BANKING

Modes of charging Securities: Only tangible security can be charged. Charging of securities means making it available as a cover for an advance. Bank does not became absolute owner but get defined rights until debt is repaid.

Fixed charge or Crystallized charge: On immovable property eg: Land and Building, Plant and Machinery embedded to earth. Mortgage- subsequent charges have no priority.. Floating charge: Assets change their from constantly such as raw materials, work in progress, stock of goods etc Borrower to deal with it freely till crystallized or fixed (on default by borrower) on happening of an event. Types of charger: 1. 2. 3. 4. 5. 6. Pledge Hypothecation Mortgage Lien Set-off Assignment Legal

Pledge: Defined in sec.72 of Indian Contract Act 1872. Pledge is the bailment of goods as a security for payment of a debt or performance of a promise. Bailment: Delivery of goods by one person to another for some purpose under a contract, the goods when the purpose is accomplished be returned or disposed of according to the direction of the person delivering them. Person delivering the goods Pledger or Pawner. Person to whom goods are delivered Pledgee or Pawnee. Handing over goods or the documents of the title to goods as defined in sales of goods act 1932 sec 2(d) by borrower to the creditor with an intention to create thereon as a security for the debt . Ownership remains with borrower but possession is taken by creditor and this is essence of pledge. Borrower Pledger Banker Pledgee

Feature of Pledge:1) Delivery of goods is essential to complete a pledge. Delivery- actual or constructive. Actual means physical transfer. . Constructive or symbolic possession does not require actual delivery but legal effects of putting bailee or its agent in possession. Eg: Handing over keys of godown or documents of title to goods 2) Pledge- of goods, stocks, shares, fixed or recurring deposit, N.S.C, I.V.P, debentures, gold, documents of title to goods eg: railway receipt, bills of lading, ware housekeepers certificate, dock warrant, and wharfingers certificate. 3) Delivery- with intention to deliver as security for payment of debt or performance of promise. 4) On default by pledger, pledge can sell the goods after giving a reasonable notice or can file a suit. What cannot be pledged? Immovable property, inventory, standing crops, book-debts, vehicles, LIC policys etc. Who can pledge? 1) Owner 2) Mercantile agent of the owner (with consent of owner) 3) Joint owner with consent of other co-owner 4) A person in possession of goods under voidable contract ie. Fraud, misrepresentation, coercion or undue influence if pledgee acts in good faith and without notice of the defective title 5) A buyer in possession of goods before sale (price not paid) got possession with consent of the seller- valid pledge provided pledgee acts in good faith 6) Pledgee can re-pledge. Rights of the Bank as pledgee: Right to retain goods particular lien Right to sue on default- issuance of notice is must before sale. Right to sale- after reasonable notice. Reasonableness depends on circumstances.- notice should be clear and specific indicating the intention to sale with exact date and time. Right to sue and right to sell are alternative rights .Pledgee cannot exercise both of them concurrently. Right to recover the deficit and extraordinary expenses . Right to claim damages- for non-disclosure of faults- also if title of pledge is defectiveobtained by pledger under voidable contract-provided pledgee acts in good faith and without notice of pledgers defective title. Pledgees right of sale is not barred by law of limitation.

1) 2) 3)

4) 5)

6)

Duties of bank as pledgee: 1) Return of goods pledged. 2

2) 3) 4) 5)

Care of goods. Not to make use of goods. Return of surplus. Return of profit.

Note: bank is secured creditor as pledgee or mortgagee and government dues like income tax has no priority. Hypothecation: Now defined in 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 for financial assistance. * includes floating charge and crystallization of such charge into fixed charge on movable property. It is more convenient method to get advance against movable properties which can not be pledged.. Neither the ownership nor possession is transferred to the creditor but an equitable charge is created in favour of the creditor. The borrower binds himself under the agreement to give possession of goods to the bank whenever bank requires him to do so (generally on default). The charge of hypothecation is then converted into pledge and bank enjoys the rights of a pldgee. (through letter of hypothecation ). Hypothecation facility is given to customers of undoubted integrity. The borrower is required to submit a statement of stocks monthly which will contain details of goods like quality and value with its ownership. Cares required to be taken by bank as hypothecate:. 1) Stocks should be fully insured against fire, theft and all other possible risks. (comprehensive insurance policy) 2) Stock statements are ensured to be submitted within stipulated time (generally within 10 days of the end of the month) and are recorded in a register. 3. As a post sanction follow up, inspection of the stocks is carried out by bank official once in two months. 4. Borrower to display a name plate of the bank reading Stocks Hypothecated with X bank at prominent place where goods are kept. 5. The stock statement is scrutinised to check correctness. Then margins are applied & drawing power is calculated, the borrower is allowed drawing power or limit whichever is less. 6. In case of joint stock company, the charge of hypothecation must be registered with Registrar of Companies under section 125 of The Companies Act 1956 within a period of 30 days from its creation. What can be hypothecated? 1. 2. Movable property like Goods & Commodities. Inventory Raw Material, Work in Progress & Finished Goods. 3

3. 4. 5.

Standing Crops. Book Debts. Vehicles.

What cannot be hypothecated? Immovable property, Doc. Of title to goods, Fixed / Recurring Deposit, Shares & Debentures, Gold, LIC Policy, Supply Bills. Mortgage: - Defined under Sec. 58 of Transfer of Property Act 1882. Mortgage is transfer of 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. Transferor is called Mortgager. Transferee is called Mortgagee. Principal Amount and Interest is called mortgage money. The instrument is called Mortgage Deed Possession of the mortgaged property is with mortgager. There are six types of mortgages defined in Sec 58(b) of Transfer of Property Act 1882. Banks are concerned with only two types of mortgages namely 1. Simple Mortgage 2. Mortgage by deposit of title deeds or Equitable Mortgage.

1. Simple Mortgage :The mortgager binds him personally to pay the mortgaged money and agrees either expressly or impliedly that in case of his failure to repay, the mortgagee shall have the right to cause the mortgaged property to be sold and apply the sale proceeds in payment of mortgage money. Effected only by registered document. Mortgagee has no power to sell the property without intervention of the court. The Principal Amount should be Rs. 1oo or more. Remedies available to mortgagee are of two types: 1. To obtain a personal decree against the mortgager 2. To apply to the court for a decree permitting the sale of the mortgaged property. Legal Mortgage requires registration with Registrar of Assurances within 4 months of its creation. Both remedies can be resorted to at the same time or in succession. 4

2. Mortgage by Deposit of Title Deeds or Equitable Mortgage : Delivery by debtor to the creditor (Bank) or his agent documents of title to immovable property with an intention to create the security thereon. Legal title to the property is not passed on to the mortgagee but the mortgager undertakes through a Memorandum of Deposit to execute a legal mortgage if he fails to pay the debt. The remedy available to mortgagee is to get the property sold after the court orders. Eg. Mortgage has received statutory recognition but is restricted to the towns of Kolkata, Mumbai & Chennai and other towns notified by State Government for this purpose in Official Gazette. Registration of documents is not necessary. Hence, registration charges & stamp duty are saved. Hence, this charge by equitable mortgage is preferred by both borrower & the Bank If borrower is a limited company, the charge should be registered with the Registrar of Companies within 30 days of execution of mortgage (Creation of Charge). Rights of the bank as a mortgagee (In Respect of Legal Mortgage & Equitable Mortgage) 1. Right to sell or foreclosure : To obtain a decree from the court that mortgager shall be absolutely debarred of his right to redeem the property (Foreclosure) or to obtain a decree that property be sold. 2. Right to sue for Mortgaged money. 3. Right to the accession (Addition) of the mortgaged property. Eg when a plot is mortgaged & afterwards a house is constructed on it. Mortgagee has right over the plot as well as the house. 4. Right to recover the money spent on mortgaged property. Eg. Cost of Preservation of Property, cost of renewal of lease if Mortgaged property is on lease. The interest on this money will be payable at the rate payable on principal amt & if no rate is fixed at 9 % per annum. 5. Right in case of renewal of lease by mortgager, the mortgagee is entitled to the new lease. Limitation period for mortgage is 12 years from the date the mortgage money becomes due. Care Bank has to take: A. Give notice to mortgager to confirm the amount due from him to the mortgagee. B .Take original mortgage deed & title deed from mortgagee. C. Direct mortgager to make payment to Bank & not the mortgagee. D .Bank to scrutinise terms & conditions of mortgage deed & is bound by it. 5

Assignment :Means a transfer by one person of a right, property, or debt existing or future, to another person. Possible in case of actionable claims only. Actionable claim is defined in Transfer of Property Act (sec.3) 1882 as A Claim to any debt, but other than a debt secured by the mortgage of immovable property or by hypothecation of or pledge of movable property or to any beneficial interest in the movable property not in possession either actual or constructive of the claimant which civil courts recognise as affording ground for relief, whether such debt or beneficial interest be existent, accruing , conditional or contingent. Transfer of actionable claim shall be affected only by execution of an instrument in writing signed by the transferor or his agent. Person who transfers right- Assignor, Assignee Receiver of the benefit.

Legal assignment is an absolute transfer of an actionable claim which must bein writing & signed by the assignor. Assignor informs his debtor in writing intimating assignees name and address. The assignee also serves a notice on the debtor of the assignor and confirms the balance so assigned. An assignment should be for the whole debt and not a part of it. . Banks finance LIC policy against assignment. Bank should finance against surrender value of LIC policy which a policy acquires (surrender value) which are three years of regular payment of premium. A life policy is an actionable claim because it is a debt payable by LIC for which policy holder does not have security as mortgage, pledge or hypothecation of asset of LIC. Banks keep margin of 10 % to 20 % on surrender value & finance. Banks can also finance against assignment of book debts (receivables or trade debtors). But Banks do not prefer assignment of book debts because, a) It attracts stamp duty and b) Bank is required to give the notice to the debtor of the borrower which is a tedious process. Banks therefore prefer financing book debts by hypothecation of book-debts. Monthly statement of bookdebts are obtained and scrutinised. Borrower is expected to give book debt statement certified by Chartered Accountants once in a quarter. Set off : - The right of the banker (statutory right) as a creditor to adjust the debit balance in one A/c with the credit balance in the otherA/c of a customer provided both the A/c are in the same name and same right and amounts are due immediately. The debit balance in single A/c cannot be set off against the credit balance in the joint A/c but debit balance in the joint A/c can be set off against the credit balance in the single A/c provided the liability in the joint A/c is joint and several. In case of sole proprietary firm, the A/c in his personal name and that in the name of the firm is deemed to be in the same right and as such the right of set-off can be exercised.

The rights can be exercised in respect of debts due and not in respect of future or contingent debts. Book debts due from borrowers and another due to him by bank should be immediately payable. The amount of debt to be recovered must be certain eg. if the customer is a guarantee for a loan, his credit balance cannot be set off against the dues from .t.he borrower till demand is made on the borrower and if he fails to pay. For exercising the right of set-off, all branches of a bank are considered as one and A/cs can be combined. The right of set-off is subject to no express or implied agreement to the contrary. In case of garnishee order ( an order issued by the competent court at the instance of judgement creditor addressed to the garnishee (i.e. Bank) attaching the funds lying in the hands of the garnishee of judgement debtor) When such order is received by the bank, the bank recovers his dues by combining the accounts of the customer and then surrenders the balance in the A/c to the judgement creditor. On Death, insolvency and insanity of a customer, the operations in his A/c are stopped and banks right of set-off accrues immediately on receipt of such notice, the bank can combine all the accounts of the customer and can recover his dues and then accounts are sent to the executors administrator, official receiver as the case may be. Banks should issue a notice to the customer for exercising the right of set-off and preferably advise him after exercising the right of set off so that he may not issue cheque from the A/c having credit balance. Lien :Lien is the right of a creditor to retain the possession of properties belonging to the debtor until the debt due to him is paid. The creditor here has right of possession of the property but does not get the right to sell the property. There are two presumptions: 1) The person having right of lien is in possession of the properties in ordinary and usual course of business and 2) The owner has a lawful debt due or obligation to discharge to the person in possession of the said properties. Once the debt is paid or obligation is discharged, the right of lien will extinguish and the property will have to be returned to the debtor. Two Types of Lien. Sec. 171 of Indian Contract Act 1. Particular Lien ( Right of tailor to retain cloth till stitching charges are paid) 2. General Lien The Bankers, factors, wharfingers, attorneys of High Court and policy brokers can exercise general lien and retain the property as security for a general balance of account any goods bailed to him unless there is a contract to the contrary. The ownership of the goods is not transferred from the customer to the bank. The lien only gives a right of possession of goods or securities and to retain them until the dues are paid. But a Bankers Lien is more than general lien. It is considered as Implied Pledge. It means that the bank can exercise all the rights of pledgee i.e. in default by borrower to sell goods without filing suit in a court of law after giving reasonable notice The Banks right of general lien does not extend to 1. Goods & Securities entrusted to the bank as a trusty or an agent of the customer e.g. bill sent for collection and proceeds for a specific purpose 7

2. When the things are kept for safe custody or in a safe deposit vault. 3. When amount is deposited by borrower for a special purpose. E.g. for purchasing a demand draft. 4. When goods or securities are given to the bank for a fresh loan which is not sanctioned. 5. Where goods or securities are left with bank inadvertently. 6. When the borrower is a trustee of the goods or securities. 7. When goods & securities are owned by more than one person & loan is granted to any one of them. 8. When shares are given for sale with specific introduction to apply proceeds for a specific purpose. However when goods and securities remain in possession of the bank after the loan taken against them has been repaid, the same can be retained for other dues of the same borrower..

Distinction between Hypothecation & Pledge:Hypothecation Pledge Defined in SARFESIA Act 2002 (Sec 2n) Defined as charge on movable property in favour of secured creditor without delivery or possession. Two Parties Hypothecator and Hypothecatee Movable asserts eg. Stocks, machinery, vehicles, standing crop etc... can be hypothecated. Neither ownership nor possession is transferred to Hypothecatee. Limitation is 3 years. Under SARFESIA Act, sale is possible after possession. Otherwise, only through court. Delivery of goods if demanded by the bank.

Defined in Indian Contract Act 1872 (172) Defined as Bailment of goods or security for payment of a debt or performance of promise. Two Parties Pledger or Pawner and Pledgee or Pawnee Goods, Shares, NSC, IVP, Gold etc... Can be pledged. Ownership remains with pledger, possession is given to pledgee. Limitation is not applicable. Available by giving reasonable notice. Then through public auction.

Delivery can constructive.

be

actual

or

Various Kinds Of Charges over Securities : Sr . No 1 Nature of Security Immovable Property Defined in Sec 58 Transfer of Property Act 1882. Actionable Claims (i.e Book Debts, Life Assignment Transfer of Unsecured Debtor) Policies Property Act 1882. Movable Property & Goods Plant & Pledge or Indian Contract Machinery, Hypothecation or Act (Pledge) and Stocks, FDR Lien SARFESIA Act Shares, NSY, IVP (Hypothecation) LIC Policy LIC Policy Assignment I.P.Act Type of Security Land & Building Kind of Charge Mortgage

Drawing Power of Securities is determined by deducting margin from market value of securities. Margin is decided by banker as per volatility in market price. E.g. FDR is least volatile and hence only 10 to 15% shares are higly volatile and hence minimum 50% (RBI guidelines). Raw Material 25%, Stock in Process 35%, Finished Goods 25%, Receivables- 25%, LIC Policy -10% to 20% on surrender value. Additional Precautions while Lending 1. FDR: - Ensure that FDR should be of the same branch. FDR should be discharged. If held jointly, then all parties should discharge FDR. Lien on FDR is then noted by the Bank. Loan or Overdraft can be granted against the security of FDR. 2. LIC Policy: - LIC Policy must have acquired surrender value i.e. after 3 years of regular payment. Bank keeps margin on surrender value and loan or overdraft is granted. Assignment to be noted with LIC. 3. Shares: - Only of A & B group.(Pledge) Fully paid. Transferred in Banks name. There is high margin(Min. 50% asper RBI guidelines). Market Value is to be monitored. 4. Gold: - Valuation to be done by approved valuer. Margin of about 30%. Gold to be sealed in presence of borrower and is to be pledged. 5. Goods: - Generally goods are hypothecated as they have to undergo process to become finished goods. However, sometimes imported goods are kept under pledge with Bank. Bank hires a godown and godown keeper looks after the goods which are released on payment by borrower.. . 9

In case of hypothecation, stock statements are required to be submitted by borrower every month & branch officials carry out inspection of goods once in two months. From stock statement, market value is determined and by applying margin, drawing power is calculated every month. The borrower is allowed limit sanctioned or drawing power, whichever, is less. Limits in A/c are fixed once in a year based on projected sales (turnover) but drawing power is calculated every month on the basis of particulars in stock statements. Inspection of securities by branch officials should be a surprise inspection and the basis for inspection is stock statement which is declaration by the borrower about holding of goods as on the date of the stock statement. 6. Receivables or Book Debts: - Banks finance receivables. Receivables can be assigned or hypothecated. Assignment is not preferreded by Banks as it attracts stamp duty and the debtors of the borrowers are required to be given notices which are a cumbersome procedure. Hence, Banks finance book debts by hypothecation as cash credit (Book Debts). A statement of receivables is obtained every month from the borrower and drawing power is calculated every month as done in the bank statement. However, banks insist that the receivables are certified by Chartered Accountant atleast once in a quarter. Banks take immovable property as collateral security to secure their advance. Banks also take third party guarantee while sanctioning advance. 7. Documents of title to Goods: - A document of title to goods is a document used in the ordinary course of business as a proof of possession or control of goods. It authorises by endorsement and delivery, the possession of documents to transfer or receive the goods mentioned therein. The Sale of Goods Act 1930 defines the documents of title to goods as, These documents such as a bill of lading, dock warrant, warehouse keepers certificate, wharfingers certificate, railway receipt for delivery of goods and other documents. used in ordinary course of business as proof of possession or control of goods or purporting to authorise either by endorsement or by delivery. The possession of documents to transfer or receive the goods thereby represented. By accepting pledge of documents of title to goods, the bank gets constructive delivery of goods. Bill of lading is a document used in case of foreign trade. It is issued by shipping Company. Acknowledging the receipt of goods to carry to a specific port. A Bill of Lading is not a negotiable instrument but sometimes referred to as quasi- negotiable instrument wherein the transferee does not get better title than the transferor. 8. Supply Bills: - When Govt or semi Govt Bodies intend to purchase, they invite tenders from the public. The contract is entered into between Govt & seller, when goods are despatched, an authorised person from Govt inspects. On certification, goods are despatched to the concerned Department. Thereafter, supplier prepares the bill for goods supplied. Such a bill is known as a Supply Bill. Supply bills are not a bill of exchange and do not enjoy legal status of negotiable instrument. It represents a debt and can be assigned in favour of the third party. The supply bills are not accompanied by documents of title to goods. The security to bank is by assignment of debts. This facility is given to honest and borrowers with high integrity who know how to deal with the Govt Department. Banks should obtain an irrevocable power of attorney executed by the supplier in favour of the Banks authorising Bank to receive the amount of bills from the Government and it should be registered with the concerned 10

Department of the Government. Banks should also obtain an undertaking from the supplier to pay the bank the amount of the bill if received by him directly from the Government. Bank should keep adequate margin while advancing money as the bill may not be sanctioned fully by the Government. The bill should be discharged by the supplier under requisite stamp and duly endorsed in favour of the bank. If the bill remains outstanding for a very long time, the advance should be cancelled and the amount should be recovered from the borrower. The bill then should be treated as bills for collection.

11