6 November, 2017
Security interests over movable property can be created by way of mortgage, pledge, hypothecation, lien and charge. However, mortgage is usually a method of creating security interest over immovable properties, and its only in certain specified cases that it is coupled with a mortgage on moveable properties thereon. This article provides a brief introduction to some of the more commonly used security interests for moveable properties (being pledge, hypothecation, lien and charge).
What are the various types of security interests which can be created over moveable assets?
Pledge: A ‘pledge’ is a bailment of goods as security for payment of a debt or performance of a promise in terms of the Indian Contract Act, 1872 (“Contract Act”). The goods so pledged are returned, upon payment of the debt or performance of the promise.
Hypothecation: Hypothecation on the other hand, is defined under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 as 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 a floating charge and crystallisation of such charge into a fixed charge on movable property. In case of failure by the owners of the hypothecated property to repay the debt within the stipulated time, the creditor would have the option to recover its dues by way of sale of the hypothecated property.
Charge: A charge is generally understood as a right created by the borrower on its assets in favour of the lender extending financial assistance to the borrower. A charge may be in the nature of a “fixed” or “floating” charge. A fixed charge may be created on ascertainable property (present or future), and a floating charge may be created on assets, present or in future, whether they are ascertainable or not. A floating charge becomes fixed on assets which are in existence upon occurrence of stipulated events, such as failure to repay the debt.
Lien: A Lien can be in the form of a particular or general lien. As per Section 170 of the Contract Act a bailee of goods, has particular lien over it, where the bailee has rendered any service involving exercise of labour or skill in respect of goods bailed. Such bailee (in the absence of a contract to the contrary) can retain such goods unless he receives due remuneration for the services rendered. Section 171 of the Contract Act, confers a general lien in favour of bankers, factors, wharfingers, attorneys and policy brokers. No other person enjoys a general lien, unless conferred by express contract. A general lien is the right to retain the property of another for a general balance of accounts, unlike a particular lien which is a right to retain the property only for a charge on account of labour or skill employed or expenses incurred in this regard1. The sections in the Contract Act for liens are not exhaustive, and there is nothing preventing the parties from granting a right of lien (general or particular) over assets of another person in terms of an express contract, to the another person to whom a debt is owed, as security for such debt.
Which factors which may affect one’s choice of security interests?
Pledge and Hypothecation are typically the most common form of security interests used in relation to moveable assets. In case of hypothecation, the possession of the security remains with the borrower, while in case of pledge the pledgee takes control of the assets.
Pledge, can therefore, be a preferred mode of creation of security interests, in cases where the moveable property is intended to be transferred to the possession (by physical or constructive delivery) of the security holder (say in case of shares, where the shares are pledged and original share certificates are delivered to the possession of the security holder). Hypothecation, on the other hand can be made for both moveable assets presently existing, but those which might be subsequently acquired and brought (such as cash balances, book debts, receivables, revenues, stock, plant and machinery, equipment etc.). Hypothecation, is therefore, usually relied upon when future assets are also being secured and/or where the borrower requires possession of such moveable assets for business activities.
Lien, as generally understood, usually provides the lien holder to retain the goods until payment is made for monies owed and not the power of sale or disposition of goods in case of default (unlike the case of pledge or hypothecation). Accordingly, parties prefer to typically secure their interests over moveable assets by way of pledge and/or hypothecation, depending on the nature of the moveable assets being secured.
What additional requirements should be kept in mind?
Requirement of paying stamp duty: The instrument creating any security interests over the moveable assets would need to be adequately stamped as per the stamp laws applicable to the state where the document is executed. We may add that non-payment of stamp duty or payment of inadequate stamp duty renders the document inadmissible in evidence in courts. It can also lead to imposition of a penalty; prosecution and impoundment of the document, if there was an intent to evade stamp duty.
Requirement of registration with local authorities: The Indian Registration Act, 1908 requires certain instruments to be mandatorily registered. However, the instruments relating to creation of interests over movable property need not be registered compulsorily and registration of such documents is at the option of the parties. That being said, the persons (in whose favour such security interests are created) prefer having such instruments registered with the applicable sub-registrars.
Registration with the Registrar of Companies: As per Section 77 of Companies Act, 2013 (“CA 13”), in case of creation of charges (‘charge’ in this context is wide enough to include all the aforementioned types of security interest) over assets of Indian companies, the said charges are required to be registered (by filing of a prescribed form) with the Registrar of Companies within thirty (30) days of creation of such charge. The company is also required to maintain a register of charges recording the details of the charge(s) created on its assets. If the company fails to register the charge as specified above, then CA 13 also allows the charge holders to apply directly to the Registrar of Companies for registration of the said charge.
Endnotes:
[1] O.N.G.C. Ltd. v O.L. of Ambica Mills Co. Ltd. and 11 Ors.; [2006] 132 CompCas 606 (Guj).
For further information, please contact:
Dimpy Mohanty, Partner, Lex Counsel Law Offices
dmohanty@lexcounsel.in
