From Justice Definitions Project

What is Pledge?

A pledge is as an act of the owner delivering goods to the creditor as a kind of security or collateral against a loan. A contract of pledge is a type of a contract of bailment. Here, the goods that have been bailed are kept as collateral for a debt or a performance of a promise. Goods can be delivered either physically or constructively. The pawnee has the right to possess the items, but not the right to enjoy them.

Official Definition of Pledge

Pledge is defined in Section 172 of the Indian Contract Act, 1872 (“ICA”) as “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 ‘pawnee’.” It is covered under Chapter IX of the Indian Contract Act, 1872.

Essential features of a contract of pledge

  • All the basic essentials of a valid contract should be present.
  • The goods passed as security to the pawnee must be movable property and ascertainable at the time of the contract.[1]
  • The pawnor must be the owner of the goods. However, pledge by non-owners is valid in certain circumstances - - By mercantile agent[2] - By person in possession of goods under voidable contract[3] - By a pledgee[4]
  • There must be delivery[5] of possession of goods from the pawnor to the pawnee. The delivery can be either actual or constructive.[6] However, there may be exceptions in which the pawnor retains possession.
  • Mere possession of the goods is transferred to the pawnee, and not ownership.
  • The goods must be pledged as security against an outstanding debt of the pawnor.
  • Once the debt is repaid, the goods must be returned to the pawnor.

Duties of the pawnor

  • The pawnor must compensate the pawnee for all expenses made by the pawnee in order to ensure the well-being of the pledged goods.
  • The pawnor has to repay the total of the principal amount as well as any interest accrued.
  • The pawnor has to disclose all the faults in the goods to the pawnee.

Duties of the pawnee

  • The pawnee must take reasonable care of the goods[7] i.e., just, fair and reasonable and not be negligent.
  • The pawnee can use the goods pledged only if the pawnor authorises the same.
  • The pawnee must return the goods pledged to the pawnor once the debt is repaid.
  • If the pawnee earns profit from the pledged goods, the same shall be returned to the pawnor during the termination of the contract.
  • The pawnee must keep the pledged goods separate from his own goods. If he mixes the pledged assets, all costs associated with their segregation will be assumed by the pawnee. If it is not feasible to separate, the pawnee will have full responsibility for all the damages.

Rights of the pawnor

  • Right of redeem[8] whereby if the pawnor fails to pay the debt or fulfil the promise at the agreed time, they can still reclaim the pledged goods before they are sold. However, the pawnor must cover any extra expenses incurred due to their default.
  • Right to get the goods back once he pays back the amount due along with the interest .

Rights of the pawnee

  • Right to retain the goods until the amount owed by the pawnor is paid in full or the promise is completely performed.[9]
  • Right to extraordinary expenses needed for the safekeeping of the goods.[10] However, the pawnee cannot retain the goods for non-payment of such expenses.
  • Right in case the pawnor makes a default[11] is threefold: - He may bring a suit upon the debt - He may retain the pawn as a collateral security - He may sell it giving the pawnor reasonable notice of sale - The pawnor must be given proper and enough notice before selling the goods.[12] Additionally, if the sum obtained from the sale is lower than the outstanding debt, the person who pawned the item is responsible for settling the remaining balance. If the money obtained from the sale exceeds the outstanding amount, the pawnee is obligated to transfer the excess funds to the pawnor.

It must be noted that the right to sue and the right to sell are not concurrent rights and the pawnee can only exercise either of them.[13] Further, while exercising the right of sale of pledged goods, the pawnee is restricted from making a sale of the pledged goods to himself as it amounts to unauthorized conversion.[14]

Also known as/ Similar Terms

Pledge is similar to bailment; both are types of collateral. While in bailment, possession of an asset is transferred from one party to another for a specific purpose (not limited to debt), that specific purpose in pledge is security against a debt. Pledge is a special kind of bailment.

Pledge is also similar to hypothecation, as both are contracts for debt. The major difference lies in the fact that in a pledge, the possession of the asset is with the creditor; whereas in a hypothecation, the possession of the asset is with the debtor. Both pledge and hypothecation can be created on future assets. When the borrower fails to make payments under the pledge, the lender has the right to sell the asset to recover the outstanding amount. However, in hypothecation, where the lender does not have possession of the assets, he can initiate a suit to recover his dues by taking possession first and then disposing of them.

International Experience

United Kingdom: Under English law, a pledge is the delivery of possession of a good by one party (the pledgor) to another (the pledgee) as security, while the pledgor retains ownership of the asset. Furthermore, delivery of the item in question can be actual or constructive, such as giving over the keys to the warehouse where the pledged goods are stored. If the pledgor fails to make payment, the creditor (or pledgee) has the right to sell the pledged asset, provided the pledgee provides the pledgor with proper notice.

California: In California, a pledge is only valid as a binding contract if there is consideration. In 2010, a measure was introduced in the California Legislature to amend the state's rule, making any written pledge to a nonprofit organization enforceable with or without consideration. But the bill was never signed into law. So the law stays consistent with how California judges have decided on this subject throughout the years: there must be a legally substantial degree of contemplation.

  1. Appa Rao v. Salem Motors & Salem Radios & Electricals, AIR 1955 Mad 505.
  2. Section 178, Indian Contract Act, 1872.
  3. Section 178A, Indian Contract Act, 1872.
  4. Section 179, Indian Contract Act, 1872.
  5. Jyoti Prokash Nande v. Muti Prokash Nande, AIR 1918 Cal 947.
  6. Gopal Singh Hira Singh Merchant v. Punjab National Bank, AIR 1976 Del 115.
  7. Central Bank of India Ltd v. Grains and Gunny Agencies, AIR 1989 MP 28.
  8. Section 177, Indian Contract Act, 1872.
  9. Section 173, 174, Indian Contract Act, 1872.
  10. Section 175, Indian Contract Act, 1872.
  11. Section 176, Indian Contract Act, 1872.
  12. Lallan Prasad v. Rahmat Ali, AIR 1967 SC 1322.
  13. Haridas Mundra v. National & Grindlays Bank Ltd, AIR 1963 Cal 132.
  14. The Official Assignee of Bombay v. Madholal Sindhu & Ors., AIR 1947 Bom 217; Ramdeyal Prasad v Sayed Hasan, AIR 1944 Pat 135.
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