Security for bank advance has no doubt been reduced to secondary
importance in the present context particularly for priority sector advances but
it is still very important to influence the decision of banks in conventional
advances. Reserve Bank of India has also stipulated certain quantitative
restrictions on the banks' power to grant clean advances. Banks have prescribed
their own formats for documentation for various types of advances and the
borrowers in almost all the cases have to execute those documents without any
choice. It would never be advantageous to know the general characteristics of
securities, methods of their charging and documentation procedures adopted by
the banks.
The securities may primarily be divided in two categories as under
q
Primary security.
q
Collateral security.
The assets created by the borrower from the credit facilities granted by
the bank form the primary security for the bank advance as a matter of rule.
The bank invariably obtains a charge over those assets. Similarly, other assets
on which the advance is primarily based even if it is not created from the
credit facilities granted by the bank will also be taken as primary security.
In some cases where primary security is not considered adequate or the
charge on the security is open the bank may insist on an additional security to
collaterally secure advances granted by it. Such securities are termed as
collateral securities. Collateral security may either be tangible or third
party guarantees may also be accepted.
Bank now grant need
based advance after proper assessment and should not normally insist for
collateral security in most of the cases.1bip matter needs to be discussed at
die time of sanctioning of limits. Reserve Bank, of India has advised the banks
not to obtain any collateral security in case of all priority sector advances
upto Rs. 25,000. In other cases, it is left to the mutual agreement of the
borrower with the bank.
BASIC CHARACTERISTICS OF SECURITIES AND
CONCEPT OF MARGIN
The securities acceptable to banks either as primary or collateral must
have certain, basic characteristics as under:
§ Ascertainment of value. A security will be considered good and will be acceptable to the bank only if its value can be ascertained with a definite degree of correctness. Certain articles may be valuable but may not be accepted as security if the value cannot be ascertained such as paintings/antiques etc.
§
Marketability. A
good security must have a ready market. Raw materials, articles of necessity,
other primary commodities are easily marketable and are considered good
security. Semi‑finished goods may be more valuable than raw material for
the borrower but may not be marketable at all and will thus be considered
inferior to raw material in as much as its acceptance as a security is
concerned.
§
Stability in value. A good security should have
a stable value over along period. If the value of a security fluctuates violently
over a short period, it may not be considered a good security and may be
accepted by the bank only after keeping a very high margin.
§
Ascertainment of title and
transferability. An asset can be accepted as security by the bank only when the title over
that asset can be ascertained. Furthermore, the title should be easily
transferable. The purpose of obtaining a security is to apply the sale proceeds
of the security if the customer fails to repay the advance. But if the security
is not easily transferable the very purpose of obtaining a security may be
defeated. Immovable property located at a prime location may be very stable in
value has a ready market and the value can also be ascertained but may still
not be considered as a good security due to difficulty in ascertaining the
title and elaborate legal process involved for effecting its sale through a
court of law.
§
Durability. The security accepted by the
Bank must be durable. No bank advance is granted against perishable
commodities.
§
In case loan or advances to Muslims offering
their property as primary or collateral security, it should be ensured, before
accepting property as security that such property has not been alienated under
the Muslim Law like 'waqf‑ul‑ulad' and/or 'Haq‑rnehr' in
favour of their wives or for the benefit of their heirs since it will
jeopardise the interest of the banker as lender.
§
There are circumstances when securities given
to the bank as security to cover the loan, have become void as against income
tax dues/arrears of land revenues. To avoid such an unpleasant situation, the
borrower should be asked to furnish income tax clearance certificate/clearance
from local authorities.
§
There are few other characteristics such as
controllability of an asset as a security and securities having a yield which
will enhance their value etc. which are critically analysed by the bank while
accepting any security. The percentage of margin which is kept by the bank as a cushion for any unforeseen drop in
the value of security is directly linked to various characteristic as discussed
above. Lower margin may be prescribed for those securities which have a stable
value and easy marketability whereas higher margins are prescribed for those
securities where fluctuations are wide. Margin fixed on raw material may be
lower as compared to margin on stocks‑in‑process as the
marketability has been effected in the latter case. The usual margin on
advances against life policies is 10% on surrender value as compared to margin
of 50% on shares. This is explained by the fact that life policies have a
stable value which in fact increases with passage of time whereas share prices
are subject to wide fluctuations.
The fixation of margin may also depend on the credit worthiness of the
borrower and in some cases even Reserve Bank may issue directives to the banks.
Security is obtained by the bank as an additional cover against default
by the borrower in repayment of bank's dues. Charging of security means making
such security available to the bank and involves certain formalities. Charging
should be legal and perfect so that it is possible to realise the security if
such a need arises. There are six different modes of charging a security as
under:
§
Pledge. Pledge is bailment of goods
by the debtor to the creditor with an intention to create a charge thereon as
security for the debt. It has a legal backing as per the Indian Contract Act,
1872 wherein the definition of pledge and bailment and also the rights and
liabilities of all the parties to pledge have been clearly spelt out. Important
conditions to be complied with for constitution of a valid pledge are:
§
There should be bailment of goods which implies
that goods should be delivered the debtor (pledger) to the creditor (pledgee).
The delivery may nevertheless be actual physical delivery or constructive
delivery as in case of documents of title to goods.
§
The bailment must be by the debtor or on behalf
of the debtor.
§
The delivery of goods must be with an intention
of the parties to create security for die debt or performance of a promise.
In pledge the ownership of the goods remain with the borrower whereas
physical control over these goods will be exercised by the bank. The borrower
has a right to get the goods returned to him after payment of debt created here
against.
In case of default by
die borrower the bank can sell the
goods after giving a reasonable notice of sale as required under Section 176 of
the Indian Contract Act,1872. Notice must clearly indicate the intention of the
pledgee to sell the security and is compulsory before the sale can be effected.
If the bank realises more than its dues by such sale, the excess realised will
have to be returned to the borrower. However, if there is any shortfall, die
bank can proceed against the borrower in a court of law for recovery of the
balance.
This mode of charge may be considered as an ideal one for the bank as it
has full control over the security and can even realise it without any legal
process merely by serving a notice on the borrower. The borrower however, is
put to great disadvantage as he losses coned over the goods and the account
involves operational difficulties. Generally the raw material or finished goods
or stock in‑trade etc. not immediately required by the borrower may be
offered to the bank for pledge.
The goods pledged to the bank may sometimes be required by the borrower
for undertaking a small process. The documents of title to goods deposited with
the bank in the pledge account may be required to take delivery from the port/
railway etc. In such situations the bank may temporarily part with the goods on
the borrower signing a 'Trust Receipt'. The possession of goods legally remains
with the bank and the borrower keeps those goods 'in trust' for the bank during
that temporary period. This facility is sometimes given by the bank as a sub‑limit
of pledge account for operational convenience.
§
Hypothecation. Pledge
takes away control over the goods from the borrower which may not be
practicable as the borrower would require certain goods under his control to
continue its manufacturing and/or trading activities.
An equitable charge
in favour of the bank over the goods is created in such cases without parting
with the possession of the goods. A
charge on a property for a debt where neither ownership nor possession is
passed on to the creditor is known as ‘hypothecation charge’ Hypothecation
agreements obtained by banks generally have a clause under which hypothecation
can be converted into a pledge at, a later date.
This form of charge is ideal from the point of view of the borrower as
he is always in control of goods offered as security to die bank. In case of
default by the borrower, the bank may take possession of goods and convert it
to pledge only with the consent of the borrower notwithstanding any clause w
this effect being included in the hypothecation agreement. The bank will have
to move a court of law for taking physical possession of goods or their
attachment before judgement.
Hypothecation charge extends to all the goods and moveable properties
with the borrower as per the agreement of hypothecation and operations in these
accounts are permitted on the basis of stock statement, submitted by the
borrower periodically usually every month. Hypothecation may, however, be created
as a fixed charge over a particular machinery/vehicle etc.
§
Assignment. Assignment means transfer of
a right, property or debt by one person to another person. The person
transferring the right is known as assignor and the person to whom the right is
transferred is known as assignee. The assignment may be legal in which case the
assignor must give a written notice of the assignment stating the name and
address of the assignee to the debtor or may he equitable where no such notice
is sent. This form of charge is generally adopted for charging of book debts,
monies due from Government (supply bills) and life insurance policies etc.
Banks generally go in for legal assignment and insist for obtaining an
acknowledgement of assignment from the debtor.
§
Mortgage. Mortgage is a mode of
charge associated with immovable property. Immovable property has been defined
by Section 3(26) of General Clauses Act, 1887 as under:
Immovable property shall include land, benefits to arise out of land and
things attached to the earth or permanently fastened to anything attached to
the earth".
Section 4 of General Clauses Act, 1887 further provides that the above
definition of immovable property shall hold good under the Transfer of Property
Act, 1882 as well.
Section 3 of Transfer of Property Act, 1882 provides that immovable
property does not include standing timber, growing crops or grass. It also
provides explanation to the term "attached to the earth" which means:
(a) rooted in the earth, as in case of
trees and shrubs,
(b)
imbedded in the earth, as in case of walls or
buildings, or
(c)
attached to what is so imbedded for the
permanent enjoyment of that to which it is attached.
A similar definition of immovable property has been given by Section 2(6)
of the Registration Act, 1908 as under:
Immovable property' includes land, buildings, hereditary allowances, rights to ways, lights, ferries, fisheries or any other benefit to arise out of land and things attached to the earth or permanently fastened to anything which is attached to the earth but not standing timber, growing crops nor grass".
A point in case may arise in respect of machinery. Machinery which is
not permanently attached to the earth and can be shifted to other place will
not be considered as immovable property. But if a machinery is permanently
attached to the earth in, a manner that
it cannot be removed from there, it shall be considered as immovable property.
Section 58 of 'Transfer of Property Act, 1882 defines mortgage’ as a
transfer of an interest in a specific immovable property for the purpose of
securing an existing or future debt. The person transferring the interest is
known as 'mortgagor' and the person to whom the interest is transferred is
known as 'mortgagee'. Indian law recognises six different types of mortgages
out of which the two most acceptable form of mortgages are discussed hereunder
:
§
Mortgage by deposit of title
deeds or equitable mortgage. Section 58(f) of the Transfer of Property Act, 1882 defines equitable mortgage
as mortgage created by depositing title deeds of an immovable property to
secure a debt, existing or future. Three basic conditions to constitute a valid
equitable mortgage are
(i) Delivery of title deeds
(original) by the mortgagor to the bank.
(ii) Existence of a debt,
existing or future.
(iii) Intention of the
mortgagor to create a mortgage on that property to secure the debt.
No equitable mortgage can be created if any of the above three
conditions' is not complied with.
This form of mortgage is very popular because it does not require
finalisation of any mortgage deed and its subsequent registration which
requires payment of heavy stamp duty. Mortgage is created simply by depositing
the title deeds with the bank with an intention to create a security and no
other agreement etc. is strictly required. Equitable mortgage can, however, be
created only at places as notified by government in this regard.
§
Simple Mortgage. Section 58(b) of Transfer
of Property Act, 1882 relates to simple mortgage in which the mortgagor
personally binds himself to pay the debt and agrees that in the event of non‑payment
by him, the mortgager may cause the mortgaged property to be sold and the
proceeds of sale be applied in repayment of debt. The possession of mortgaged
property, however, still remains with the mortgagor. The mortgagee does not
have an absolute right to sell the property in case of default but has to seek
intervention of the court.
A formal mortgage deed will have to be executed for creation of a simple
mortgage which will also be required to be registered after payment of
necessary stamp duty which is quite substantial and in all the cases will have
to be borne by the borrower. All efforts should, therefore, be made to convince
the bank to accept equitable mortgage. Simple mortgage may be resorted to only
when equitable mortgage cannot be created as in cases where title deeds are not
available,
In all forms of mortgages the mortgagor has a right of redemption on payment
of the debt after it has become due. The mortgagor also has a right to inspect
the documents of title to goods and make copies of or extracts from the title
deeds which are in the custody of the bank.
§
Lien. Lien means the right of the
creditor to retain the goods or securities of the debtor, which are in his
possession until the debt due from the debtor is paid. It does not require any
specific agreement to support this right. The lien may be general which confers
the right to retain any goods for a general balance of account or it may be
particular lien where goods can be retained by the creditor for a particular
debt only. The person exercising general lien has only a right to retain the
goods till the dues are paid and may not be able to sell those goods.
The right of the banks to general lien is however, considered on a
different footing and banks have a general lien on all securities deposited
with them as bankers by a customer, unless there be an express contract or
circumstances that show an implied contract, inconsistent with lien. A banker’s
lien is thus more than a general lien, it is an implied pledge. The bank,
therefore, has a right to sell the goods in his possession after giving a
reasonable notice. The lien can be exercised on bills and cheque deposited for
collection, dividend warrants received by the banker as a mandatee from the
customer, securities left with the banker after a particular loan has been
paid. The bankers lien however, does not extend to:
(i) Securities or
valuables lying in the locker rented to the customer.
(ii) Securities deposited
upon a particular trust.
(iii) Securities deposited
to secure a specific loan.
(iv) Securities left with the
banks after an advance against them has been adjusted.
(v) Securities left
inadvertently with the bank.
No specific letter of lien agreement is necessary as the banks enjoy the
right of lien under the Contract Act. However, in some cases the bank may
obtain a specific letter of lien so that the borrower is not able to contend later
that the securities were deposited by him for a specific purpose inconsistent
with the lien.
The borrower may sometime be having non‑encumbered assets which
are not charged to the bank as security. The borrower is thus free to deal with
these assets and may even sell them if he so desires. To restrict this right of
the borrower, bank may sometimes request him to give an undertaking to the
effect that he will neither create any encumbrance on these assets nor sell
them without the previous permission of the bank so long as the advance
continues. This type of an undertaking obtained by the bank is known as
'Negative Lien'. Negative lien is in the form of a personal assurance or
undertaking which has binding effect but confers no right on the bank to
proceed against the property itself and thus creates no encumbrance or charge
on the property.
§
Set Off. Set off is the right of
combining of accounts between a debtor and a creditor so as to arrive at a net
balance payable to one or the other. Set off in relation to bank means his
right to apply the credit balance in customer's account towards liquidation of
debit balance in another account of the customer provided both the accounts are
maintained by him in the same capacity. The right may not be considered as
absolute and the bank may be required to give a notice for exercising his right
of set off. The right of set off can be applied by the bank only if the
following conditions are met:
(a) The liability of the
borrower is for a sum which is certain,
(b) The repayment of debt is
due, and
(c) Both the accounts are
held by the customer in the same capacity.
The right of set off should, however, not be exercised arbitrarily and a
notice for combining the accounts must invariably be served by the bank on the
customer.
Banks generally grant advance to persons having legal capacity to enter
into a contract. Minors/lunatics/drunken persons etc. who cannot enter into a
valid contract may not be favoured as borrowers and no credit facilities may be
sanctioned to such persons.
The borrowers may have different constitution conferring on themselves
various legal rights and responsibilities and banks as creditors will be
interested to know the exact constitution of the borrower. Banks may also
require additional undertakings information in some cases. This information is
very essential for the banks while getting the documents executed from the
borrowers. The documents can be executed only by the persons who can validly
bind the borrower. The position regarding obtaining of undertaking/information
may differ from bank to bank. Chart given on the next page gives details of
various types of borrowers, the additional undertakings required by banks and
the persons who are authorised to execute the documents which is based upon the
common practice of most of the banks.
|
S.NO. Constitution
of Additional papers
required Persons
authorised to execute the document Borrower |
||
|
1. Individual |
---- |
Individual in his personal capacity |
|
2. Joint |
---- |
All the borrowers in their personal capacity
binding themselves jointly and severally. |
|
3. Sole
Proprietorship |
Declaration regarding his sole interest in the business. |
Sole proprietor in his capacity as sole
proprietor. He is, however, personally liable for all the dealings and
obligations in the name of business. |
|
4. Joint
Hindu Family |
1. Letter of Joint Hindu Family giving details of all the male members including minors 2. Declaration to the effect
that the advances will be utilised only for the family business
to be signed by Karta & all other major coparceners. |
All documents to be signed by Karta of HUF
and all major coparceners in their capacity as Karta & coparceners and
also in their individual capacity.
|
|
5. Trusts |
1. Copy of trust deed. 2. Legal opinion regarding the power of trustee to borrow. |
All the trustees in their representative capacity or as per trust deed and supported by the legal opinion. |
|
|
||
|
6. Partnership
firm |
1. Copy of partnership deed. 2. Declaration from all partners to inform the bank of any change in constitution. |
All partners in their representative capacity
i.e. as partner and also in their individual capacity. |
|
7. Limited
Companies |
1. Articles and Memorandum Association 2. Copy of Certificate of
incorporation. 3.Copy of Certificate of commencement of business (only in case of public limited companies) 4.Copy of Board Resolution empowering the company to borrow from the
bank and also authorising managing director/ directors/other officers to execute the documents as
required by the bank. 5.Copy of the resolution of general body meeting of the company under
Section 293 (1) (D) authorising the company to borrow in excess of its own
paid up capital and free reserve. 6.Declaration from the company that borrowings will remain within the
powers conferred on it as in (5) above |
Documents to be signed by authorised persons
in terms of board resolution in their representative capacity. The common
seal of die company is also required to be affixed wherever necessary. The charge created by the company over its
assets will also require registration under Section 125 of Companies Act,
1956. |
Banks have their own standard forms for promissory notes and other
documents and no deviations are normally permitted. The borrowers are expected
to execute these documents as required by the bank. Banks also do not generally
give copies of these documents to the borrower which sometimes creates
difficulty when these documents become subject matter of a legal dispute. The
following points must be kept in mind while executing the documents as required
by the Bank.
The following are the precautions, in nutshell, which should be taken
care of both by the borrower as well as banker, at the time of preparation,
execution and registration of loan documents etc.:
(a) Person,
executing the loan documents must be competent to enter into a contract i.e.,
he or she should have contractual capacity. Thus, minor, insolvent person,
lunatic etc. are not competent persons to execute documents.
(b) The
loan documents should bear proper type of stamps i.e. adhesive, embossed etc.
Further value of stamp duty should be adequate, keeping in view the laws of the
State in which the documents are executed. The Non‑Judicial Stamp papers,
if used, should bear the date, prior to its execution and also the date should
not be earlier than six months. The text of the agreement may be written on the
Stamp papers itself and plain papers (additional sheets) may be used, if
required in addition to Stamp papers.
(c) No
column of the loan documents should be left blank. While executing the
documents, the borrower must sign in full and in the same flow in which his
signatures are available in the bank. The cuttings & over writings must be
avoided and if at all, they become unavoidable, they should be authenticated by
the borrowers by signing in full.
(d) Sometimes
the borrower does not understand the language of the loan documents. In such a
case, a separate letter, in the language of the borrower should he taken from
him stating that the contents of the loan documents have been well understood
by him, including the terms and conditions of the loan sanctioned. The letter
should be got witnessed by another person.
(e) In the
case of an illiterate borrower who puts his thumb impression on the loan
documents, the bank official in whose presence the documents are executed,
should give a certificate on a separate paper that the contents have been fully
explained to the borrower in a language which he speaks and understands. This
certificate should be got witnessed by independent persons.
(f) Similarly,
in case of a blind person, such a certificate should be obtained from lawyer or
notary public in whose presence the borrower executes documents.
(g) In
case the borrowers reside at different places, the loan documents should he got
executed through the branches of the bank situated at those stations, after
properly verifying the identity of the borrowers. As
regards stamp duty, it should be according to the state which attracts
highest value of stamp duty. The borrowers while signing the documents must put
date and place of execution after their signatures.
(h) In the
case of a partnership firm where a minor is admitted as partner to the benefits
of partnership, he should not be allowed to execute any loan document. This is
so because a creditor i.e. lending banker cannot proceed against the minor in person.
However, minor's share in the firm can be proceeded against, as the major
partners of the firm have executed loan documents, thereby binding each other
by their act of execution. After the minor attains majority and elects to
remain as partner in the firm, the bank should proceed to obtain an undertaking
from him stating that he (minor attaining majority) stands fully liable for the
dues of the bank against the partnership firm.
(i) Sometimes
loan documents are executed by the holder of power of Attorney on behalf of a
trading concern, partnership firm, Hindu undivided family (HUF), company,
individual etc. In such a case, a notice should be sent to the principal,
stating that the attorney has executed the documents on their behalf. A
certified copy of Power of Attorney should be kept along with main loan
documents. And also the letter/confirmation received from the principal in this
regard, in response to the notice should be preserved.
(j) The borrowers must
obtain a copy of the sanction and ensure that documents only for those
facilities which are sanctioned in their favour are executed.
(k)
All the documents must be completely filled in
before their execution.
(l)
The guarantee form should be executed if so
agreed and stipulated as a term of sanction.
(m) Copies of all the documents executed
must be obtained and kept on record for any future reference.