BANKING SECURITIES

CHARGE, BAILMENT,
PLEDGE

ASWATHY S NAIR
8TH SEM BA LLB
ROLL NO: 417

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 PREFACE

It is a fundamental precept of banking everywhere that advances are made to

customers in reliance on his promise to repay, rather than the security held by the
banker security is required by the banker as a protection against unexpected default
in repayment by the customer. A banker must bear in mind all times that if he has
reason to believe that a would be borrower would default if a loan is granted he
should decline to make an advance. Whether or not security is offered, so far
unsecured advances are concerned, prudence dictates that such advances should be
made only to customers of undoubted integrity and of the highest financial
standing, although following the nationalization of commercial banks in India, the
concept of slowing change and proposes for unsecured advances have been
considered from various types of new clients.

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 ACKNOWLEDGEMENT

I would like to express my special thanks of gratitude to my Professor Jeyanthi

mam as well as our Principal Dr. E R Jayaraman who gave me the olden
opportunity to do this wonderful project on the topic Banking securities- Charge,
Bailment, Pledge, which also helped me in doing a lot of research and I came to
know about so many new things. I am thankful to them. Secondly, I would also
like to thank my parents and friends who helped me a lot in finalizing this
assignment within the limited time frame.

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 INTRODUCTION

Banking securities may be regarded as a safeguard against unforeseen eventualities

which deprive the banker of direct repayment from the customer himself rather
than as the expected source of repayment.

Security for bank advance has no doubt been reduced to secondary importance in
the present context particularly for priority sector advances but it is still very
important to influence the decision of banks in conventional advances. Reserve
Bank of India has also stipulated certain quantitative restrictions on the banks'
power to grant clean advances. Banks have prescribed their own formats for
documentation for various types of advances and the borrowers in almost all the
cases have to execute those documents without any choice. It would never be
advantageous to know the general characteristics of securities, methods of their
charging and documentation procedures adopted by the banks.

The securities may primarily be divided in two categories as under

1. Primary security.
2. Collateral security.

The assets created by the borrower from the credit facilities granted by the bank
form the primary security for the bank advance as a matter of rule. The bank
invariably obtains a charge over those assets. Similarly, other assets on which the
advance is primarily based even if it is not created from the credit facilities granted
by the bank will also be taken as primary security.

In some cases where primary security is not considered adequate or the charge on
the security is open the bank may insist on an additional security to collaterally
secure advances granted by it. Such securities are termed as collateral securities.
Collateral security may either be tangible or third party guarantees may also be
accepted.

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A banks advance can be divided into 2 groups, viz , those made against security
upon which the bank realize but does not expect to have to restore for ultimate
repayment, and those made on general credit standing of the borrowers and
evidenced only by a promissory note. Thus bank advances fall under 2 broad
heads, unsecured and secured advances.

Unsecured advance

An unsecured advance is a advance that is issued and supported only by the

borrower's creditworthiness, rather than by any type of collateral. Unsecured
advances—sometimes referred to as signature advances or personal advances—are
obtained without the use of property or other assets as collateral. The terms of such
loans, including approval and receipt, are therefore most often contingent on the
borrower's credit score. Borrowers must generally have high credit ratings to be
approved for certain unsecured advances.

Secured Advances

In accordance with the principles of safety and security of sound lending,

commercial banks prefer to make advances against securities. A secured advance is
one which is made on the security of either assets or against personal security or
other guarantees. An advance which is not secured is called an unsecured advance.

The basic objective of obtaining securities is to recover the unpaid

amount of loan if any, through the sale of these securities. Hence, the securities
should be clearly identifiable be easily marketable, have stability and their title
should be clear and easily transferable.1

1
Dr. REGA SURYA RAO, LECTURES ON BANKING LAW pg:47-49 (1d ed.2014)

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 CLASSIFICATION OF SECURITIES

Based on their nature, securities can be divided into various categories:

1. Personal Securities

These are also called intangible securities. In case of these, the banker has a
personal right of action against the borrower, e.g. promissory notes, bills or
exchange, a security bond, personal liability of guarantor etc.

2.Tangible Securities

These are forms of impersonal security, such as, land, buildings and machinery. In
the event of recovery of loans, banks have to get such securities enforced or sold
through the intervention of court.

3. Primary Securities

These are those securities or assets which are created with the help of finance made
available by the bank, like machinery or equipment purchased with the help of
bank finance.

4.Collateral Security

This security is not what is financed out of the bank advance. It is additional
security given by the borrower where the primary security is not enough to recover
the loan amount at the time of realization, e.g. the land of the factory is given as
security along with the machinery purchased out of the bank loan.2

2
Ibid

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 MODES OF CREATING CHARGES

In case of secured loan, a charge is created on the asset in favour of the bank. In
other words, the banker obtains a legal right to get payment of the loan amount out
of the security charged. Charges can be of the following types such as lien, pledge,
assignment and mortgage. Charges can also be categorized according to their
nature such as fixed charge or floating charge. A fixed charge is created on assets
whose identity does not change, e.g., land and building. In the case of floating
charge, the identity of the asset keeps fluctuating, e.g., stocks.

The legal provisions regarding modes of creating charge over tangible assets
and the rights and obligations of various parties are explained hereinafter:

LIEN

Lien means the right of the creditor to retain the goods and securities owned by the
debtor until the debt due from him is repaid. The creditor gets only the right to
retain the goods and not the right to sell. Lien can be either particular or general.
The right of particular lien can be exercised by a person who has spent his time,
money or labour on the goods, e.g. a car mechanic, a tailor, etc. It can be exercised
against only those goods for which charges have to be paid. A banker, however,
enjoys the right of general lien.3

The right of the banks to general lien is however, considered on a different footing
and banks have a general lien on all securities deposited with them as bankers by a
customer, unless there be an express contract or circumstances that show an
implied contract, inconsistent with lien. A banker’s lien is thus more than a general
lien, it is an implied pledge. The bank, therefore, has a right to sell the goods in his
possession after giving a reasonable notice. The lien can be exercised on bills and

3
DR. R.K BANGIA, BANKING LAW AND THE NEGOTIABLE INSTRUMENTS ACT, pg:59 (6d ed 2018)

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cheque deposited for collection, dividend warrants received by the banker as a
mandatee from the customer, securities left with the banker after a particular loan
has been paid. The bankers lien however, does not extend to:

(i) Securities or valuables lying in the locker rented to the customer.

(ii) Securities deposited upon a particular trust.

(iii) Securities deposited to secure a specific loan.

(iv) Securities left with the banks after an advance against them has been
adjusted.

(v) Securities left inadvertently with the bank.

No specific letter of lien agreement is necessary as the banks enjoy the right of lien
under the Contract Act. However, in some cases the bank may obtain a specific
letter of lien so that the borrower is not able to contend later that the securities
were deposited by him for a specific purpose inconsistent with the lien.

Features

The right of general lien right of a banker is a blanket right, and is applicable in
respect of all amounts which are due from the debtor such as security handed over
to the banker for a machinery loan after its repayment can also be used by the
banker in respect of any other advances outstanding in his name, e.g., against an
overdraft taken by the borrower.

Even though this right is conferred upon the banker by the Indian Contract Act, yet
it is advisable to take a letter from the customer mentioning that the goods have
been entrusted to the banker as security, and he may exercise his right of lien
against it.

The bankers’ right of lien is tantamount to an implied pledge. Unlike as in the case
of particular lien the creditor can only retain the goods till the amount due is paid,
the banker has the right to sell the goods in case of default of the customer.

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Negative Lien

The borrower may sometime 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, bank
may sometimes request him to give an undertaking to the effect that he will neither
create any encumbrance on these assets nor sell them without the previous
permission of 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.

Under this arrangement, the borrower has to

1. give a declaration that the assets given as security are free from any charge or
encumbrance,

2. That no charge will be created on them nor will the borrower dispose of those
assets without the consent of the banker. The banker’s interests are only partially
safe by securitizing a negative lien as he cannot realize his dues from these assets.4

PLEDGE

Pledge is the bailment of goods as security for payment of a debt or performance

of a promise. When a borrower secures a loan through a pledge, he is called a
pawner or pledger, and the bank is called the pawnee or pledge.

Features

1. The goods can be pledged by the owner, a joint owner with consent of other
joint owners, a mercantile agent or in some cases by an unpaid seller.
2. The banker can retain the goods for the payment of the debt, for any interest
that has accrued on it as well as any expenses incurred by him for keeping
the goods safe and secure.

4
DR. R P NAINTA, BANKING LAW AND NEGOTIABLE INSTRUMENTS ACT, pg:127-129 (5d ed 2015)

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 3. Goods can be retained for any subsequent advances also, but not for any
existing debt which is not covered by the pledge.
4. In case of non-payment, the banker has the right to sell the goods and
recover the amount of loan along with the interest and expenses, if any.
5. In case of default by the pledger, the banker has the right either to·
6. File a civil suit against the pledger and retain the goods as additional security
or
7. Sell the goods. In case of sale, banker must give due notice of sale to the
borrower before making a sale.
8. This right is not limited by the law of limitation.
9. Banker’s right of pledge prevails over any other dues including government
dues except worker’s wages.

In pledge the ownership of the goods remain with the borrower whereas physical
control over these goods will be exercised by the bank. The borrower has a right to
get the goods returned to him after payment of debt created here against.

In case of default by die borrower the bank can sell the goods after giving a
reasonable notice of sale as required under Section 176 of the Indian Contract
Act,1872. Notice must clearly indicate the intention of the pledgee to sell the
security and is compulsory before the sale can be effected. If the bank realises
more than its dues by such sale, the excess realised will have to be returned to the
borrower. However, if there is any shortfall, die bank can proceed against the
borrower in a court of law for recovery of the balance.

This mode of charge may be considered as an ideal one for the bank as it has full
control over the security and can even realise it without any legal process merely
by serving a notice on the borrower. The borrower however, is put to great
disadvantage as he losses coned over the goods and the account involves
operational difficulties. Generally the raw material or finished goods or stock in
trade etc. not immediately required by the borrower may be offered to the bank for
pledge.

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The goods pledged to the bank may sometimes be required by the borrower for
undertaking a small process. The documents of title to goods deposited with the
bank in the pledge account may be required to take delivery from the port/ railway
etc. In such situations the bank may temporarily part with the goods on the
borrower signing a 'Trust Receipt'. The possession of goods legally remains with
the bank and the borrower keeps those goods 'in trust' for the bank during that
temporary period. This facility is sometimes given by the bank as a sublimit of
pledge account for operational convenience.5

BAILMENT

A bailment is the delivery of goods by one person to another for some8purpose,

upon a contract that they shall, when the purpose is accomplished, be returned or
otherwise disposed of according to the directions of the person delivering them.
The person delivering the goods is called the "bailor". The person to whom they
are delivered is called the "bailee".

Essentials of Valid Bailment

i) Agreement

For creating a bailment the first essential requirement is the exis'tence of an

agreement between the bailor and the bailee. As you have read just now bailor is
the person who bails the goods and bailee is the person to whom the goods are
bailed. The agreement between the bailor and bailee, may be either express or
implied.

ii) Delivery of goods

For bailment, it is necessary that the goods should be delivered to the bailee. It is
the essence of the contract of bailrnent. It follows that bailment can be of movable
goods only. It is further necessary that the possession of the goods should be
voluntarily transferred and is in accordance with the contract. For example, A, a
thief enters a house and by showing the revolver, orders the owner of the house to
surrender all ornaments in the house to him. The owner of the house surrenders the
ornaments. In this case although, the possession of goods has been transferred but

5
Ibid

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it does not create bailment because the delivery of goods is not voluntary. Delivery
of possession may be actual or constructive. Actual delivery means actual physical
transfer of goods from one person to another.

iii) Purpose

In a bailment, the goods are delivered for some purpose. The purpose for which the
goods are delivered is usually in the contemplation of both the bailor and the
bailee.

iv) Return of the specific goods.

It is important that the goods which form the subject matter of the bailment should
be returned to the bailor or disposed oi according to the directions of bailor, after
the accomplishment of purpose or after thi: expiry of period of bailment. Where
goods are transferrcd by the owner to another, in consideration of price, it is a safe.

Duties of a Bailee

Duties of a bailee in respect of goods are as follows:

1. Take proper care of goods

2. Not to make unauthorized use

3. Keep goods separate

5. Return Goods

6. Return increase or profits

Duties of a bailor

Duties of a bailor are as follows:

1. It is the duty of a bailor to disclose all faults. If bailor fails to disclose such
faults then he will be responsible for the damage caused to goods or loss
suffered by the bailee.Also, the bailor is under the duty to pay the
extraordinary expenses incurred by the bailee for such bailment.

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 2. It is the duty of the bailor to accept the goods after the purpose for which
such goods were bailed is accomplished.
3. It is the duty of the bailor to indemnify the bailee for the cost incurred due to
the defective title of goods bailed to the bailee.

Rights of Bailor

1. Right to Enforce

2. Right to Avoid the Contract

3. Right to Return the Goods Lent Gratuitously

4. Right to Get Compensation

Rights of Bailee

1. Right to Deliver the Goods to any one of the Joint Bailors

2. Right to Deliver the Goods to Bailor without Title

3. Right to Apply to Court to Decide the Title to the Goods

4. Right of Lien6

HYPOTHECATION

Hypothecation is an extended idea of pledge, whereby the creditor permits the

debtor to retain possession of goods, either on behalf of or in trust for him.
Hypothecation is a charge made on movable property in favour of a secured
creditor without delivery or possession. Charge is created only on movable goods
like stocks, machinery and vehicles. The borrower binds himself to give the
possession of the goods to the banker, whenever the latter desires. It is a
convenient device in the circumstances in which the transfer of possession is either
inconvenient or impracticable such as buses and taxies, which are given as security
by taxi operators, but are used by them. The agreement is entered into through a
deed of hypothecation.

6
Supra n 3 at 68

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 The bank cannot take possession without the consent of the borrower,
but after taking possession, the banker is free to exercise the right of pledge, and
sell the assets without intervention of the court.

ASSIGNMENT

Assignment of a contract means transfer of contractual rights and liabilities to a

third party. The transferor or borrower is called the assignor, and the transferee or
banker is called the assignee. The borrower can assign any of his rights, properties
or debts to the banker as security for a loan. These might be existing or future.
Generally the ‘actionable claims’ are assigned by the borrower. An actionable
claim is 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 interest in
movable property not in the possession, either actual or constructive, of the
claimant which the civil court recognizes as affording ground of relief, whether
such debt or beneficial interest be existent, accruing, conditional and contingent.
Usually the borrower may assign books debts, money due from government or
semi-government or semi-government organizations or life insurance policies.

Although notice of assignment of the debtor is not required under law

(section 130 of Transfer of Property Act, 1881), nevertheless it is in the interest of
the assignee to give notice to the debtor because in the absence of the notice, the
assignee is bound by any payments which the debtor might make to the assignor in
ignorance of the assignment. For example, if the borrower assigns his life
insurance policy in favour of his banker as security for a loan, the bank should give
a notice to the Life Insurance Corporation (LIC), otherwise if any payment is made
by the LIC to the borrower, the banker will not be able to claim it.

Assignment may be legal or equitable. A legal assignment is effected through

an instrument in writing signed by the assignor. The assignor too informs the
debtor in writing about the assignment, the assignee’s name and address. The
assignee also serves a notice on the debtor of the assignor, and seeks confirmation

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of assigned balance. If the above conditions are not fulfilled, i.e. assignment is not
done in writing, or notice of assignment is not given to debtor, then such
assignment is called equitable assignment.

MORTGAGE

When a customer secures an advance on the security of specific immovable

property the charge created thereon is called a mortgage. Section 58 of the Transfer
of Property Act, 1882, defines a mortgage as, The transfer of an interest in a
specific immovable property for the purpose of securing the payment of money
advanced or to be advanced by way of loan, on existing or future debt, or the
performance of an engagement which may give rise to pecuniary liability. The
instrument through which it is affected is called a mortgage deed, the customer
(transferor) is called the mortgagor and the bank (transferee) is called the
mortgagee. The payment so secured which includes both the principal money and
the interest thereon is called the mortgage money.

Section 58 of Transfer of Property Act, recognizes six types of mortgagers

which are discussed hereinafter.

Simple Mortgage: In case of simple mortgage, the mortgagor does not give
possession of property, but binds himself personally to pay the mortgage money.
He agrees expressly or impliedly that in case he fails to make the payment
according to the contract, then the mortgagee shall have right to cause the
mortgage property to be sold and proceeds of sale to be applied, as far as may be
necessary, in payment of the mortgage money. The mortgagee himself cannot sell
the property, but has to seek intervention of the court.

Mortgage by Conditional Sale: Under this form of mortgage the mortgager

ostensibly (on the face of it) sells the mortgaged property with any one of the
following conditions:
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 1. On default of payment of mortgage money, the sale shall become absolute.
2. On payment being made on a certain date, the sale shall become void.
3. When the payment is made, the buyer shall transfer the property to the seller.

Usufructuary mortgage: Unlike the simple mortgage which is non-possessory, in

case of usufructuary mortgage, the mortgagor delivers possession of the mortgaged
property. The mortgagee is also entitled to receive rents and profits accruing from
the property and appropriate the same in lieu of interest or in payment of
mortgaged money or both. When the debt is so discharged or repaid, the mortgagor
is entitled to recover possession of his property. There is no personal liability on
the mortgagor.

English Mortgage: In case of English mortgage, there is transfer of ownership on

the condition that the mortgagee will re-transfer the same on the payment of
mortgage money. Further, the mortgagor personally undertakes to repay the
mortgaged money. In case of default, the mortgagee has the right to sell the
property without seeking permission of the court in the special circumstances
mentioned in section 69 of the Transfer of Property Act.

Mortgage by deposit of title deeds (equitable mortgage): This mortgage is

affected by deposits of title deeds of the property by the debtor in favour of the
creditor to create a security thereon. This type of mortgage is called equitable
mortgage in English law. In India, it is restricted to the cities of Delhi, Mumbai,
Kolkata and Chennai or any other town which the concerned state government may
notify in the official gazette in this behalf. No registration is necessary and delivery
can be either actual or constructive. There is personal liability of the mortgagor to
pay, and the mortgagee can sell the property with the sanction of the court if the
mortgaged money is not repaid.

Anomalous Mortgage: A mortgage which is not simple mortgage, mortgage by

conditional sale, usufructuary mortgage, English mortgage and mortgage by
deposit of title deeds (equitable mortgage) is called an anomalous mortgage. If the

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terms of the mortgage do not strictly adhere to any of the above five types, e.g. in
case of simple mortgage if the mortgagee is allowed to use the mortgage property,
then it will not be called simple or usufructuary but an anomalous mortgage. Under
this the rights and liabilities of the parties are determined by the terms agreed upon
in the mortgage deed, and in the absence of such a deed by the local usage.

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 CONCLUSION

Security for bank advance has no doubt been reduced to secondary importance in
the present context particularly for priority sector advances but it is still very
important to influence the decision of banks in conventional advances. Reserve
Bank of India has also stipulated certain quantitative restrictions on the banks'
power to grant clean advances. Banks have prescribed their own formats for
documentation for various types of advances and the borrowers in almost all the
cases have to execute those documents without any choice. It would never be
advantageous to know the general characteristics of securities, methods of their
charging and documentation procedures adopted by the banks.

18
 BIBLIOGRAPHY

1. DR. R P NAINTA, BANKING LAW AND NEGOTIABLE

INSTRUMENTS ACT, (5d ed 2015)

2. DR. R.K BANGIA, BANKING LAW AND THE NEGOTIABLE

INSTRUMENTS ACT, (6d ed 2018)

3. Dr. REGA SURYA RAO, LECTURES ON BANKING LAW (1d ed.2014)

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