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PLEDGE AND
HYPOTHECATION
CHAPTER V
PLEDGE
Dictionary of Banking by F.E. Perry & G.Klein, 3rd Edn, 1988, p.240
147
Possessory Security
4 Thomson’s Dictionary of Banking by F.R. Ryder & D.B. Jenkins, 12th Edn,
1974, p.462
148
The pledgee gets no absolute title at law. He gets what has been
called a "Special Property" in the goods, whilst the pledgor retains the
general ownership. The so - called special property, apart from the right of
possession, merely consists of the power to sell on default. There is no
transfer of legal ownership to the pledgee.
149
A pledge of goods is not complete unless and until there has been
actual or constructive delivery of goods. Constructive delivery is usually
described as the handing over of the key to the warehouse where the goods
are stored. In modern practice, constructive delivery will usually consist
either of delivery of a valid document of title which represents the goods,
such as a bill of lading, or of an acknowledgment (called an attornment) by
the warehouse - keeper that he holds the goods to the order or at the
disposition of the bank. The position is lucidly explained by Lord Wright in
Madras Official Assignee v Mercantile Bank of India Ltd5.
"At the common law a pledge could not be created except by delivery
of possession of the thing pledged, either actual or constructive. It involved
a bailment. If the pledgor had the actual goods in his physical possession,
he could effect the pledge by actual delivery; in other cases he could give
possession by some symbolic act, such as handing over the key of the store
in which they were. If, however, the goods were in the custody of a third
person, who held for the bailor so that in law his possession was that of the
bailor, the pledge could be effected by a change of the possession of the
third party, that is by an order to him from the pledgor to hold for the
pledgee, the change being perfected by the third party attorning to the
pledgee, that is acknowledging that he thereupon held for him; there was
thus a change of possession and a constructive delivery; the goods in the
hands of the third party became by this process in the possession
constructively of the pledgee".
5
[1935] AC 53
150
Trust Receipts
The rule that the pledgee loses his security if he loses possession
seriously limits the usefulness of pledge as security. Therefore, trust receipt
is obtained from a customer of a banker where goods have been pledged as
security for an advance. To pay the advance it is necessary for the customer
to get the goods and sell them, but the documents of title which would
enable the customer to get them, are in the possession of the bank. The
bank, therefore, releases the documents of title to the customer against
signature on a trust receipt, by the terms of which the customer undertakes
to deal with the goods as an agent for the banker for the purpose of getting
delivery of the goods and then selling or warehousing them. The customer
undertakes to effect any necessary insurance and to hold the proceeds of
sale on behalf of the banker until the loan is repaid. The trust receipt
151
protects the rights of the banker as pledgee, which would otherwise be lost
when the banker gave up the documents of title, and protects the banker
in the case of the customer’s bankruptcy, by taking the relative goods out
of the reputed ownership clause. The bank’s books must show that the
documents of title actually came into the hands of the bank before the trust
receipt relating to those same goods was signed. This shows that the pledge
was created by the deposit of the documents, and was extended by the
terms of the trust receipt. The point was made clear by the House of Lords
in North Western Bank Ltd v John Poynter, Son and Macdonalds6,
Lord Herschell LJ asserting :
"There can be no doubt that the pledgee might hand back to the
pledgor, as his agent for the purpose of sale, as was done in this case, the
goods he had pledged without in the slightest degree diminishing the full
force and effect of his security".
[1895] AC 56 at 67, 68
152
upon default, but if there is no stipulated time for payment, the pledgee
may demand payment and in default thereof, may exercise his power of sale
after giving notice to the pledgor of his intention to do so.
follows:
7
AIR 1965 SC 1322
153
While the owner has the right of possession coupled with right of
enjoyment and disposition, the pledgee has only the right of possession but
not the right of enjoyment. The pledgee’s right of disposition is governed by
the terms of the pledge and is limited to the recovery of the amount due to
him under that pledge.
The Supreme Court laid down a very enlightening decision about the
pawnee’s status as secured creditor and his priority of charge. In Bank of
Bihar v The State ofBihar and others9, the facts were that the pledgor
availed cash credit facility from the bank against the pledge of sugar bags.
The key of the godowns containing the sugar bags was with the bank. The
Rationing Officer and the District Magistrate broke open the godown and
seized the sugar bags on account of arrears of sugar cess from the pledgor
under the Public Demands Recovery Act. The pledgee - bank filed a suit for
return of the sugar bags or recovery of the value.
9
AIR 1971 SC 1210
155
The Court, after referring to the Sections 172, 173 and 176 of the
Indian Contract Act, quoted the Halsbury’s Laws of England10 which
describe a pawn as a security where, by contract, a deposit of goods is made
a security for a debt and the right to property vests in the pledgee so far as
is necessary to secure the debt.
The Supreme Court held that the Bank as pawnee has special
property and a lien which is not of an ordinary nature on the goods. So long
as the bank’s claim is not satisfied no other creditor of the pawnor has any
right to take away the goods or its price. After the goods had been seized
by the Government it was bound to pay the amount due to the bank. The
balance could have been made available to satisfy the claim of other
creditors of the pawnor. By the mere act of the lawful seizure, the
Government could not deprive the pledgee - Bank of the amount which was
secured by the pledge of the goods. The government was bound to reimburse
the amount which the bank would have, in the ordinary course, realised by
sale of the pledged goods on default by pawnor in making payment of debt.
been pledged with the petitioner - bank stored in the petitioner - bank's
godown. The stocks of soya bean were confiscated by the Collector, Indore,
under Section 6A of Essential Commodities Act, 1955 (which regulates,
inter alia, stocking of essential commodities to ensure equitable distribution
at fair prices):
The court, allowing the writ petition, held that the rights of the
pawnee who had parted with money in favour of the pawnor on the security
of goods cannot be defeated by the lawful seizure of the goods by the
Government. The petitioner bank was not bound by the confiscation order
passed against respondent No.5 as the petitioner bank held the stock in
question not on behalf of the dealer, but in exercise of its own right as a
pawnee to whom the goods have been duly pledged under the cash credit
agreement. In exercise of its right as pawnee, it had every authority to have
its debts discharged from out of the pledged goods before they could be
made available for any other purpose.
The High Court, in deciding the case, followed the judicial precedent
laid down by the Supreme Court in Bank ofBihar Ltd v State of Bihar
(supra).
158
its godowns to two banks, with the first bank the advance was termed as
"open cash credit" and the borrower was bound to submit periodical returns
of stock to the bank. When they did not do so the clerk of the bank went to
inspect the godown, and found the doors locked with the locks of another
bank, from whom the borrower took the advance under "Key loan" system.
The question arose as to the priority of the claim. The Madras High Court
held that the judicial relationship between the parties (first bank and the
borrower) is that of the pledgor and pledgee, though the system was
termed as "Open Cash Credit" in mercantile practice. The court observed
that in order to constitute a valid pledge it is essential that there must be
delivery of goods either actual or constructive. Constructive delivery will be
adequate to create a pledge and it applies to all cases where the pledgor
remains in possession of the goods under the specific authority of the
pledgee or for limited purposes. The condition that the prior consent of the
pledgee was necessary for the pledgor to deal with the goods ensures the
constructive possession as well as the character of the pledge. There can be
no hard and fast rule that the delivery of the keys of the warehouse is
essential to secure constructive possession. There cannot also be any rigid
delimitation of the purposes for which the pledgor is permitted to retain the
possession of the goods. The essential test is not the purpose but whether
the dominion over the goods pledged is retained and the physical possession
or handling of the goods by the pledgor is under the delegated authority of
12
AIR 1961 Madras 326
159
the pledgee or is independent. The court held that where the possession of
the pledgee is not lost and possession may be manual or constructive, a
subsequent pledgee even without notice cannot obtain any preference upon
a rule of estoppel.
The court had to decide which of the two innocent parties should
suffer the loss arising from the fraud of a third party. A reference was made
to Lickbarrow v Mason13 where Ashhurst, J. Stated:
Pledge of Shares
The facts of the case before the Calcutta High Court were that one
Mt. Fatma Begum was the registered holder of six shares in the respondent
company. On 5th December 1922, she transferred them along with a blank
transfer deed bearing her signature to one A.S.A. Suhrawardy for Rs.2100/-.
She died in 1935. Suhrawardy transferred the shares along with the same
transfer deed to the petitioner for Rs.2400/- on 10th December 1940. When
in March 1941 the petitioner presented the share scrip and the transfer
deed to the company, the directors refused to register the transfer.
Thereupon the petitioner applied to the Calcutta High Court for an order
rectifying the register of members of the company and his petition was
allowed.
The Court provided the following illustraction to romp home its point
of decision.
"A gives authority to B to sell A’s land, and to pay himself, out of the
proceeds, the debts due to him from A. A cannot revoke his authority, nor
can it be terminated by his insanity or death" the authority for the
proposition being Gaussert v Martin15.
The said illustration forms part of Sec 202 of the Indian Contract Act,
1872 dealing with termination of agency where agent has an interest in the
subject - matter. This section of the Contract Act merely states in a codified
form the well - known principles of English Law regarding "authority
coupled with interest".
15
(1830) 10 B & C 731
161
The court also referred to Carter v White16 the head note of which
is as follows :
Following the authority laid down in Bengal Silk Mills case (supra),
it was held by the Calcutta High Court in Kanhaiya Lai Jhanwar v
Pandit Shirali and company17 that a transferee to whom share scrips
and transfer in blank are given has the authority of the transferor to fill up
the names of the transferee. It was also held that the deposit of share scrips
themselves is sufficient to create a pledge thereon. Blank transfers, if in
order, have the effect of transferring the title in the shares to the pledgees,
but a transfer of title is not necessary to create a pledge, simple delivery of
possession being enough.
Right to Sell
If the proceeds of such sale are less than the amount due in respect
of the debt or promise, the pawnor is still liable to pay the balance. If the
proceeds of the sale are greater than the amount so due, the pawnee shall
pay over the surplus to the pawnor".
once the pawnee after reasonable notice to the pawnor of his intention to
sell the goods pawned, sells them under Section 176 of the Contract Act, the
pawnor’s right of re - delivery is extinguished but his right to redeem
continues upto sale, i.e. at any moment upto the time of exercise by the
pawnee of his power of sale by entering into a valid contract of sale. After
sale, it is the pawnee’s ordinary right to recover the balance of the loan
unsatisfied on the sale of the pledge.
The most frequent model of pledge with the bankers is the pledge of
jewels. The bankers on the reverse of the Jewel Loan Applications stipulate
that the bank will sell the jewels without notice in the event of default in
repayment by the pledgor. This clause violates the provisions of Section 176
of the Indian Contract Act, 1872 which clearly lays down that the pawnee
may sell the goods under pledge on giving reasonable notice of sale.
This clause is a nullity in the jewel loan applications since it is
unenforceable. In practice, the bankers issue advance notice to the pledgors
before auctioning the pledged jewels.
Section 411 of the Indian Penal Code, 1860, provides that whoever
dishonestly receives or retains any stolen property, knowing or having
reason to believe the same to be stolen property, shall be punished with
imprisonment of either description for a term which may extend to three
years, or with fine, or with both. Dishonest intention is the sine qua non
of the offence under Section 411 of the Indian Penal Code. Unless and until
there is dishonest reception or retention of any stolen property the section
is not attracted.
23
(1875) 44 LJCP 233
166
of title. Thus the pledgee of stolen goods will nearly always be forced to
restore them to the true owner, unless it can be proved that the goods have
been sold in "Market Overt" (recognised market throughout the country)
after having been stolen; or unless it can be shown that the true owner is
estopped from asserting his rights, as would be the case if he knowingly
stood by when the pledge was made.
HYPOTHECATION
24
Bouvier’s Law Dictionary, 8th Edn, 1914, Vol 2, p.1480
167
this were possible the banker would take a pledge. In recognition of this
fact the agreement usually undertakes to give a pledge when the goods or
documents become available25.
25 Dictionary of Banking by F.E.Perry & G.Klein, 3rd Edn, 1988, p.140 - 141
28 H.L. Hart, The Law of Banking, 4th Ed, 1931, Vol. 2, p 906
168
30
AIR 1969 Mysore 280
170
The Madhya Pradesh High Court in M/s. Tara Rerolling Mills &
Five others v Punjab National Bank32 held that so far as hypothecation
is concerned, the possession remains with the hypothecator but the
hypothecatee has the right to get possession of the hypothecated property
and sell it for realisation of the debt secured by way of hypothecation. The
goods hypothecated to the Bank are covered by Section 176 of the Indian
Contract Act, 1872. There can be no distinction between "hypothecation"
and "pledge" for application of Section 176 of the Contract Act.
33 (1977) 2 MU 499
34
1989 (2) BCLR 78
172
appellant filed the appeal before the Gujarat High Court praying for time
for payment of the amount of the loan availed for purchase of the truck
from the bank. The High Court rejected the prayer. The borrower submitted
that the bank had no right to recover the possession without recourse to the
court. The question before the Court was whether the clause in the
hypothecation deed which enables the bank to recover possession of the
truck can be enforced or not. The High Court held that the loan is secured
by the hypothecation of truck and if such a clause for recapture of
possession is provided in the agreement, it is lawful. The High Court
observed that the real course the borrower should have adopted was to
approach the bank to accept a reasonable amount in the light of the adverse
circumstances which he had to suffer. Instead of doing that, the borrower
rushed to the court to pre - empt the bank from resorting to a remedy which
has been reserved to it under the agreement and dismissed the appeal.
35 Unreported Judgment - Appeal from order No. 165 of 1987 - Gujarat High
Court
36 (1977) 2 MLJ 499
173
In February 1963, the camera was attached and taken possession of by the
District Revenue Authorities in the course of proceedings against the third
defendant for recovery of arrears of Income Tax for the assessment year
1958 - 59. The plaintiff filed a claim petition for release of the camera to
him to enable him to preserve it for the realisation of the dues under the
hypothecation bond. Upon rejection of the petition by the Sub - ordinate
Judge, Salem, the plaintiff filed a suit against the Government of India
(first defendant) and the Salem District Collector (Second defendant)
seeking a declaration that the camera was not liable to be attached by the
defendants in the tax recovery proceedings, in view of the plaintiffs prior
charge over it. The trial court gave judgment for the plaintiff and the
Government appealed. The appeal was allowed by the Madras High Court.
The Court held that the right of the hypothecatee is that of a bare money
creditor with the ancillary right to proceed against the hypothecated goods
after obtaining a decree in a court of law. Thus, a hypothecation is a
right in a creditor over a thing belonging to another and which consists in
the power in him to cause the goods to be sold in order that his debt might
be paid to him from the sale proceeds.
State and a private debt payable to a citizen, the former has priority. Under
the circumstances, the State Authorities are capable of attaching the
camera for recovery of Income - Tax arrears and they have a priority in the
sense that they are entitled to recover the tax dues from out of the sale
proceeds of the camera.
37 AIR 1988 AP 18
A loan was advanced by the bank for purchase of a truck which was
hypothecated to the bank. On default in making repayment, the bank
brought a suit against the borrowers for recovery of the loan.
179
During the pendency of the suit, the said truck was seized by the
Range Forest Officer for violation of forest laws. An application was moved
by the bank for attachment before judgment of the truck. An order of
attachment before judgment was granted.
46
(1995) 82 Comp. Cas. 435
180
The Madras High Court decided a case titled "Sukra Shoe Fabric
v United Commercial Bank'*7 in respect of the hypothecator’s (borrower)
right to file a writ before the High Court questioning the hypotheeatee -
bank’s act in locking and sealing the factory premises containing the
hypothecated machinery.
47
(1992) 73 Comp. Cas. 179
181
The High Court rejected the first contention that the writ petition is
not maintainable. The only other question is whether the respondent - bank
has any authority of law to enter the premises, lock and seal the same.
Hypothecation agreement will not enable the creditor to enter the
premises, lock and seal the same without recourse to law.
Under what provision of law the police accompanied the bank officials
when they purported to enforce a term of the hypothecation deed? More
often than not, the public complain that the police do not lend their support
in urgent cases where there is a threat to life, liberty and property of a
citizen. While so, it is rather strange that the police should have
accompanied the officers of the respondent - bank when they are allegedly
enforcing a term of the hypothecation deed. The said action of the
respondent bank is totally unauthorised and arbitrary".
The Madras High Court allowing the writ petition, directed the
respondent bank to remove the lock and seal applied to the petitioner’s
factory and to deliver the possession of the factory premises along with the
goods and articles to the petitioner.
"The expression" entrusted with property" "or with any dominion over
the property" has been used in a wide sense in section 405 of the Indian
Penal Code, 1860. Such expression includes all cases in which goods are
entrusted, that is, voluntarily handed over for a specific purpose and
dishonestly disposed of in violation of law. The expression "entrusted"
appearing in section 405 of the Indian Penal Code, 1860, is not necessarily
a term of law. It has wide and different implications in different contexts.
It is, however, necessary that the ownership or beneficial interest in the
ownership of the property entrusted in respect of which offence is alleged
to have been committed must be in some person other than the accused and
the latter must hold it on account of some person or in some ways for his
benefit. The expression "trust" in section 405 of the Indian Panel Code,
1860, is a comprehensive expression and has been used to denote various
kinds of relationship like that of the trustee and beneficiary, bailor and
bailee, master and servant, pledgor and pledgee. When some goods are
hypothecated by a person to another person, the ownership of the goods still
remains with the person who has hypothecated such goods. The property in
respect of which criminal breach of trust can be committed must necessarily
be the property of some person other than the accused or the beneficial
interest or ownership of it must be in other person and the offender must
hold the property in trust for such other person or for his benefit. In a case
of pledge, the pledged article belongs to some other person but the same is
kept in trust by the pledgee. In the instant case, a floating charge was made
on the goods by way of security to cover up credit facility. In such case for
disposing of the goods covering the security against credit facility the
offence of criminal breach of trust is not committed".
185
51
2000 ISJ (Banking) 385
186
The Punjab and Haryana High Court held that whether the
entrustment was there or not is a matter of evidence. The goods were
pledged by the respondents with the petitioner - bank though the possession
was kept in their godown. So prima facie it cannot be said that there was
no entrustment. Moreover, the learned Chief Judicial Magistrate could have
also considered whether the case falls under section 379 (punishment for
theft) of the Indian Penal Code. The allegation of the petitioner is that the
goods were hypothecated and the possession was kept in the godown with
the respondents. When this is the position, the view taken by the learned
Chief Judicial Magistrate cannot be accepted.
The High Court allowed the Criminal Revision setting aside the order
of discharge of the respondents. The case was remanded to the learned
Chief Judicial Magistrate for proceeding with the case in accordance with
law.
The observations of the Madras High Court in the case are as follows:
The Madras High court further observed that it is clear that there is
no necessity to issue notice even in the case of certain administrative action.
If this is the position even in the case of administrative orders, in the case
of contracts it can be said that there is no need for prior notice. If prior
notice is issued before seizure of the vehicle, naturally the vehicle will be
taken away from the jurisdiction of the State and the very purpose of
exercising the power of seizure will be taken away.