Hypothecation And Safeguards By Banks
Hypothecation is the most famous method adopted by banks in India for security creation. This method is adopted while extending cash credits for raising working capital and term loans for acquiring movable assets. Hypothecation as a method of security creation for debts is not defined either in the Indian Contract Act or Transfer of Property Act. Hypothecation is considered as an extended idea of pledge.
What constitute a hypothecation?
Pledge as a security is a special form of bailment where the ownership is retained with the pledgor while the possession is passed on to the pledgee. In pledge, a voluntary transfer of possession, actual or constructive, happens from pledgor to pledgee. In hypothecation, the creditor (bank) permits the debtor (borrower) to retain possession either on behalf of or in trust of the creditor. Here, the debtor has the freedom to use the goods in his possession subject to the right of the creditor.
Right or security interest on the assets or goods in the possession of debtor is created by banks through execution of documents and creates a floating or equitable charge. Hypothecation can be considered as a ‘mortgage of movables’. The best way of defining hypothecation is as a charge against a movable property for an amount of debt where neither ownership or possession is passed to the creditor.
The right on the security created by hypothecation can be exercised by banks by approaching courts. In a working loan or term loan extended against hypothecation, the assets acquired by utilizing the debt/ loan becomes the primary security. Since an unscrupulous borrower can dispose of such a movable asset without intimating bank by violating the terms and conditions of the sanction, bank as a precaution demands collateral security by way of mortgages, assignments or pledge. This is in addition to primary security.
What are the precautions that banks take while extending advance/ loans against hypothecation?
1. When loans and advances are granted against hypothecation of goods as only security, banks ensure that the individual or persons behind the firm/ company are of undoubted integrity. Further, they insist on collateral security by way of mortgages, assignments or pledge.
2. Before and after granting advance/ loans banks ensures the following:
a. The borrower, individual, form or company is not enjoying similar credit facility against same security from anywhere else. This is done by verifying CIBIL, CRILC and CERSAI data bases. PCR will be an added weapon for banks. On sanctioning a loan, details are registered with CERSAI and Registrar of Companies or ROC (for companies).
b. They normally insist that loans/ advance shall be only from a single bank or with written consent from the existing bank. This is ascertained by verifying audited balance sheets.
c. Bank ensures that hypothecation boards mentioning the name of the bank are displayed in godowns / factory.
d. Withdrawals in the account are regulated based on the value of stock mentioned in the stock statement submitted by the borrower.
e. Banks conduct periodical inspection to ensure that sufficient stock is maintained. It also ascertains the accuracy of details furnished in the stock statements.
f. Banks monitor transactions in the working capital limits and ensure that the debits in the accounts are only for effecting payments to suppliers. When term loans are disbursed, the payments are made directly to the supplier.
g. The turnover in the account is compared with the projections submitted and also that furnished in the audited balance sheet.
h. Banks insist on taking insurance for the assets for mitigating risks that may arise from natural calamities.
Remedies available to banks in case of default by a borrower under Hypothecation advance
The major three remedies available to banks in case of default in advances secured by hypothecation are
a. Proceeding with court cases or approaching Debt Recovery Tribunals (DRT). Banks can approach DRTs for fast actions for credit limits of rupees ten lakhs and above.
b. Proceeding under SARFAESI Act
c. Initiating actions under Insolvency and Bankruptcy Code (IBC)
