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eMPTBS V

PLEDGE AND
HYPOTHECATION
CHAPTER V

PLEDGE AND HYPOTHECATION

PLEDGE

Pledge is a bailment of personal property as security for some debt


or engagement. Pawn was synonymous with pledge at common law, but
modem usage tends to restrict these words to the bailment of tangible
chattels for money advanced, and has introduced the term "Collateral
Security", or simply "Collateral", to designate the subject matter of a pledge
given as security for an engagement other than a simple borrowing of
money, and particularly when the subject - matter consists of incorporeal
chattels such as stocks, bonds, or choses in action1.

Pledge is the transfer by one person to another of the possession of


certain goods to be held by the latter as security for the performance by the
former of some obligation to pay or perform, which being performed, the
pledge must be restored2.

Pledge is a delivery of goods, or the documents of title to goods, by a


debtor to his creditors as security for a debt, or for any other obligation. It
is understood that the subject of the pledge will be returned to the pledgor
when the debt has been paid or the obligation fulfilled3.

Bouvier’s Law Dictionary, 8th Edition, 1914, Vol III, p.2604

The Oxford Companion to Law by David M. Walker, 1980, p.963

Dictionary of Banking by F.E. Perry & G.Klein, 3rd Edn, 1988, p.240
147

A pledge or pawn is a delivery of chattels or choses in action by a


debtor to his creditor as security for his debt or any other obligation. Whilst
possession of the thing passes to the pledgee, the property in the thing (i.e.
the legal ownership) remains with the pledgor4.

The commonest case of pledge is the transaction with a pawn broker


by which some article is pledged as security for a loan of money and either
later redeemed or sold under statutory power provided under Section 176
of the Indian Contract Act, 1872. This section empowers the pledgee to sell
the thing pledged on giving reasonable notice to the pledgor if the pledgor
makes default in payment of the debt.

Possessory Security

Possession is the essence of the contract of pledge, but without


suitable written evidence the pledgee will be entitled only to hold the goods
until the pledgor defaults. For the sake of liquidity the banker normally
reserves the right of sale, with or without reasonable notice, and the
contract is evidenced by the execution of a document setting out the facts
and embodying, amongst other things, a power of sale. It is prudent to
ensure wherever possible that the pledge is completed before any document
is signed, thereby avoiding any suggestion of a contract of hypothecation
amounting to an agreement to create a pledge. "Get your goods first" is,
therefore, the prudent banking maxim.

4 Thomson’s Dictionary of Banking by F.R. Ryder & D.B. Jenkins, 12th Edn,
1974, p.462
148

A pledge is not a pledge if there be not either actual or token delivery


to the pledgee. Both mortgages and possessory securities (e.g. pledge)
partake to some extent of the conveyance type of security; under the
mortgage the mortgagor conveys, in point of form, the sum totality of
juristic rights possessed by him; under the possessory security he transfers
one right only, viz. possession. Logically therefore, the creditor, apart from
special agreement, should have one right only, viz. the negative right of
withholding possession from the debtor until the debt is paid. However the
pledge goes beyond this in giving the pledgee, even apart from agreement,
a power to sell on default, though not a power to foreclose.

The possessory security transfers the right of possession. It is,


however, the more striking characteristic that it must transfer factual
possession. The term "factual possession" is here used to include both or
either of the two concepts of physical or de facto possession on the one hand
and the legal possession on the other. Both are . distinct from a right to
possess or a right of possession, though in many cases, all three will
co - exist. Thus if the pledgor physically delivers the goods to the pledgee
in person, the latter will have physical possession, legal possession and a
right of possession.

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

Customers who have obtained advances on the security of goods, or


of documents of title frequently cannot repay the amount borrowed until
they realise the goods. As possession of the documents of title is essential
to obtain the goods from the shipping company or warehouse - keeper,
bankers sometimes arrange to deliver the documents to the customer
against his signature to an instrument known as a Trust Receipt, by
which the customer undertakes to hold the documents or the goods, and any
proceeds therefrom, as a Trustee for the banker, in whose name the goods
are insured and warehoused. He further undertakes to keep the transaction
separate from others to prevent the prejudicing of the bank’s security by the
merging of the goods in his general stock; or he may undertake to store the
goods separately.

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".

The law relating to pledge in India is traced to the English Law.


Sections 172 to 181 of the Indian Contract Act, 1872 relating to pledges are'
framed on the principles of English Law.

A pledge arises when movable property (goods) is delivered by one


person (pledgor) to another person (pledgee) to be held as security for the
payment of debt or for discharge of some other obligation, upon the express
or implied understanding that the subject matter of pledge is to be restored
to the pledgor as soon as the debt or other obligation is discharged. Where
a definite time is fixed for payment, pledgee has an implied power of sale

[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.

Section 172 of the Indian Contract Act, 1872 defines pledge as

follows:

The bailment of goods as security for payment of a debt or


performance of a promise is called ‘Pledge’. The bailor is in this case called
the "Pawnor". The bailee is called the "Pawnee".

Section 172 affirms the common law. There is no difference between


the common law of England and the law with regard to pledge as contained
in Sections 172 to 176 of the Indian Contract Act, 1872. Under the English
Common Law, a pawn or a pledge is a bailment of personal property as a
security for some debt or engagement.

The Supreme Court in Lallan Prasad v Rehmat All7 held that


there are two ingredients of a bond or a pledge namely 1) that it is essential
to contract of pawn that the property pledged should be actually or
constructively delivered to the pawnee and 2) that a pawnee has only a
special property in the pledge but the general property remains in the
pawnor and wholly reverts to him on discharge of the debt. The right to
property vests in the pledgee so far as is necessary to secure the debt.

7
AIR 1965 SC 1322
153

It is not necessary that there should be delivery of tangible property.


In the case of Morvi Mercantile Bank Ltd, by Official Liquidator v
Union of India*, the Supreme Court held that delivery of goods by one
person to another under a contract as security for payment of debt in
accordance with Sections 148 and 172 of the Indian Contract Act, 1872 is
a pledge and ordinarily delivery of tangible property is essential to a true
pledge; where, however, the law recognises that delivery of tangible symbol
involves a transfer of possession of the property symbolised such symbolic
possession takes the place of physical delivery. Since railway receipt is a
document of title and its transfer for consideration effects constructive
delivery of goods, these receipts can be pledged and the endorsee of the
railway receipt is held to be pledgee of goods and not only of document of
title.

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.

Legally speaking, pledge does not warrant any written evidence. A


banker usually obtains a letter of pledge’ from the customer containing the
list of documents of title to goods and also clauses to the effect that

8AIR 1965 SC 1954


154

1. the bank is to have pledge upon all goods delivered by the


customer

2. the pledge be held as continuing security

3. right of sale to the banker on default by the pledgor

4. goods be insured by the customer

5. customer to pay rents and warehousing expenses

6. banker not responsible for default of any broker engaged for


selling the goods.

Pledgee as Secured Creditor

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 point for determination by the Supreme Court was :

Whether the sugar seized by the Government was in possession of the


Bank as a pledgee at the time of the seizure and whether the rights of the
Bank as such pledgee have been determined by the seizure in question.

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.

10 3rd Edition, Volume 29, p.211, 218, 219, 222


156

The Bank’s right as a pawnee could not be extinguished by the


seizure of goods in its possession. The pledge was intended to give the bank
a primary right to sell the goods in satisfaction of the liability of the
pawnor. The Cane Commissioner who was an unsecured creditor could not
have any higher rights than the pawnor and was entitled to only the
surplus money after satisfaction of the Bank’s dues.

The Supreme Court decision establishes that a bank’s right over


goods pledged to it cannot be defeated by a seizure thereof by government
authorities, however lawful the seizure may be, and by appropriation of the
sale proceeds towards the pledgor’s dues to the government. So long as the
bank’s claim is not satisfied, no other creditor has a right to seize and sell
the goods and take away the sale proceeds.

In Bank of Baroda v Collector of Indore and othersn, the


petitioner - bank advanced a cash credit loan to respondent No.5, the
dealers in soya bean, against the security of stocks of soya bean purchased
by respondent No.5 for the purpose of sale. The pledged stocks of soya bean
were kept in a godown under lock and key of the petitioner - bank in their
actual and exclusive physical possession, control and dominion. The stocks
of soya bean were redeemed by respondent No.5 and were released by the
petitioner - bank form pledge from time to time against payments by
respondent No.5. The Assistant Inspector, Food and Civil Supplies, visited
the office premises of respondent No.5, inspected the records maintained by
them and found that they had stocked 6400 quintals of soya bean which had

11 (1995) 82 Comp. Cas. 580


157

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 petitioner - bank challenged the act of the Government in


confiscating the pledged stocks. The question before the Madhya Pradesh
High Court in the writ petition was whether the confiscation under Section
6A of the Essential commodities Act, 1955 as against the respondent No.5
would override the rights of the pledgee - bank.

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

Goods Charged to Two Banks

In Nadar Bank Ltd v Canara Bank Ltd12, the borrower pledged

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:

"Wherever one of two innocent persons must suffer by the acts of a


third, he who has enabled such third person to occasion the loss must
sustain it".

The same goods were pledged by a borrower to two different banks


and it was held that the first pledgee - bank had priority over the second.

Pledge of Shares

It is not necessary that there should be the pledge duly filed in


transfer form. It has been held in Bengal Silks Mills Co. Ltd, In Reu
that a transferee in the case of a transfer of shares in blank has the right
to fill in the particulars, including his own name as transferee and the date
of the transfer, even after the death oforiginal transferor. The transfer
so made will be a valid one and the transferee will be entitled to have his
name registered in the company’s register as the holder of the shares.

13 (1794) 5 Term Rep. 683

14(1942) 12 Comp. Cas. 206


160

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 :

"A bill of exchange accepted for valuable consideration, with the


drawer’s name left blank, may be completed by the drawer’s name being
added after the death of the acceptor".

Bengal Silks Mills case (supra) is of interest to bankers since often


company shares together with blank transfers are lodged with banks as
security for advances. In such cases, according to this decision, the death of
the shareholder does not terminate the bank’s authority to complete the
blank transfer and get the share registered in its name in the company’s
books.

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.

16 (1884) 25 Ch. D. 666


17
(1953) 23 Comp. Cas. 399
162

Right to Sell

Section 176 of the Indian Contract Act, 1872 provides as follows :

"If the pawnor makes default in payment of the debt, or performance,


at the stipulated time of the promise, in respect of which the goods were
pledged, the pawnee may bring a suit against the pawnor upon the debt or
promise, and retain the goods pledged as a collateral security; or he may
sell the thing pledged, on giving the pawnor reasonable notice of sale.

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".

The substance of this section is familiar and well settled English


Law.

It was held by Cotton L.J. in Re Morrit, ex p Official Receiver18


that a contract of pledge carries with it the implication that the security
may be made available to satisfy the obligation, and enables the pledgee in
possession (though he has not the general properly in the thing pledged, but
a special property only) to sell on default in payment and after notice to the
pledgor although the pledgor may redeem at any moment upto sale.

18 (1886) 18 QBD 222 at 232, CA


163

The Supreme Court in Lallan Prasad v Rehmat All19 held that

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.

Reasonable Notice of Sale

In Raja K.V.S. Sundara Narasayyamma Garu v Andhra Bank


Ltd?0, the Andhra Pradesh High Court held that before exercising the
power of sale the pawnee should give to the pledgor a reasonable notice of
sale. The provision of section 176 of the Indian Contract Act, 1872 is
mandatory and cannot be waived. The notice should be given
notwithstanding any contract to the contrary. Thus at the time of entering
into the contract of pledge, the pawnor cannot agree to waive notice as it
would be inconsistent with the provisions of Section 176.

19 AIR 1965 SC 1322


20
AIR 1960 AP 273
164

The Bombay High Court held in Official Assignee, Bombay v

Madholal Sindhu21 that a notice must be given in all cases of pledge

even when an instrument of pledge itself contains an unconditional power


of sale.

In Srinivasulu Naidu & others v Gajaraj Mehtra & Sons22, the


notice sent to the pawnor by the pawnee was not signed by the pawnee or
any other person authorised by him. The Madras High Court held that
nowhere it is stated that a notice of sale must be signed by the pawnee or
anybody on his behalf. Notice under Section 176 of the Indian Contract Act,
1872, is only an intimation of the intention to sell. The reasonable notice of
sale under Section 176 does not require specification or date, time and place
of sale. It is the moot question whether the pawnor has been given notice
of sale, whether signed or unsigned, by the pawnee.

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.

21 AIR 1947 Bombay 217

22 (1991) 1 All India Banking Law Judgments 195


165

Principle of "Nemo Dat Quod Non Habet"

There is a general rule of common law that a man cannot give a


better title to property than be himself possesses. This is often expressed
in the maxim "Nemo dat quod non habet". If, therefore, a customer steals
certain property and pledges it to his banker as security for a loan, the
banker although acting in perfect good faith without any knowledge of the
theft - will usually obtain no title thereto and will be obliged to return it to
the person from whom it was stolen.

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.

Blackburn J stated in Cole v North Western Bank23 that at


common law, a person in possession of goods cannot confer on another,
either by sale or by pledge, any better title to the goods than he himself
had. There are few exceptions to this general principle. The most important
of them relates to negotiable instruments. A pledgee of such instruments is
entitled to the same favourable treatment as a transferee for value. Goods,
however, are not negotiable; neither are bills of lading or other documents

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.

Thus a valid pledge of goods or of documents can normally be created


only by or with the consent of the true owner.

HYPOTHECATION

Hypothecation is a right which a creditor has over a thing belonging


to another, and which consists in a power to cause it to be sold, in order to
be paid his claim out of the proceeds. There are two species of
hypothecation, one called pledge, pignus, and the other properly
denominated hypothecation. Pledge is that species of hypothcation which is
contracted by the delivery by the debtor to the creditor of the thing
hypothecated. Hypothecation, properly so called, is that which is contracted
without delivery of the thing.hypothecated24.

Hypothecation is a type of security where neither ownership nor


possession passes to the lender. In banking, it means an agreement to give
a charge over goods, or over the documents of title to goods, in
circumstances which make it impossible to give the banker possession. If

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.

Hypothecation is the pledging of something as security without


delivery of title or possession26.

Hypothecation is the act of pledging a thing as security for a debt or


demand without parting with the possession. In modem times attempts
have been made to introduce "hypothecation" from the Civil Law as a
general term equivalent to "charge" the proper English term. In this use of
the word, to hypothecate property is to charge it with the payment of a sum
of money or the performance of an obligation, giving the person in whose
favour it exists neither the right to the possession of the property, nor the
right to sell it, but merely the right of realisation by judicial proceedings in
case of default by the person who has made the hypothecation27.

H.L. Hart gives the following definition:

"Where property is charged with the amount of a debt, but neither


ownership nor possession is passed to the creditor, it is said to be
hypothecated28.

25 Dictionary of Banking by F.E.Perry & G.Klein, 3rd Edn, 1988, p.140 - 141

26 Black’s Law Dictionary, 7th Ed, 1999, p 747

27 Jowitt’s Dictionary of English Law, 2nd Edn, 1977, Vol 1, p.933

28 H.L. Hart, The Law of Banking, 4th Ed, 1931, Vol. 2, p 906
168

It is submitted that Hart’s definition is more accurate, in that it gives


the term a meaning of its own, not dependent on pledge or other forms of
security.

Salmond brings out the character of hypothecation when he states


that this security, which he calls a "hen", is of its own nature a security for
a debt and nothing more; it cannot survive the debt. "It is merely the
shadow, so to speak, cast by the debt upon the property of the debtor29.

If a customer is in possession (whether actual or constructive) of


goods, he will normally be able to pass that possession to his banker.
Accordingly, he will be able to create a valid pledge of goods. In some
instances, it is impossible for a banker to be given the actual or constructive
possession of goods, and in these cases that the possibility of hypothecating
them must be considered. For example, the goods may be in a part of the
customer’s own warehouse which cannot be sealed off in such a way as to
enable the banker to become a pledgee.

The risk of lending against hypothecation of goods is that since the


lender does not obtain actual or constructive possession of the goods, his
measure of control over them is very limited with the results that the
borrower will probably have ample opportunity of dealing with them
fraudulently. The fact that the borrower may thereafter find himself in
prison is but cold comfort to a lender who has lost money. An innocent
purchaser and a pledgee who obtain possession of the hypothecated goods
in good faith are unaffected by hypothecation.

29 Salmond, Jurisprudence, 11th Edn, p.469


169

Hypothecation implies that the possession and property in the goods


remain with the borrower and only an equitable charge is created in favour
of the banker. This is not a very satisfactory position for the banker as he
cannot have a preferential claim in the event of insolvency of the borrower
or in case of an attachment of goods by another creditor or if the goods are
pledged by the borrower to a third party who has no notice of hypothecation
to the banker.

The concept of hypothecation is not provided under the Indian


Contract Act, 1872. Hypothecation is neither governed by any statute nor
is there any law governing it directly or indirectly. It has been in mercantile
usage since time immemorial. Therefore courts have to consider the cases
involving hypothecation purely on general conditions of contract as per the
terms of hypothecation agreement.

The word "Hypothecation" is found under Section 3 of the Transfer


of Property Act, 1882 under "actionable claim". The interpretation clause of
Section 3 does not define the term "hypothecation".

Hypothecation - an Extended Pledge

In Bank of Maharashtra v Official Liquidator•30, the Mysore


(now Karnataka) High Court observed as follows :

"In the case of hypothecation or pledges of movable goods there is no


doubt about the creditor’s right to take possession, to retain possession and
to sell the goods directly without the intervention of court for the purpose

30
AIR 1969 Mysore 280
170

of recovering his dues. The position in the regular pledge completed by


possession is undoubted and set out in the relevant sections of the Contract
Act. Hypothecation is only extended idea of pledge, the creditor permitting
the debtor to retain possession either on behalf of or in trust for himself.

In Sewakram v State Bank of India51, the Madhya Badesh High


Court held that hypothecation is an extended idea of pledge. Therefore, if
the creditor has permitted the debtor to retain possession the debtor retains
that possession either on behalf of or in the trust for the creditor. The
hypothecatee is supposed to be in legal possession and custody of the
property though its physical possession is with the debtor.

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.

31 1990 (2) All India Banking Law Judgments 173


32
1998 (4) All India Banking Law Judgments 275
171

Status of Lender under Hypothecation

In Union of India and another v Ct. Shenthilnathan and

another33, the Madras High Court held that hypothecation of goods is a


concept which is not expressly provided in the law of contracts, but is
accepted in the law merchant by long usage and practice. Hypothecation is
not a pledge and there is no transfer of interest or property in the goods by
the hypothecator to the hypothecatee. It only creates a notional and
equitable charge in favour of the hypothecatee and the right of the
hypothecatee is only to sue on the debt and proceed in execution against the
hypothecated goods, if they are available. The only right which the
hypothecatee got under hypothecation was a right to seek for the sale of
the hypothecated goods after a money decree on the debt. This Madras High
Court decision classifies the hypothecatee as unsecured creditor.

In Bank of India v State of Madhya Pradesh34, the R.T.O.


attached the bus (hypothecated to the Bank) for passenger tax and motor
vehicle tax under the Motor Vehicle Taxation Act. The Madhya Pradesh
High Court held that though the action taken by the RTO was legal, yet
because of special lien and hypothecation the Bank being a secured
creditor it has first charge and was entitled to sell the bus and appropriate

the sale proceeds towards its dues first.

33 (1977) 2 MU 499
34
1989 (2) BCLR 78
172

Bank’s Right to Seize the Hypothecated Asset

In Lambersingh Mavasingh v Punjab National Bank35, the

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.

Priority of Hypothecation Charge

In Union of India and another v Ct. Shenthilnathan and


another36, the facts were that the plaintiff was lending moneys to the
third defendant from time to time on the basis of a deed executed by the
latter in August 1960 hypothecating his camera and certain other articles.

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.

The best that can be claimed by the plaintiff is an equitable charge.


He could work out the equitable charge only after obtaining a decree on the
private debt. After obtaining the decree, he should seek execution as against
the goods under the hypothecation deed if available with the hypothecator
at or about the time when he seeks execution. The tax dues are public debt
and were not a debt which arose in the course of commercial dealings
between the citizen and the State. As between public debt payable to the
174

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.

In State of Andhra Pradesh and another v Andhra Bank Ltd


and others37, a bank granted cash credit advance against hypothecation
of stock in the godown of the Sugar Mill under the open credit system. The
Tahsildar attached the sugar in the godown hypothecated to the bank for
recovery of dues towards sugar cane purchase tax to the State under the
provisions of the Andhra Pradesh Sugarcane (Regulation and Purchase) Act,
1961. The stocks were sold and the amount realised was deposited. The
Bank filed a suit claiming that the Bank is entitled to preferential first
charge and lien based on the hypothecation of the stocks to recover the suit
amount. The State, being simple money creditors (on account of tax
recovery) is entitled to any surplus that may be left. The Andhra Pradesh
High Court held that the concept of hypothecation is recognised in the civil
courts and it has become "law in force" in the country within the meaning
of Article 372 (1) of the Constitution of India as laid down by the Supreme
Court in Builders Supply Corporation v Union of India38. The rules
of common law relating to substantive rights have been recognised, adopted
and enforced by judicial decisions. That being so, to say that secured
creditor does not get any lien over the property hypothecated will amount

37 AIR 1988 AP 18

38AIR 1965 SC 1061


175

to negativing his right as a secured creditor. In view of these principles, the


doctrine of "Priority of Crown debts" is not applicable as against the secured
debt and therefore the bank’s (hypothecatee) claim has to be satisfied first.
In Canara Bank v Asst. Commissioner (Commercial Taxes),
Madras39, the Commercial Taxes Dept of Tamilnadu attached the
movables of the borrower on account of the Sales Tax dues. The movables
were already hypothecated to the Bank for certain credit facilities availed
by the borrower. The Bank filed a writ of mandamus before the Madras
High Court seeking a direction to the Taxation Authorities not to sell the
property as the bank has the first charge over the property by virtue of the
hypothecation in its favour. The High Court held that the hypothecation in
favour of the Bank is not a secured debt. Therefore the Bank’s charge as
hypothecatee could not be treated in preference to the government dues that
can be recovered as a prior charge if the goods hypothecated are available
for being proceeded against and attached for tax arrears.

Hypothecatee’s Right of Private Sale

The Nagpur Judicial Commissioner’s Court in Nanhuji v Chimnd40


held that a non - possessory hypothecation of movables is a valid contract
and should be recognised and enforced by the courts. The rights of the
hypothecatee are entirely regulated by the terms of the contract between
the parties. On default in payment of the debt, he can compel delivery of
property or obtain a decree for sale of the property, if so stipulated in the

39 1989 (1) All India Banking Law Judgments 258


40
(1911) 10 Indian Cases 869
176

contract. If the property is simply hypothecated without any stipulation as


to the manner in which it is to be dealt with, the only remedy open to the
creditor is to obtain a money decree declaring his lien on the property and
his right to sell.

In Re S.Y.C. W & S. Mills41, the Mysore High Court (now


Karnataka High Court) held that in hypothecation or pledge of movables,
there is no doubt about the creditor’s right to take possession, to retain
possession and to sell the goods directly without the intervention of court
for the purpose of recovering his dues. Hypothecation is only extended idea
of pledge, the creditor permitting the debtor to retain possession either on
behalf of or in trust for himself (the creditor). Hence so far as movables
actually covered by the hypothecation deeds are concerned, there can be no
doubt that the bank is entitled to retain possession and also to exercise the
right ofprivate sale.

In Syndicate Bank v Official Liquidator42, the Delhi High Court


held that hypothecation creates a special property in the goods in favour of
the hypothecatee. In the case of hypothecation, possession remains with the
hypothecator but the hypothecatee has the right to take possession of the
hypothecated property and to sell it for the realisation of the debt secured
by hypothecation. It is open to the bank to take possession of the
hypothecated property on its own or through the court. It is also open to the
bank to enforce the security by the suit.

41 AIR 1969 Mysore 280

42 AIR 1985 Delhi 256


177

In Union of India v Ct. Shenthilnathan43 the Madras High Court

held that hypotehcation creates only a notional and an equitable charge in


favour of the hypothecatee. The right of the hypothecates is only to sue on
the debt and proceed in execution against the hypothecated goods, if they
are available.

The Andhra Pradesh High Court in State Bank of India v S.B.


Shah Ali (Died) and others44 held that where there is a mere charge in
hypothecation agreement, the hypothecatee has to approach the court and
seek intervention of the court for obtaining money decree and for bringing
the hypothecated goods for sale through the court. When there is any
specific clause in the hypothecation agreement empowering the
hypothecatee to take possession of the goods and to sell the same, in the
event of default in payment, as per the said terms the hypothecatee can
proceed ahead without intervention of the court. It cannot be said that the
hypothecatee has to approach the court even though the deed provides for
taking possession in case of default of the hypothecator. If there is any
violation of the terms of the deed it will not bar the hypothecator to
approach the court and seek proper relief.

In Canara Bank v Official Assignee, Madras45 before the


Supreme Court the facts were that the appellant bank in an appeal before
the Madras High Court prayed that it should be permitted, as a secured

43 (1977) 2 MLJ 499

44 1994 (3) ALT 332 (D.B)


45
1997 I AD (SC)
178

creditor in insolvency proceedings, to sell the hypothecated goods in the


possession of the insolvent for recovery of its dues, by virtue of the proviso
to Section 17 of the Presidency Towns Insolvency Act, 1909, read with
Section 52 (2) (a) of the Act. The High Court disallowed the claim. The bank
appealed to the Supreme Court contending that the insolvents of the goods
hypothecated to the appellant bank were in possession of such goods at the
commencement of the bankruptcy as its true owners, and had not been in
possession of the goods belonging to a third party by the consent of such
party, that the hypothecated goods were identifiable and therefore covered
by clause (a) of sub - section (2) of Section 52 of the Act and not by clause
(c) and that omission by the bank to give notice to the debtor did not
disentitle the bank to proceed against the hypothecated goods.

The Supreme Court held that in as much as the hypothecated goods


are clearly identifiable, the justice of the case required that the appellant
bank ought to be allowed to recover its dues by sale of the hypothecated
goods.

It is submitted that the judicial decisions about hypothecatee’s right


to sell the goods on default are variegated due to absence of a separate
legislation on hypothecation in India.

Illegal Use of Hypothecated Asset - Bank’s Status

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.

The Forest Department passed orders for confiscation of the vehicle.


Apprehending sale of the.vehicle by the Forest Department, the Bank again
applied for an order against sale or disposal of the truck. This application
was dismissed. Against that order, the Bank filed an appeal before the
Madhya Pradesh High Court. The High Court in the case titled "'Bank of
Baroda v Sitaram and others46 held that hypothecation of the truck
does not mean that the owner of the truck or the person responsible for its
running is absolved of the liabilities under any other law. If the truck is
utilised for transporting the contraband and is rendered liable for
confiscation, it is no defence that it was hypothecated to a
nationalised bank. The Forest Department officials had nothing to do
with the transaction the Bank had with the borrowers. If the truck is found
to be liable to be confiscated under law, the officers of the Forest
Department are within their rights to confiscate the same. In such a case,
the bank would lose its security but this cannot be helped.

46
(1995) 82 Comp. Cas. 435
180

Hypothecation and Writ Remedy

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.

The petitioner - firm was granted certain credit facilities by the


respondent bank against hypothecation of machinery. On default by the
borrower in making repayment within the stipulated time, the officers of
the bank along with an Inspector of Police entered the factory premises,
locked and sealed the premises after taking an inventory of the machinery.
A writ petition was filed by the petitioner - borrower for the issue of writ
of mandamus to direct the bank to remove the lock and seal applied to the
factory premises and deliver the possession of the same back to the
petitioner. The petitioner contended that the bank had no right either
in law or under the hypothecation agreement to enter the premises
and lock and seal the same.

The bank contended that it exercised the powers reserved under


clause 4 (j) of the Hypothecation Deed and seized the goods by means of
locking and sealing the premises. The Police Inspector, though present, did
not enter the premises. The bank raised a preliminary objection that writ
petition under Article 226 of the Constitution of India is not maintainable
since the rights of the parties are governed by a non - statutory contract
and the remedy of the borrower is Only to file a civil suit.

47
(1992) 73 Comp. Cas. 179
181

The High Court observed that the hypothecatee is a nationalised


bank and an authority under Article 12 of the Constitution of India. It owes
a public duty to its customers as well as to the borrowers. It has been held
by the Supreme Court in Shri Anadi Mukta Satguru Shree Muktajee
Vandasjiswami Suvama Jayanti Mahotsav Smarak Trust v V.R.
Rudani48 that mandamus can issue against any person provided that the
court is satisfied that such a person owes a duty to the public at large. The
bank falls within this category. The following passage of the said Supreme
Court Judgment is relevant here:

"Here again we may point out that mandamus cannot be denied on


the ground that the duty to be enforced is not imposed by the statute.
Commenting on the development of this law, Professor de Smith states : "To
be enforceable by mandamus a public duty does not necessarily have to be
one imposed by statute. It may be sufficient to have been imposed by
Charter, Common Law, Custom or even Contract"49. We share this view.
The judicial control over the fast expanding maze of bodies affecting the
rights of the people should not be put into water - tight compartments. It
should remain flexible to meet the requirements of variable circumstances.
Mandamus is a very wide remedy which must be easily available "to reach
injustice wherever it is found". Technicalities should not come in the way
of granting that relief under Article 226. We, therefore, reject the contention
urged for the appellants on the maintainability of the writ petition".

48 AIR 1989 SC 1607

49 de Smith, Judicial Review of Administrative Action, 4th Edn, p.540


182

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.

The High Court further observed as follows on the bank’s act in


locking and sealing the factory premises :

"When the factory was actually working, the officers of the


respondent - bank along with the police have gate - crashed into the factory
and purported to lock and seal the premises. If a nationalised bank can take
the law into its own hands, how can the courts criticise and find fault with
others?. The rights given to a creditor under a hypothecation agreement can
be exercised only by approaching the court of law, and not by taking the law
into its own hands. If we recognise such a power in a nationalised bank,
then every other State Financial Corporation and Government Company
will be emboldened to follow the same procedure. It will tantamount to
bidding good - bye to the rule of law. There are sufficient remedies available
to the creditor - bank. Even in case there is an imminent danger of the
debtor secreting the properties or depleting the securities, it is not
uncommon for civil courts to issue temporary orders of attachment as well
as appointment of commissioners to safeguard the interests of the deserving
creditors.
183

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.

Hypothecation and Criminal Breach of Trust

The Supreme Court in Central Bureau ofInvestigation v Duncan


Agro Industries Ltd50 held that when the debtor hypothecates his goods
to the bank by way of security, there is no entrustment of the goods by the
debtor to the banker. If there is any contravention of the terms of the
contract it will be a mere breach of contract making the debtor liable for
damages under the civil law. There will be no occasion for committing any
offence of criminal breach of trust by the borrower in the case of
hypothecation.

50 (1996) 87 Comp. Cas. 849


184

The observations of the Supreme Court are as follows :

"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

In Punjab National Bank v Anand Kumar51, the facts were that


the respondents have opened an account with the petitioner - bank. Cash
credit facility was given to them. The respondents have hypothecated goods
with petitioner - bank. On 26.9.1983 manager of the petitioner - bank
inspected the factory premises of the respondents and the bank godown
situated therein and found that goods hypothecated with the bank had been
removed by the respondents to the extent of 3760 quintals and the goods
placed there were found short to a large extent. The petitioner’s Manager,
therefore, made a complaint to the S.H.O. Hissar for registration of a case.
The case was registered against the respondents. After investigation, the
police concluded that there was no evidence that the respondents have
committed any offence with regard to the pledged goods. However, the
police found the respondents to be guilty of the offences punishable under
sections 420 (cheating and dishonestly inducing delivery of property) and
406 (punishment for criminal breach of trust) of the Indian Panel Code and
the police put up a challan against them. Learned Chief Judicial Magistrate
found that offence under sections 420 / 406 of the Indian Penal Code was
not made out.

It was observed by the learned Chief Judicial Magistrate that for


misappropriation of hypothecated goods, the entrustment of goods by one
person to another is an essential ingredient and the ownership of goods
remains with the original owner and only the possession changes hands and
it was held that no entrustment was made in the present case.

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.

It is submitted that this case points to change injudicial thinking as


far as illegal removal of hypothecated goods is concerned. Criminal breach
of trust was thought of hitherto. The turn to the offence of theft in case of
illegal removal of hypothecated goods is welcomed in banking circles as it
will signal a warning note to the offenders.

Hypothecation and Natural Justice

In Sri Rama Machinery Corpn. Ltd v Standard Chartered


Bank, Madras52 before the Madras High Court, the facts were that there
was a contract between the bank and customer for advancement of loan for

52AIR 1999 Madras 137


187

purchase of vehicle. The borrower defaulted in repayment. The bank seized


the vehicle as per the terms of the contract between the parties. The issue
before the High Court was whether prior notice before seizure is necessary
to be given to the borrower by the bank under the Principles of Natural
Justice. The High Court held that 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.

The observations of the Madras High Court in the case are as follows:

"In Penumbra of Natural Justice by Tapash Gan Choudhaiy, at page


58, the circumstances under which principles of natural justice could be
excluded are also stated, which read thus,

"It is well established both in England and in India that where a


right to a prior notice and an opportunity to be heard before an order is
passed would obstruct the taking of prompt action, such a right can be
excluded. Thus, the rule may be discarded in an emergent situation where
immediate action brooks no delay to prevent some imminent danger or
injury or hazard to paramount public interests".

In the case between Union of India v Tulsiram Patel53, it is held


thus,

53 1985 (3) SCG 398 in para 101; AIR 1985 SC 1416


188

"Not only, therefore, can the principles of natural justice be modified


but in exceptional cases, they can even be excluded. There are well - defined
exceptions to the "nemo judex in causa sua" rule as also to the "audi
alterum partem" rule. The "nemo judex in cause sua" rule is subject to the
doctrine of necessity. So far as the "audi alterum partem" rule is concerned
both in England and in India, it is well established that where a right to a
prior notice and an opportunity to be heard before an order is passed would
obstruct the taking of prompt action, such a right can be excluded. This
right can also be excluded where the nature of the action to be taken, its
object and purpose and the scheme of the relevant statutory provisions
warrant its exclusion; nor can the "audi alterum partem" rule be invoked
if importing it would have the effect of paralysing the administrative
process or where the need for promptitude or the urgency of taking action
so demands, as pointed out in Menaka Gandhi Case54’.

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.

54 Menaka Gandhi v Union of India AIR 1978 SC 597 at p.681

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