrument will not be admitted in the court of law as evidence.

3)   Filling Up: The next step of documentation procedure is filling up of the documents before execution. The documents should be filled completely in all respect. No column of the loan documents should be left blank. Date, place, amount, rate of interest, type of facility and security, terms etc. should be filled carefully without any alteration, overwriting and cutting. Entire document should be filled with same ink, in same handwriting by same person. Once the document is executed it becomes a concluded contract and any subsequent filling by bank without the consent of the executant will invalidate it. Place of execution is very important for deciding the jurisdiction of the court. Security documents bearing dates of execution prior to the date affixed by the stamp authority on the special adhesive stamps are invalid.

4)  Execution or signing: The next step of documentation procedure is execution or signing of the documents. Person, executing the loan documents must be competent to enter into a contract i.e., he or she should have contractual capacity. Thus, minor, insolvent person, lunatic etc. are not competent persons to execute documents.  During the execution of document, it should be ensured that the signature in the documents must tallies with the signature as appearing in the application for the loan and also with the specimen signature available in the deposit account. In case, execution in the representative capacity of sole proprietor or partner or agent or trustee or executor etc, the capacity property should be clearly mentioned. While executing the documents, the borrower must sign in full and in the same flow in which his signatures are available in the bank. The cuttings & over writings must be avoided and if at all, they become unavoidable, they should be authenticated by the borrowers by signing in full. In case the borrowers reside at different places, the loan documents should be got executed through the branches of the bank situated at those stations, after properly verifying the identity of the borrowers. The guarantee form should be executed if so agreed and stipulated as a term of sanction.

Sometimes loan documents are executed by the holder of power of Attorney on behalf of a trading concern, partnership firm, Hindu undivided family (HUF), company, individual etc. In such a case, a notice should be sent to the principal, stating that the attorney has executed the documents on their behalf. A certified copy of Power of Attorney should be kept along with main loan documents. And also, the letter/confirmation received from the principal in this regard, in response to the notice should be preserved.

The borrowers must obtain a copy of the sanction (Sanction letter) and ensure that documents only for those facilities which are sanctioned in their favour are executed.

5)   Checking & vetting of documents: After proper signing or execution of the documents, it should be checked that documents are in proper format, properly filled in all respect and properly executed as per sanction term and conditions. Documents of the high value of loan amounts should be vetted by the penal advocate. Banks should, scrupulously adhere to the instructions/guidelines laid down in this regard. It should be borne in mind that if the Bank is faced with a situation of remedying any defects or irregularities in the security documents at the time of filing a suit, it would be difficult to get the co-operation from the borrowers and guarantors, if any, and the Bank’s action against them might be in jeopardy. 

6)  Registration of Loan Documents: The Registration Act, 1908 was enacted to consolidate the laws relating to the registration of documents. In case of advances of limited companies against his assets, it should be registered to the registrar of companies within 30 days from the date of execution. Similarly, in case of registered mortgage, the mortgage deed is presented for registration within 4 months from date of execution of deed. Equitable mortgage should be registered with CERSAI within 30 days.  If these formalities are not done then the bank may have to lose priority over security. The documents may not be admissible as evidence before the competent authority. 

7)  Keeping documents in force: After doing all the formalities, the documents should be kept in safe. But, the documents taken by banks for a credit facility do not have perpetual life. The law of limitation as per Limitation Act applied on the documents. For example, the period of limitation for DP Note is three years from date of execution. It means, the bank has to get fresh documents or obtained acknowledgement of debt for extending the period of limitation as per the provision of limitation act. After obtaining of acknowledgement of debt the expiry period of limitation extended for further three years. According to section 3 of Limitation Act, a suit cannot be filed for recovery on the strength of a time barred document.