This article is written by Komal Mittal pursuing a Diploma in Advanced Contract Drafting, Negotiation, and Dispute Resolution from Lawsikho.
Have you ever got confused with the terms like hypothecation, pledge and mortgage? This article is an attempt to make the difference between these terms clear and to understand the important aspects of the hypothecation deed. The concept of hypothecation in India is regulated by The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002.
What is a hypothecation deed?
To understand the concept of hypothecation, it is important to understand the meaning of these two terms. The term Hypothecation is defined under Section 2 which simply means a charge on the movable property which is created by the borrower in the favour of the creditor as a security to get financial assistance from the creditor. For example; Karan wants to get a loan from the bank and in order to secure that loan, he keeps his car as a security deposit with the bank and the terms are such that the possession of the car will still be with Karan, so it becomes a case of hypothecation.
A deed is a signed and usually sealed instrument containing some contract, legal transfer or bargain. The deed is generally one-sided. So, a hypothecation deed is an instrument that covers the details of hypothecation.
The parties in a hypothecation deed
Who creates the charge in favour of the lender. The borrower is the person or entity which gets financial assistance from the lender.
When is a hypothecation deed needed?
Whenever a charge on the movable property needs to be made in such a way that even after the creation of such a charge, the movable property remains in possession of the borrower then, in that case, the parties need a hypothecation deed. For example; if a person wants to get a loan of INR 3lakhs from the bank and don’t have any immovable property or don’t want to keep his immovable property as a security for the loan amount with the bank, in that case, he can create a charge on his movable property like a vehicle, machinery, furniture, etc.
How is hypothecation different from mortgage and pledge?
The concept of hypothecation is usually confused with mortgage and pledge. But, in reality, these three terms deal with three different situations. A comparison is drawn below in order to make the difference of hypothecation with these 2 concepts clear.
Difference between hypothecation and mortgage
The concept of hypothecation is governed by The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 in India. The concept of a mortgage is governed by The Transfer of Property Act,1882 in India.
The term hypothecation is defined under Section 2(n) of The Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002 which simply means a charge on the movable property which is created by the borrower in the favour of the creditor as a security to get financial assistance from the creditor.
In case of hypothecation, the parties involved are called the lender and the borrower. In a mortgage, the parties involved are known as the mortgagor(transferor) and the mortgagee(transferee).
The hypothecation is related to movable property whereas mortgage is generally related to immovable property.
The instrument by which the hypothecation takes effect is called the hypothecation deed of the hypothecation agreement and in the case of a mortgage, it is called the mortgage deed or mortgage agreement.
In case of hypothecation, the lender has the ownership rights of the property. Whereas, in the case of a mortgage, ownership remains with the mortgagor.
In case of hypothecation, the possession is with the borrower. Whereas, in the case of a mortgage, it depends on the kind of mortgage.
Amount of loan
In the case of hypothecation, the amount of loan secured by the borrower by hypothecating the movable property is generally less than the amount of loan secured by the mortgagor, as the mortgage is against the immovable property.
The time period for which the security is hypothecated is generally less than the time for which immovable properties are mortgaged.
Difference between hypothecation and pledge
The concept of hypothecation is governed by The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 in India. The concept of a pledge is governed by The Indian Contract Act,1872 in India.
The term hypothecation is defined under Section 2(n) of The Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002. The term pledge is defined under Section 172 of the Indian Contract Act,1872 which means bailment of goods like gold as a security for the performance of a promise or for payment of a debt.
In case of hypothecation, the parties involved are called the lender and the borrower. In pledge, the parties involved are known as the pawnor(bailor) and the pawnee(bailee).
Possession of security
In case of hypothecation, the possession of security remains with the borrower. Whereas, in the case of a pledge, the possession of security gets transferred from the pawnor to the pawnee. In the case of Chief Controlling Revenue … vs Sudarsanam Picture, Madras, the film producer took a loan and agreed to deliver the final prints of the film when they are ready. The court in this held that it was pledge as the possession of the property was not transferred at the time of the agreement.
The instrument by which the hypothecation takes effect is called the hypothecation deed of the hypothecation agreement and in the case of pledge, it is called the Contract of pledge or pledge agreement.
The scope of a pledge is wider than the hypothecation as hypothecation is the species of the pledge. When the borrower does not pay the dues to the lender as per the hypothecation deed, the charge of hypothecation is then converted into that of a pledge, and the lender then enjoys the rights of a pawnee.
Some essential clauses of hypothecation deed
Grant of loan
This clause generally mentions that a loan is being granted along with some other details like:
- The rate of interest;
- When does it need to be repaid (repayment date);
- Repayment conditions (if there exists any such condition).
This clause contains the list of securities (movable property) to be hypothecated by the borrower to the lender. It also contains some negative covenants and positive covenants.
Example of negative covenants; the borrower shall not create any charge/ interest other than the charge created as per this deed on the securities. Examples of positive covenants:
- The borrower shall repay the loan amount along with interest agreed;
- The borrower shall be responsible for the maintenance of the securities and to get the securities insured.
Title and ownership
This clause should specify which party will have title and ownership rights over the movable property. For example; the title and ownership of the property will remain with the lender and the borrower will have the right of possession of the property and the borrower can use the property as per this deed.
This clause provides for the details related to the insurance of the property. This clause generally answers questions such as:
- Which party will be responsible to get the security ensured?
- Which type of insurance needs to be done?
- Does the party who is getting the insurance of securities done need to get it endorsed in favour of another party?
Points to keep in mind while drafting or entering into a transaction involving hypothecation deed
- The lender is advised to take the assistance of judicial and police authorities while taking possession of the property from the borrower in the case of default by the borrower.
- If the movable property can be insured, in that case, an obligation can be imposed on the borrower to get it insured and to get it endorsed in favour of the lender.
Hypothecation should be considered to be a surety against a movable property where the possession of the property does not change due to hypothecation. While securing a loan, first of all, the party must understand the nature of the transaction, whether it is hypothecation, pledge or mortgage. In the case of a hypothecation deed, all the above-mentioned points must be considered and the borrower must go through it properly as the hypothecation deed may contain some conditions which might not be acceptable to the borrower.
Students of Lawsikho courses regularly produce writing assignments and work on practical exercises as a part of their coursework and develop themselves in real-life practical skills.
LawSikho has created a telegram group for exchanging legal knowledge, referrals, and various opportunities. You can click on this link and join: