Table of Contents
To safeguard their advances, the bank accepts different types of securities during the lending and creates charges upon them. When land/buildings and fixed assets that are permanently fastened to the earth are offered as a security, it is charged by a mortgage in favor of a bank. When movable goods are offered as a security, these are charged as pledge or hypothecation. Paper securities are lien or assigned in favor of the bank. The law relating to the different types of securities is defined in the Concern Acts.
Charges on Securities
The word ‘charge’ is used to mean any form of security or debt. Sec 2(16) of the Companies Act, 2013 provides the following charges of a Company are to be registered with the Registrar of Companies: –
- A charge for security debentures,
- A charge on the uncalled capital of the Company,
- A charge on immovable property;
- A charge on any book debts of the company,
- A charge, not being a pledge, on any movable property of the company,
- A floating charge on the undertaking or any property including stock-in-trade,
- A charge on a ship or share in a ship
- A charge on goodwill, on a patent or a trademark or a license under copyright.
As per Chapter VI, Section 77(1) of the Companies Act 2013 ‘It shall be the duty of every company creating a charge within or outside India, on its property or assets or any of its undertakings, whether tangible or otherwise, and situated in or outside India, to register the particulars of the charge signed by the company and the charge-holder together with the instruments, if any, creating such charge in such form, on payment of such fees and in such manner as may be prescribed, with the Registrar within thirty days of its creation’.
‘Provided that the Registrar may, on an application by the company, allow such registration to be made within a period of three hundred days of such creation on payment of such additional fees as may be prescribed’.
Creation of Charge
Creation of charge by the borrowers on various kinds of securities/assets means the creation of a right in favour of the bank. By creation of charge, the ownership is not transferred in favour of the creditor. (Except in a few transactions such as English Mortgage).
Types of Charge
Charges can be classified into two types:
Also called ‘specific charge’. It extends over a specific property of the company. It gives right to the creditor to sell the property and claim the proceeds towards the dues payable by the Company. It is created on properties such as Land and Building, Plant & Machinery, whose identity does not change during the period of loan.
This means a charge that is general and not specific. It is created on assets which undergone change(stock).
- a) Floats over the present and future property of the Company, and it do not attach any specific property.
- b) On happening of an event or contingency, crystallizes as a fixed charge. A floating charge is an equitable charge which does not attach on any specific property but covers the whole of the company’s property.
Crystallization of Charge
It means the Floating Charge becomes fixed when the company/firm ceases to be a going concern or upon the commencement of winding up or on the appointment of a receiver.
Charges can also be classified as under:
Where assets are charged to a creditor on a first basis, that creditor has the 1st charge.
Where assets are already charged to a creditor on 1st basis and subsequently the charge is created in favour of another creditor.
Pari Passu Charge
The term is usually used in the case of consortium lending. In the case of such lending, many banks or financial institutions join together to lend to a single borrower in an agreed ratio against some common securities. The securities are charged to all the bankers/financial institutions with the condition that they have priority on a proportionate basis in the ratio of their loans. The term that institutions will have a “paripassu charge” over the assets of the borrower means that the lenders are entitled to have equal rights over the assets as per the agreed share.
Registration of charge
After the creation of charges on the securities, the charges must be registered with the appropriate authority where applicable. Charges are registered with RTO, CERSAI, ROC, etc. within the prescribed periods. All Mortgages and Hypothecations shall be filed with the CERSAI within 30 days of their creation.
All the charges created by the Company shall be filed with the ROC within 30 days of its creation. The registration, modification, and satisfaction of charge are to be filed in form No CHG – 1 & CHG-4 in MOC21. Recently Government of India has introduced electronic filing of returns.
MCA Charge filing fees new structure wef 1 August 2019
- Within 30 days – Normal Fees
- Delay Up to 30 days – 6 times normal fees
- Delay More than 30 days and up to 90 days – 6 times normal fees plus ad valorem fees 0.05% of amt secured by charge subject to a maximum of Rs.5 lacs.
Note: 120 days and above charge will not be taken on record by MCA
Effect of non-registration
As per Chapter VI, Section 78 of the Companies Act 2013: ‘Where a company fails to register the charge within the period specified in section 77, without prejudice to its liability in respect of any offense under this Chapter, the person in whose favour the charge is created may apply to the Registrar for registration of the charge along with the instrument created for the charge, within such time and in such form and manner as may be prescribed and the Registrar may, on such application, within fourteen days after giving notice to the company’.
If the charge created is not registered with ROC, the charge would not be valid against the liquidator and any other creditor of the Company in the event of winding up of the company, as against the company itself. So long as the company does not go into liquidation, the mortgage or charge is good and may be enforced.
Different types of securities, charges, and related acts are as under.
|Nature of Security
|Types of Security
|Kind of Charge
|Defined in Act
|Land & Building
|Transfer of Property Act (58)
|Actionable claims (i.e. unsecured debts)
|Book debts, FDR, NSC, Life Policies
|Transfer of Property Act (130, 135)
|Plant & Machinery, Stocks, Vehicles etc
|Pledge or hypothecation or lien as agreed between bank and borrower
|Indian Contract Act (170,171)
|Indian Contract Act (172)
|SARFAESI Act -2(n)
|Shares, debentures, mutual fund units, bonds
|Indian Contract Act (170,171)
Mortgage is defined in the Transfer of Property Act 1882 Section 58(a). As per the Act:
“A mortgage is the transfer of an interest in specific immoveable property to secure 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 a ‘mortgagor’, the transferee a ‘mortgagee’; the principal money and interest of which payment is secured for the time being are called the mortgage money, and the instrument(if any) by which the transfer is effected is called a ‘mortgage-deed’.
Interest in the property &possession
The mortgagor only parts with the interest in the property and not the ownership. A mortgage is not merely a contract but it is the conveyance of an interest in the mortgaged property. As regards the possession, except for the usufructuary mortgage, the possession remains with the mortgagor.
Essential features of mortgages
Essential features of a mortgage are as under:
- Loan amount: Mortgages can be created to cover general balances, existing payments as well as future loans or advances.
- Relationship: there must be a creditor and debtor relationship (or contract of guarantee) between the bank and the mortgagor at the time of deposit of title deed.
- Future debt: actual existence of the debit is not necessary. Even an application for debt and its acceptance establishes this relationship.
- Effective date: a registered mortgage (and equitable mortgage) becomes effective from date of mortgage (Section 47 & 48 of Indian Registration Act).
- Enhanced limits: To cover the enhanced bank limits, a supplemental registration deed is required because the mortgage already does not cover the enhanced amount.
- Repayment of loan: On repayment of debt, the mortgage does not remain valid.
Different types of mortgages are as under:
Types of mortgage defined in Transfer of Property Act 1882 Section 58(b) to 58(g).
- Simple mortgage: Sec. 58(b)
- Mortgage by conditional sale: Sec. 58(c)
- Usufructuary mortgage: Sec. 58(d)
- English mortgage. Sec. 58(e)
- Equitable Mortgage or Mortgage by deposit of title deeds. Sec. 58 (f)
- Anomalous mortgage.(Sec. 58g)
|Defined in Transfer of Property Act
|Personal Liability of Mortgager
|Registration with Sub Registrar
|How the mortgage created?
Limitation Period of Mortgage: The limitation period for a mortgage is 12 years from the date the mortgage money becomes due. For the right of foreclosure and the right of redemption, it is 30 years.
For details about Mortgage must study my blog MORTGAGE – AN OVERVIEW https://bankingdigests.com/blog/mortgage-an-overview/
ASSIGNMENT AND ACTIONABLE CLAIMS
As per Sections 130 and 135 of the Transfer of Property Act, assignment is the transfer of an actionable claim, which may be existing or future, as a security for the loan.
Assignment is another mode of providing security to the lending banker. Assignment means the transfer of a right, property, or a debt existing or future. The borrower of the bank may assign any of his rights, properties, or debt to the banker to secure a loan. An assignment is also a transfer of an actionable claim (such as a life insurance policy), which may be existing or future, as a security for the loan. The transferor of such a claim is called the ‘assignor’ and the transferee is called the ‘assignee’.
Actionable claim 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 as affording grounds for relief, whether such debt or beneficial interest be existent, accruing, conditional or contingent.
Transfer of actionable claim (Sec 130): The transfer shall be effected only by the execution of an instrument in writing signed by the transferor or his duly authorised agent, shall be complete and effectual upon the execution of such instruments, and thereupon all the rights and remedies of the transferor, whether by way of damages or otherwise, shall vest in the transferee, whether such notice of the transfer as is hereinafter provided be given or not. Accordingly, the transferee may sue or institute proceedings for the same in his name without obtaining the transferor’s consent to such suit or proceeding and without making him a party thereto.
For example, ‘An’ effects a policy on his own life with an insurance company and assigns it to a bank for securing the payment of an existing or future debt. if ‘A’ dies, the bank is entitled to receive the amount of the policy and to sue on it without the concurrence of executor of ‘A’, subject to the proviso in sub-section(1) of section 130 and to provisions of section 132.
Notice to be in writing, signed (Sec 131): Every notice of transfer of an actionable claim shall be inwriting, signed by the transferor or his agent duly authorised on this behalf, or, in case the transferor refuses to sign, by the transferee or his agent, and shall state the name and address of the transferee.
Liability of transferee of actionable claim (Sec 132): The transferee of an actionable claim shall take it subject to all the liabilities and equities and.tp which the transferor was subject in respect thereof at the date of the transfer.
U/s 172 of Indian Contracts Act, pledge is bailment or delivery of goods as security for payment of a debt or performance of a promise. It may be remembered that only goods (movable assets excluding actionable claims (Sec 2(7) of the Sales of Goods Act) can be pledged. The bailor, in this case, is called the “pawnor or pledger”. The bailee is called “pawnee or pledgee”. Pledge is different from bailment. Bailment is the delivery of goods by one person to another for some purpose while the purpose in a pledge is performance of a specific promise or security for a debt. The pledgee can sell the goods pledged after giving notice to the pledger while in bailment the goods can be retained or the bailer can be sued for charges.
Authority to pledge the goods
The owner of goods, the agent of the owner, the joint owner with the consent of other co-owner and a person having limited interest in the goods (to the extent of his interest), can pledge the securities.
Pledge by mercantile agent: U/s 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 authorized 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 the pledge notice that the pawnor has no authority to pledge.
Pledge where pawnor has only a limited interest: As per Section 179, where a person pledges goods in which he has only a limited interest, the pledge is valid to the extent of that interest.
Rights of pledgee
The pledgee gets the rights of a bailee which include:
- Right to retain (Section 173): The pawnee may retain the goods pledged, not only for payment of the debt or the performance of the promise, but for the interests of the debt, and all necessary expenses incurred by him in respect of the possession or for the preservation of the goods pledged.U/s 174, the pawnee shall not (in the absence of a contract to that effect), retain the goods pledged for any debt or promise of other than the debt or promise for which they are pledged.
- Right as to extraordinary expenses incurred (Section 175): The Pawnee is entitled to receive from the pawnor extraordinary expenses incurred by him for the preservation of the goods pledged.
- Right, where pawnor makes default (Section 176):If the pawnor makes default in payment of the debt, or performance, at the stipulated time, the pawnee may bring a suit against the pawnor upon the debt or promise and retain the goods pledged as collateral security; or he may sell the thing pledged, on giving the pawnor reasonable notice of the sale.
If the proceeds of such sale are less than the amount due in respect of the debt or promise, the pawnor is still liable to pay the balance. If the proceeds of the sale are greater than the amount so due, the Pawnee shall pay over the surplus to the pawnor.
- Defaulting pawnor right to redeem (Section 177): If a time is stipulated for the payment of the debt, or performance of the promise, for which the pledged is made, and the pawnor makes default in payment of the debt or performance of the promise at the stipulated time, he may redeem the goods pledged at any subsequent time before the actual sale of them; but he must, on that case, pay, in addition, any expenses which have arisen from his default.
Duties of the pledgee
The duties of the pledgee are as follows.
- To return the goods (along with accretion to goods if any) once the money is paid back by the pledger.
- To take that much care of the goods, which he would have been taking, had the goods belonged to him.
Banker’s right and other dues: The Bank’s right of pledge prevails over any other dues including Govt. dues (Supreme Court State of Bihar vs Bank of Bihar)”except workers’ wages.
Law of limitation: The rights of the pledgee are not limited by the Law of Limitation.
Hypothecation is defined in the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act 2002. As per Sec 2 (n) of SARFAESI Act 2002, ‘Hypothecation means 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 crystallisation of such charge into fixed charge on movable property’;
Hypothecation is an equitable charge, where the borrower is owner and keeps the possession of the security on behalf of the creditor. In hypothecation on the property, the ownership as well as possession of the security remains with the borrower. It applies to all movable properties like stock, crops, vehicles, machinery, furniture etc.
Hypothecation is resorted to in the following cases:
- When a loan is to be raised against work-in-progress, the only way of creating a charge is hypothecation.
- It is also done concerning goods that require constant handling in a factory, e.g. rice mills, oil expellers etc.
- This charge is also convenient, where lending is to be done against goods in a shop or showroom which is required in day-to-day use.
- It is easily applicable to vehicles for private or commercial use.
Drawbacks of Hypothecation:
- The main drawback of this charge is that goods remain in the possession of the borrower and therefore creditor’s control over such goods is not practically possible.
- The borrower may realise and sell the hypothecated stocks and keep only obsolete and slow moving stock.
- The borrower may hypothecate the same stock for more than one creditor or banker.
- The realisation of the assets in case of default of payment is a difficult, prolonged, and costly affair.
Precautions to be taken in case of Hypothecation:
- Banks ensure that the firm is not enjoying similar facilities with other banks on the security of same goods.
- Borrower enjoys facilities from one bank only and an undertaking in writing should be obtained from him.
- A bank name board should be displayed where the securities are located stating that the bank has charge over such goods.
- Recurring inspection should be conducted by the bank to see that the level of goods being maintained is same as the one declared by the borrower and as per his books.
- Borrower should submit a stock statement periodically,
- Such stocks should be insured for fire and other risks.
Legal aspects in Hypothecation Possession & sale
Hypothecation is an equitable charge, where the borrower keeps the possession of the security on behalf of the creditor. If the borrower fails to return the advance against the hypothecation of securities, the bank can take possession of the securities with consent of the borrower and becomes a pledgee. On becoming pledgee, the bank get all the rights of a pledge including right to sell without intervention of the court. Under Securitisation Act, the bank also has the right to sell the hypothecated securities without intervention of the court, subject to compliance of certain legal formalities.
Lien is the right of one person to retain goods and securities in his possession belonging to another until certain legal debts due to the person retaining the goods are satisfied. In other words, it is the right of the creditor to retain the goods and securities in his possession, belonging to a debtor, until the debt due is paid. The lien does not give power of sale but only to retain the property.
Section 170 of the Indian Contract Act 1872 defined Particular Lien as ‘Where the bailee has, in accordance with the purpose of the bailment, rendered any service involving the exercise of labour or skill in respect of the 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 services he has rendered in respect of them.
A particular lien is that lien which confers the right to retain that particular commodity in respect of which the particular debt arose.
Section 171 of the Indian Contract Act 1872 defined General Lien as ‘Bankers may in the absence of a contract to the contrary, retain as a security for a general balance of the account, any goods bailed to them; but no other person has a right retain, as a security for which balance, goods, bailed to them, unless is an express contract to that effect’.
A general lien confers a right to retain goods and securities not only in respect of a particular debt incurred in connection with them but in respect of the general balance due by the owner of the goods and securities, to the person in possession of them.
As a general rule, the right of lien does not give the person exercising the right, any power or right to sell or dispose of the securities retained. But in case of a bank, it is otherwise. A banker’s lien is more than a general lien.
It is an implied pledge and the banker has a right to sell the property after reasonable notice, provided the property comes into his hands in the ordinary course of his business.
Section 171 of the contract act lays down that a banker’s lien can be applied if:
- The property is in the hands of the banker as the capacity of his customer’s bankers;
- The instruments of the money or goods with the banker are not for a specific purpose inconsistent with lien;
- The possession of the instruments has been obtained lawfully as a banker;
- There exists no implied or expressed agreement contrary to the lien.
At the time the advance is made, the banker sometimes asks a borrower to execute a letter declaring that his assets are free from any sort of charge or encumbrance. The borrower also undertakes that the assets stated in the said declaration shall not be encumbered or disposed of without a bank’s permission in writing so long as the advance continues. This undertaking is known as a Negative lien. Usually the arrangement is drafted in the form of an agreement. The banker cannot directly realize his debts from such assets. However, on account of the above restrictions, the interests of the banker are to a certain extent protected.
Set-off is the right of a debtor to take into account a debt owing to him by a creditor when claiming a debt due from him to the creditor. In the case of a banker, the right of set-off enables him to adjust a debit balance in a customer’s account, with any balance outstanding to his credit in the books of the bank. In other words, the banker can adjust his claim from the amount that is payable to the customer.
Must read my blog “TYPES OF SECURITIES AND THEIR CHARACTERISTICS IN BANKS”