Securities for Advances

In one line

A security is a second source of repayment, and its kind decides whether the bank has possession, ownership or only a charge, and therefore how easily it can realise it.

In the wording a student can write in an exam: the securities a bank takes for an advance are the pledge, in which goods are delivered to the bank as security under section 172 of the Indian Contract Act, 1872; hypothecation, a charge on movable property without delivery of possession; the mortgage of immovable property under section 58 of the Transfer of Property Act, 1882; the lien; and the assignment of an actionable claim such as a book debt or a policy of insurance.

Why the classification matters

Because the whole value of a security lies in how quickly and cheaply it can be turned into money, and that depends on three questions.

Who has possession? If the bank has the goods, it can sell them. If the borrower has them, the bank must first get them, which may mean going to court, and meanwhile the borrower may sell them to somebody else.

What interest does the bank have? A charge, a special property, or the ownership itself. That decides the bank's position against a buyer from the borrower, against other creditors and against a liquidator.

And what must the bank do to make it good against third parties? Registration, notice, or nothing at all.

Chapter 320 showed what a possessory security is worth when tested. In Central Bank of India v. Siriguppa Sugars and Chemicals Ltd., (2007) 8 SCC 353, the pledgee bank's rights over sugar stocks in its possession prevailed over the State's claim for cane dues and the growers' claims, because those were unsecured and the bank's was a possessory security. That case is the practical answer to why banks prefer possession where they can get it.

Pledge

What it is. Section 172 of the Indian Contract Act, 1872 defines a pledge as the bailment of goods as security for payment of a debt or performance of a promise. The bailor is the pawnor, the bailee the pawnee.

The essential is delivery of possession. Possession may be actual, where the goods are physically handed over, or constructive, where the key of a godown is delivered, or where a third party holding the goods attorns to the bank, acknowledging that he now holds for it.

What the bank gets. A special property in the goods, with the right to retain them for the debt, interest and expenses; and, most importantly, a power of sale.

Section 176 is the power: where the pawnor makes default, the pawnee may bring a suit on the debt retaining the goods as collateral security, or he may sell the thing pledged, on giving the pawnor reasonable notice of the sale. If the proceeds are less than the amount due, the pawnor remains liable for the balance; if more, the pawnee must pay over the surplus.