Hypothecation
What is Hypothecation?
Hypothecation is a type of security by which a borrower can obtain funds by providing movable assets as collateral. The borrower retains possession of the assets and continues to utilise it. The owner of the asset retains title, possession, and ownership rights, including any revenue made by the asset. It is typically uses in cases of movable property such as vehicles, stocks etc. If the owner of the goods does not repay the loan within a specified timeframe, the creditor retains the authority to collect the debt, even if it requires selling the secured goods.[1]
Hypothecation is not a statutory right, although it has been used in the mercantile sector for a very long time. There is no specific legislation or law that directly or indirectly governs hypothecation. Consequently, courts must evaluate hypothecation related cases solely based on the general contract law, principles of justice, equity and good conscience and in accordance with the terms of the hypothecation agreement.[2]
Official Definition of Hypothecation
The term "hypothecation" is defined in Section 2(n) of the SARFAESI Act, 2002[3], “a charge in or upon any movable property, existing or future, created by a borrower in favour of a secured creditor without delivery of possession of the movable property to such creditor, as a security for financial assistance, and includes floating charge and crystallization into fixed charge on movable property”.[4] The document that establishes the implementation of hypothecation is referred to as the ‘hypothecation deed’.
As per Halsbury’s Laws of England, Hypothecation is a type of pledge of goods where there is no immediate change of possession.[5] The creditor is given the authority to seize the goods if the debts are not paid within the specified timeframe, and the owner of the goods is empowered to refund the debts and release the hypothecated commodities from the obligation.
Hypothecation is a type of pledge. While Hypothecation does not grant the creditor ownership or control, it does establish a financial claim via a charge.[6]
If the borrower fails to repay the debt to the creditor within the specified timeframe, the charge of Hypothecation is transformed into a pledge, granting the creditor the rights of a pawnee.[7] Simply put, it encompasses a floating charge and the subsequent conversion into a fixed charge on the movable property.
Pledge by Hypothecation
Where a pledge is made by hypothecation, the creditor is not allowed to directly seize the items by accessing the premises or using any other means. He must obtain either the borrower's approval or a court order in order to do so. This is called pledge by hypothecation. Even if the goods may be permitted to remain in the possession of the pledger for a specific purpose, it does not undermine the impact of the pledge.
The United Bank of India v. New Glencoe Tea Co Ltd.,[8] deals with the legality of a mortgage on transportable property without the need for physical possession. While the Act does not specifically address pledge by way of hypothecation, hypothecation is a legitimate form of security that establishes comparable rights and obligations to those provided by a pledge.
Formalities for creation of Hypothecation
Hypothecation involves the execution of a "deed of hypothecation" by the security provider in favour of the lender. The charge established through the deed of hypothecation is regulated by the rules outlined in the document, which comprehensively outline the powers and safeguards that protect the lender's interest.
Additional requirements for hypothecation include the payment of state stamp duties, filing with the Registrar of businesses in case of companies etc. Hypothecation ends when the total loan amount is settled and there are no outstanding obligations.
Also known as/ Similar Terms
Pledge and hypothecation both are types of collateral. The major difference lies in the fact that in a Pledge, the possession of asset is with the creditor; whereas in a Hypothecation, the possession of asset is with debtor. Both Pledge and hypothecation can be created on future assets.
References
- ↑ Pollock & Mulla, The Indian Contract Act and Specific Relief Acts, Vol II 1579 (14th ed., 2012)
- ↑ State Bank of India v. S.B. Shah Ali, AIR 1995 AP 134
- ↑ Section 2(n), SARFAESI Act, 2002
- ↑ P. Ramanatha Aiyar, Advanced Law Lexicon, Vol II, 2179 (3rd ed., 2005)
- ↑ Halsbury's Laws of England, Vol 43, 438 (Fourth Edition)
- ↑ Hindustan Machine Tools Ltd. v. Nedungadi Bank Ltd., AIR1995 Kar. 185
- ↑ P. Ramanatha Aiyar, Advanced Law Lexicon, Vol II, 2179 (3rd ed., 2005)
- ↑ United Bank of India v. New Glencoe Tea Co Ltd., AIR 1987Cal 143
