Hypothecation is not created by any statute but has been used in the mercantile arena for a long time. There is no provision catering to Hypothecation either in the Contract Act or the Sale of Goods Act. Any law or statute does not govern it. Hence, courts have to decide upon cases pertaining to Hypothecation purely based on the general principles of the contract according to the hypothecation agreement[i] .
However, the term “Hypothecation” has been mentioned in the SARFESI Act, 2002[ii] where it has been defined as a charge on any movable property due in future created by a debtor in favour of a secured creditor without delivering the possession of the property to that creditor, as financial security.
Hypothecation is the security of goods for a debt without the actual transfer of property or possession of the property to the creditor (hypothecatee). Here the debtor (hypothecator) retains the possession of the goods. If the owner of the goods fails to discharge the debt within an ascertained period, the creditor reserves all rights to recover the debt even if it means selling the security goods. [iii]
Halsbury’s Laws of England explains Hypothecation as a pledge of goods without immediate change of possession. [iv]It gives faith to the creditor to take possession of the goods if the dues are not paid within the agreed time and empower the owner of the goods to make the repayment and thereby free the hypothecated goods from the obligation.
Pledge is defined under Section 172 of the Indian Contract Act[v] as- the delivery of goods by the owner (Pawnor) to the creditor(Pawnee) by creating a security that when the dues are paid, the goods be returned or disposed of according to the instruction of the owner (Pawnor). The delivery of goods may be actual or constructive. A pawnee only has the rights to possession of the good and not to enjoy the goods. He is governed by the conditions of the contract to pledge.
Hypothecation is a species of Pledge. Even though Hypothecation doesn’t provide possession or title to the creditor, it does create a charge. [vi]
The term “ Charge” has been defined under Section 100 of the Transfer of Property Act[vii] as a device to create security which is enforceable in the Court of law. There is no transfer of property or interest but only a creation of a right to be paid out of the agreed property. Though it is defined in this act in terms of immovable property, it can shed light on the general meaning of the word “charge’ which can be created for both movable and immovable property. The charge created for the movable property need not be in writing.
Relation Between Charge, Hypothecation And Pledge
When the borrower does not pay the dues to the creditor within the agreed period, the charge of Hypothecation is then converted into that of a pledge, and the creditor then enjoys the rights of a pawnee [viii].
SIMILARITY BETWEEN PLEDGE AND HYPOTHECATION
Hypothecation and Pledge have many similarities between them. Some of them are illustrated here-
- In the case Rehaboth Traders By Partner R. vs Canara Bank[ix] – it was held that in Hypothecation, the Bank (hypothecatee )is treated to be a secured creditor and has a preferential right to recover with respect to the other creditors. In The Bank of Bihar v. The State of Bihar and others[x]– it was held that in Pledge as long as the claim of the Bank is not satisfied, no other creditor of pawner has the right to take away the goods which implies that the Pawnee is a secured creditor and has a preferential right over other creditors. Hence, it can be concluded that both Pledge and Hypothecation secure the pawnee/hypothecatee and endow upon them preferential rights over the other creditors of the pawnor/hypothecator.
- The debtor in Hypothecation, subject to the terms of Hypothecation is entitled to use the goods for business purposes but has to furnish regular reports to the creditor and has to maintain a particular value of the goods if the deed mandates so[xi] . In Rehaboth Traders By Partner R. vs Canara Bank[xii], it was held that it is not necessary to deliver the keys of a warehouse to secure a constructive possession as possession is of little relevance. Instead, the dominion over the goods is what is relevant, and the debtor/hypothecator(owner) is an agent of the hypothecatee (the creditor) and that the debtor only has a delegated authority over the goods subject to the rights of the hypothecatee. That is the debtor, even though is in possession of the goods is an agent of the hypothecatee. Thus, the hypothecatee has indirect but ultimate control over the goods until the debt is paid. In Pledge, as mentioned in Section 173, [xiii]the Pawnee is entitled to retain the goods until the debt, interests and expenses incurred by him are paid. Thus the goods are in the control of the creditor (Pawnee) until the debt is paid off. Thus, Hypothecation is an extension of Pledge which allows the creditor to have indirect control over the goods of security as opposed to the direct form of control in Pledge.
- In the matter of Shri Yellamma Cotton Wollen & Silk Mills and Co. Ltd., Bank of Maharashtra Ltd., Pune,[xiv] vs Official Liquidator it was held that in Hypothecation, the creditor has the right to sell the goods. He can take charge of goods and can sell the hypothecated goods without court intervention, on default or breach of terms of Hypothecation by the debtor, but only if the creditor has been vested with such power under the agreement of Hypothecation. Section 176 of the Act[xv] provides for the Pawnee’s right when the Pawnor makes default in paying the dues within the agreed period of time. It grants the Pawnee the right to sue the Pawnee and retain the goods as collateral or sell the goods after giving reasonable notice of sale. Thus in both Hypothecation and Pledge- upon default of the debtor or breach of conditions of the agreement of hypothecation/pledge by the debtor, the creditor is entitled to sell the goods to recover the debt or perform the conditions of the contract.
After the discussion above, we can conclude that the only difference between Hypothecation and Pledge lies in the fact that in Hypothecation, the possession of the goods is retained by the owner. In contrast, in Pledge, the possession of the good is transferred to the creditor. Thus it can be said that while Pledge involves the transfer of possession of goods, Hypothecation involves the transfer of interests limited by the agreement.
Hence it is seen that both Pledge and Hypothecation do create a charge, and both provide security of debt to the creditor. Both give the creditor a right to take possession of goods or sell them to recover the dues. Both endow the creditor with the ultimate dominion over the goods. In Hypothecation the position of the hypothecator ( debtor/owner) is akin to the position of bailee acting under the instructions of the Hypothecatee (the creditor).
Thus, Hypothecation is synonymous to pledge and virtually has the same legal effect.
Hence it is well justified that Hypothecation is no different from Pledge.
[i] State Bank of India v. S.B. Shah Ali, AIR 1995 AP 134
[ii] Securitization and Reconstruction of Financial Assets & Enforcement of Security Interest Act ,2002 , s. 2(n)
[iii] POLLOCK & MULLA, THE INDIAN CONTRACT ACT AND SPECIFIC RELIEF ACTS – VOLUME II 1579 (14th ed., 2012)
[iv] Halsburys Laws of England, Vol. 43 438 (Fourth Edition)
[v] Indian Contract Act 1872, S.172
[vi] Hindustan Machine Tools Ltd. v. Nedungadi Bank Ltd , A.I.R. 1995 Kar. 185
[vii] Transfer of Property Act , 1882 , S.100.
[viii] P. Ramanatha Aiyar, Advanced Law Lexicon ,Vol.2 2179 (3rd ed., 2005)
[ix] Rehaboth Traders By Partner R. vs Canara Bank , (1998) 2 Mad LJ 318.
[x] The Bank of Bihar v. The State of Bihar and others, AIR 1971 S.C. 1210 .
[xi] Pollock & Mulla, The Indian Contract Act and Specific Relief Acts – Volume II 1567 (14th ed., 2012)
[xii] Supra 8
[xiii] Indian Contract Act 1872, s.173
[xiv] Re Sree Yellamma Cotton, Woollen & Silk Mills Co. Ltd, Bank of Maharashtra Ltd. v. Official Liquidator, AIR 1969 Mys 280.
[xv] Indian Contract Act 1872, S.176
ABOUT THE AUTHOR
Rupanwita De is a second-year law student pursuing B.A.LL.B (Hons) at West Bengal National University of Juridical Sciences Kolkata.