Modes of Securing Bank

Advances:
Charge Creation, guarantee
etc

S.M. Abdul Hakim

DGM, BBTA

GOOD APPRAISAL + BAD DOCUMENTATION =

BAD ASSETS.
BAD APPRAISAL + GOOD DOCUMENTATION =
BAD ASSETS.

GOOD APPRAISAL +GOOD

DOCUMENTATION =GOOD OR
STRONG ASSETS.
2

What is a security?
Security means things deposited as a guarantee of
an undertaking or loan, to be forfeited in case of
default. Also means document as evidence of a loan,
certificate of stock, bonds etc. It is also meant to be
an insurance against an emergency.

Primay
Security

Personal
Security

Impersonal
Security

Collateral Security:
A Collateral Security is a security belonging to
and deposited by borrower himself or by a
third party to secure loans and advances.
Collateral Security in a wider sense is used to
denote any type of security that runs parallel
to or side by side with the personal right of
action against a debtor in respect of an
advance. Collateral
Security
may
be
direct
or
Collateral Security
indirect.
1
Direct collateral
security

2
Indirect collateral
security

Attributes to a good
security
Legal Aspects:

Economic aspects:

i. Ascertainment
of title
ii.Validity of title

i. Marketability
ii.Easy ascertainment of
value
iii.Stability of price
iv.Easy storability
v. Durability
vi.Transportability
vii.Cost consideration
viii.Absence of contingent
liability
ix.Yield

Charge:
Charge means right of payment out of certain
property. In a charge there is no transfer of interest or
property. It is a right over some tangible asset of the
borrower. It is a legal transaction as a result of which
the lender acquires certain rights over the property
and the borrower is refrained from dealing in them. In
a charge there must be a notice to the subsequent
transferees, otherwise the charge is not effective as
to the subsequent transferees.

Types of
Charges
1
01. Fixed Charges
02. Floating
Charges

2
** Pari Passu
Charge:
** Second
Charge:

Methods of creating charges

The common methods of charging
securities are:
01. Lien,
02. Hypothecation,
03. Pledge
04. Mortgage,
05. Assignment
06. Set-off.

O1. Lien:
Lien is the right of one person to retain goods and
securities in his possession belonging to another until
certain legal debts due to the person retaining the
goods are satisfied. In other words, it is the right of the
creditor to retain the goods securities in his possession,
belonging to a debtor, until the due is paid.
To exercise right of lien the following conditions
must be fulfilled:
I. Goods must be in the possession of the creditor in
the ordinary course of the business,
II. The debtor has a lawful debt due to discharge to
the creditor,
III. There must not be any contract to the contrary.
Lien gives a person only a right to retain the
possession of goods and not the power to sell unless

Types of lien: There are two kinds of lien:

i. Particular Lien
ii. General Lien
Other types:
. Bankers Lien
.Negative Lien
Exception to the right of lien:
i. Valuables lying in safe deposit vault.
ii. Bills of exchange or other documents for special
purpose.
iii. Money deposited for special purpose.
iv. Documents for valuable left in the banks.
v. Securities deposited before loan sanctioned.
vi. Trust account.

02. Hypothecation:
Hypothecation is a charge against property for an
amount of debt where neither ownership nor
possession is passed to the creditor. Though the
borrower is an actual physical possession but the
constructive possession remains with bank as per the
deed of hypothecation. The borrower holds the
possession not in his own right as the owner of the
goods
but asofthe
agent of the bank.
Features
Hypothecation:
Charge against a property for a amount of debt,
Goods remains in the possession of the borrower,
Equitable charge to the bank under document
(Letter of credit),
Borrower bind himself to give possession of the
hypothecated goods to the bank when called upon
to do so,
It is a floating charge,

Precautions to be taken by the banker while

granting loans on hypothecation :
The position of the banker under hypothecation is not
as safe as under a pledge. The borrower may fail to
give possession of the goods hypothecated to the
bank, or sells the entire stock or borrows from another
banker on the security of the same goods.
This facility should be given only persons or
business houses of high reputation and sound
financial standing,
The banker must periodically inspect the
hypothecated goods and the account books,
The borrower should be asked to submit a
statement of stock periodically giving correct
position about the stocks,
An undertaking should be taken from the borrower
that he shall not charge the same goods to some
other bank or persons,

03. Pledge:
Pledge is the Bailment of goods as security for
payment of a debt or performance of promise(sec172 of Cont. Act)
Bailment is the delivery of goods by one person to
another for some purpose, under a contract that the
goods shall, when the purpose is accomplished, be
returned or otherwise disposed of, according to the
direction of the persons delivering them (sec-148 of
Who
Cont. can
Act).pledge the goods?
i. The owner of the goods himself
ii. Mercantile agent (sec-178 of Contract Act, 1872)
iii. Joint-owner with consent of other co-owner
iv. If a buyer leaves the goods or document of title
after sale in the possession of the seller, the latter
may make a valid pledge of the goods provided the
pledge acts in good faith and he has no notice of
the sale of goods to the buyer.

Rights/Obligations of Pledger
i. To claim back the security pledged on repayment
of the debt with interest and other charges,
ii. To receive reasonable notices in case the pledgee
intends to sell the goods,
iii. In case of sale, the pledger is entitled to receive
from the pledgee any surplus after debt is
completely paid off,
iv. A pledger must disclose the pledge any material
faults or extra ordinary risk involved in the goods.
v. Any loss caused to the goods, because of
mishandling or negligence on the part of the
pledge, the pledger has the right to claim the
same,
vi. Pledger is responsible to meet the expenditure for
the preservation of the goods,
vii.The pledger is liable for any loss caused to the

Rights/Obligations of Pledgee
i. The pledgee has a right to retain the goods pledged to
him by the pledger till the debt, together with the
interest due therein and the expenses for preservation
of the goods, are fully paid by the pledger.
ii. In case of default by the pledger to make payment of
the debt, the pledgee has the right either
a) To file a suit against the pledger for the amount
due and retain the goods as a collateral security; or
b) To sell the goods pledged after giving the pledger
reasonable notice of sale(sec-176).
iii. The pledgee must take care of the goods pledged to
him
iv. The pledgee can not make unauthorized use of the
pledged goods.
v. The pledgee is bound to return the goods on payment of
the debt
vi. The pledgee will pay the pledger any benefit accrued
from the pledged goods.

Documents required for Pledged:

i. Demand Promissory Note
ii. Letter of continuity
iii. Agreement for pledge
iv. Letter of lien (containing set-off clause)
v. Letter of guarantee (if any)
vi. Insurance policy covering all risk
vii.Invoice of goods pledged
viii.Latest stock report
ix. Another document as per sanction letter.

04. Mortgage
As per T.P. Act, 1882 sec-58(a) A Mortgage is the
transfer of an interest in specific immovable property
for the purpose of securing:
i. The payment of money advanced or to be
advanced by way of loan,
ii. An existing or future debt,
iii. The performance of an engagement which may
give rise to pecuniary liability,
iv. The transferor is called `Mortgagor, the transferee
is called `Mortgagee, the principal money & the
interest of which payment is secured for the time
being are called `Mortgage money and the
instrument by which the transfer is effect called
`Mortgage deed.

Procedure of legal mortgage:

i.

Mortgage Deed, signed by the mortgagor and two

witnesses,
ii. Registration of mortgage deed,
iii. Effective from the date of execution.

Procedure of equitable mortgage:

a)
b)
c)
d)
e)

Deposit of original title deeds,

Sending a covering letter by the mortgagor.
All documents should be in original,
Maintaining equitable mortgage register,
Periodically submission of encumbrance
certificate,
f) Periodical tax receipts shall also be verified,
g) If mortgagor is a Ltd. Co., must be registered
within 21 days and charge with joint stock Co.

Documents In Case Simple /Legal

Mortgage:
i. Chain of documents regarding title (if available),
ii. Original title deed of the mortgagor (if available),
iii. C.S., S.A., & R.S. Parcha,
iv. Up to date rent receipt,
v. Valuation certificate from concerned authority,
vi. Clearing certificate from local body/Dev. body,
vii.Non-encumbrance certificate,
viii. Legal opinion from legal adviser,
ix. Power of attorney authorizing the bank to sell the
mortgage property,
x. Site plan/Location map,
xi. Certified copy of mortgage deed along with
receipt.

Documents in Case of Equitable

Mortgage:
All documents of legal mortgage except mortgage
deed and the additional following documents
required:
i. Original title deed,
ii. Memorandum of deposit of original title deed,
iii. A registered power of attorney,
iv. Any other documents as stated in the sanction
letter.

05. Assignment:
An assignment means a transfer by one person of a
right, property or debt (existing or future) to another
person. The person who assigns the right, property or
debt is called the assignor. The person to whom the
right etc. is assigned is called the assignee.

"actionable claim"
means a claim to any debt, other than a debt
secured by mortgage of immovable property or by
hypothecation or pledge of movable property, or to
any beneficial interest in movable property not in the
possession, either actual or constructive, of the
claimant, which the civil courts recognise as
affording grounds for relief, whether such debt or
beneficial interest be existent, accruing, conditional
or contingent;

Legal Assignment and Equitable Assignment:

Legal assignment: Section 130 of the transfer of property Act states
a legal assignment is one where:
i. Assignment Deed is in writing duly signed by the assignor and the
intention to pass by assignment is clear.
ii. The transfer of actionable claim is absolute.
iii. The assignee informs the assignors debtor about the assignment
and also gets the confirmation of the notice and the debt.
Equitable Assignment: An equitable Assignment is one which does
not fulfill any of the above requirements.

The assignee in legal assignment can sue in his own name but the
assignee of an equitable assignment cannot do so. A legal assignee
can also give a valid discharge for the debt without the concurrence of
the assignor.

Common assignment
The most common types of assignment are:
i. Book debt,
ii. Contract money due from government or semi
government bodies,
iii. Supply bills,
iv. Life insurance policies.

Assignment as security:
Assignment is not good security for following reasons:
v. Value of the assignment depends on the integrity
and credit worthiness of assignor and his debtor,
vi. In case assignors debtor exercise right of set off,
Assignees position becomes vulnerable. Assignee
cannot have better rights than those which the
assignor possessor.
vii.Right of assignee may be repudiated by breach of

Necessary Precaution:
As assignment is not good security following precautions to be taken
by banks:

i. Assignor to give irrevocable letter to debtor to pay

debt to banker.
ii. Banker must get assignment acknowledged by
debtor.
iii. Banker must get clear notice of prior assignment
iv. Banker must sent notice of assignment to debtor
to prevent subsequent assignment
v. Constant follow-up necessary.
vi. Assignment for whole.

06. Set-of:
Set-off means the total or partial merging of a
claim of one person against another in a counter
claim by the later against the former. It is in effect
the combining of accounts between a debtor and a
creditor so as to arrive at the net balance payable
to one or the other. It is a right which accrues to
the banker as a result of the banker customer
relationship.
Set-off arises when a debtor or his creditor wishes
to arrive at the net figure owing between them
when separate accounts or debt are involved.

Ingredients of Set-of:
i. Mutual debts for sums certain,
ii. Debts must be due immediately,

Notice of Set-of:
As already stated the right of set-off accrues to the
banker as a result of banker customer relationship.
When a customer opens two or more accounts, it may
be his intention to keep them separate. So his
different accounts cannot be arbitrarily combined
without proper notice to the customer. Under such
situation, it is advisable to take prior letter of set-off
so a banker can combine them at its discretion
without giving the customer any notice. It also serves
as a proof that the bankers right of set-off exists and
the customer has not waived it. However, in actual
practice the bank sends a notice to the customer as
soon as the right of set-off is exercised.

Automatic Right of set-of:

The following are the situations where the bankers right of setoff automatically accrues and no notice of set-off is necessary:
i. On the death, insanity or insolvency of the customer,
ii. On the insolvency of a partner of a firm,
iii. On receipt of a garnishee order,
iv. On the winding up of a company,
v. On receipt of notice of assignment of the credit balance of the
customer.

Bankers Right of Set-of:

The decision and judgment in different cases reveal that the
following cases where the branches can exercise the right of setoff:
.To combine two or more accounts of the same customer in the
same branch of a bank.
.To combine two or more accounts of a customer maintained in
different branches of the same bank.
.To adjust the surplus amount of the sale proceeds or
realization of the securities held as cover for one particular
debt for liquidation of any other debt after realization of the

GUARANTEES
A guarantee is a promise by a person (the guarantor)
to settle a debt or fulfill the promise of someone else.
The person to whom the promise is made is called the
creditor or lender and the person on whose behalf of
the promise is made is called the principal debtor or
borrower.

Important Aspects of Guarantees

Most standard bank and finance company
guarantees are all obligations guarantees. This
means that the guarantor is liable for all the
borrowers obligations to the creditor and the
guarantee is not limited to the particular
transaction which gave rise to the guarantee. The
guarantors liability extends not only to all future
lending but also to all debts that the principal
debtor already owes to the creditor.
Under a standard all obligations guarantee the
guarantor is also liable for the borrowers
obligations to the lender. If, for example, the
borrower has given the lender a guarantee in
respect of another person or company, the
guarantor will be liable for all claims brought

Under a standard all obligations guarantee the

guarantor will also be liable for any interest
payable by a borrower, and any legal costs
incurred by the lender in enforcing the principal
obligation against either the borrower or the
guarantor, or realizing any security given to the
lender.
In some instances a guarantee will be limited in
amount. In most standard all obligations
guarantees there is a limitation clause, which if
left blank, will mean that the guarantors liability
is unlimited.
If the guarantor has given an all obligations
mortgage or other charge as security for the
guarantors obligations to the lender, that security
will extend to the debts for which the guarantor
has given a guarantee.

Release of a Guarantee
The guarantor is not liable unless the borrower is
liable. If the principal obligation has been performed
the guarantee is discharged. For example, when the
borrower pays the lender the full amount of the
guaranteed debt. Such a payment will normally
discharge the guarantor.

The guarantee may also be discharged by an

express agreement between the lender and the
guarantor.

In some circumstances a guarantee may be

terminated if the guarantor gives written notice to
the lender. In such a case the guarantor will remain
liable for the debts or liabilities that have accrued up
to the giving of such notice. However, generally the