Borrower’s Concise Guide to Bank Loan

(1) Why security insisted?

The bank will look at:

·         Cash flow to meet the operating expenses, debt servicing and other liabilities.

·         The security likely to be created on movable and immovable assets.

Security is taken generally to make certain that bank is able to secure repayment of loan when operations collapse. However, security may also be taken to prevent third parties to deal with the assets. Generally, hypothecation of movable property, mortgage on immovable property, pledge of shares, assignment of receivables and assignment of insurance policies are required to be created in favour of bank. 

(2) Mortgage, Charge, Pledge and Hypothecation

(i)Mortgage

Section 58 of the Transfer of Property Act, 1882 (‘TP Act’) defines a mortgage and other related terms.

58. “Mortgage”,  “mortgagor”,  “mortgagee”,  “mortgage-money” and “mortgage-deed”  defined.—(a) A mortgage is the transfer of an interest in specific immoveable property for the purpose of securing the payment of money advanced or to be advanced by way of loan, an existing or future debt, or the performance of an engagement which may give rise to a pecuniary liability.

The transferor is called a mortgagor, the transferee a mortgagee; the principal money and interest of which payment is secured for the time being are called the mortgage-money, and the instrument (if any) by which the transfer is effected is called a mortgage-deed.”

(b) Simple mortgage.—Where, without delivering possession of the mortgaged property, the mortgagor binds himself personally to pay the mortgage-money, and agrees, expressly or impliedly, that, in the event of his failing to pay according to his contract, the mortgagee shall have a right to cause the mortgaged property to be sold and the proceeds of sale to be applied, so far as may be necessary, in payment of the mortgage-money, the transaction is called a simple mortgage and the mortgagee a simple mortgagee.

(c) Mortgage by conditional sale.—Where, the mortgagor ostensibly sells the mortgaged property—

on condition that on default of payment of the mortgage-money on a certain date the sale shall become absolute, or

on condition that on such payment being made the sale shall become void, or

on condition that on such payment being made the buyer shall transfer the property to the seller,

the transaction is called mortgage by conditional sale and the mortgagee a mortgagee by conditional sale:

Provided that no such transaction shall be deemed to be a mortgage, unless the condition is embodied in the document which effects or purports to effect the sale.

(d) Usufructuary mortgage.—Where the mortgagor delivers possession 1[or expressly or by implication binds himself to deliver possession] of the mortgaged property to the mortgagee, and authorises him to retain such possession until payment of the mortgage-money, and to receive the rents and profits  accruing  from the property 2[or any part of such rents and profits and to appropriate the same] in lieu of interest, or in payment of the mortgage-money, or partly in lieu of interest 3[or] partly in payment of the mortgage-money, the transaction is called an usufructuary mortgage and the mortgagee an usufructuary mortgagee.

(e) English mortgage.—Where the mortgagor binds himself to repay the mortgage-money on a certain date, and transfers the mortgaged property absolutely to the mortgagee, but subject to a proviso that he will re-transfer it to the mortgagor upon payment of the mortgage-money as agreed, the transaction is called an English mortgage.

(f) Mortgage by deposit of title-deeds.—Where a person in any of the following towns, namely, the towns of Calcutta, Madras, and Bombay, and in any other town which the State Government concerned may, by notification in the Official Gazette, specify in this behalf, delivers to a creditor or his agent documents of title to immoveable property, with intent to create a security thereon, the transaction is called a mortgage by deposit of title-deeds.

(g) Anomalous mortgage.—A mortgage which is not a simple mortgage, a mortgage by conditional sale, an usufructuary mortgage, an English mortgage or a mortgage by deposit of title-deeds within the meaning of this section is called an anomalous mortgage.]

Where the principal money secured is one hundred rupees or upwards, a mortgage, other than a mortgage by deposit of title deeds, can be effected only by a registered instrument signed by the mortgagor and attested by at least two witnesses (s. 59).

The ingredients of a ‘mortgage’ are as follows-

(i) the transfer of an interest

(ii) in specific immoveable property

(iii) for the purpose of securing-

(a) the payment of money advanced or to be advanced by way of loan, or

(b) an existing or future debt, or

(c) the performance of an engagement which may give rise to a pecuniary liability.

The transfer of an interest in specific immoveable property must, be for one of the purposes mentioned in (iii) above.

Transfer of an ‘interest’

All the rights of ownership pass from the transferor to the transferee in a sale (s. 54). In a mortgage, out of the collection of rights which comprise ownership, some are transferred to the mortgagee and some remain with the mortgagor called the right of redemption. The right of redemption is a right to resume what the mortgagor has given away. The right of redemption can not be restrained by any condition in the mortgage-deed.

Mortgagee’s right to sue to recover mortgage-money

Remedies against the mortgaged property are provided in section 67. A personal remedy against the mortgagor and the situation when a suit to recover mortgage-money can be filed are provided in section 68. (Source: Conveyancing, Precedents & Forms by Shiv Gopal Sixth Ed. 2004 Pp 294 to 296)

(ii) Charge

When immovable property is made security for the repayment of money a charge is created. Any part of interest in property is not transferred. The provisions of TP Act applicable to a simple mortgage are applicable to a charge (s. 100; reproduced below)

100. Charges.—Where immoveable property of one person is by act of parties or operation of law made security for the payment of money to another, and the transaction does not amount to a mortgage, the latter person is said to have a charge on the property; and all the provisions hereinbefore contained which apply to a simple mortgage shall, so far as may be, apply to such charge.

Nothing in this section applies to the charge of a trustee on the trust-property for expenses properly incurred in the execution of his trust, and, save as otherwise expressly provided by any law for the time being in force, no charge shall be enforced against any property in the hands of a person to whom such property has been transferred for consideration and without notice of the charge.

(iii) Difference between Mortgage and Charge

In the case of a charge, there is no transfer of any interest in property, but only the creation of right of payment out of the sale of the specified property. On the other hand, a mortgage effectuates transfer of a part of interest in property [see J.K. (Bombay) (P.) Ltd vs New Kaiser-i-Hind Spg. & Wvg. Co., AIR 1970 SC 1041] (Source: Conveyancing, Precedents & Forms by Shiv Gopal Sixth Ed. 2004 Pp 294 to 296)

(iv) Pledge

Pledge means delivery of goods by the Debtor to the Creditor under a contract to secure a debt or performance of a promise. Section 172 of the Indian Contract Act, 1872 has defined pledge as follows.

172. ‘Pledge’, ‘pawnor’ and ‘pawnee’ defined.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’.

The ingredients of a ‘pledge’ are as follows-

(i) The ownership of goods remains with the Debtor.

(ii) The possession of goods may be actual or constructive with the Creditor.

(iii) On default in repayment of loan, the Creditor can take actual possession and sell the goods without intervention of Court subject to serving prior notice to the Debtor giving sufficient time to repay the loan.

(Source: Conveyancing, Precedents & Forms by Shiv Gopal Sixth Ed. 2004 Pp 294 to 296)

(v) Hypothecation

The following definition of the term “hypothecation” in P. Ramanatha Aiyar’s Advanced Law Lexicon (3rd Edition (2005) Vol.2 pp. 2179 and 2180 ) is relevant:

“Hypothecation- It is the act of pledging an asset as security for borrowing, without parting with its possession or ownership. The borrowers enters into an agreement with the lender to hand over the possession of the hypothecated assets whenever called upon to do so.  The charge of hypothecation is then converted into that of a pledge and the lender enjoys the rights of a pledgee.

Section 2(n) of Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 has defined hypothecation as follows.

“Hypothecation” means 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 of such charge into fixed charge on movable property.”

                        In other words, hypothecation is a mode of creating a security without delivery of title or possession. Both, ownership of the movable property and  possession thereof, remain with the debtor. The creditor has an equitable charge over the property and is given a right to take possession and sell the hypothecated movables to recover his dues. The creditor may also have the right to claim payment from the sale proceeds. {Indian Oil Corporation Vs. NEPC India Ltd. & Ors ( 2006 ) 6 SCC 736}

(vi) Difference between Hypothecation and Pledge

            (i) In case of pledge, there is an actual or constructive delivery of possession of goods to the pledgee; in hypothecation the goods need not be delivered.

            (ii) A pledgee can himself sell the goods pledged, after giving the pledger a reasonable notice; but a hypothecatee can not sell the goods without a court decree.  

 

(3) Recovery proceedings that bank can undertake

Now a days the Banks/Financial Institutions (for short “Bank”) are required to initiate Recovery Proceedings either under the:

(1) Recovery through Civil Court of competent jurisdiction, or

(2) Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (for short “DRT Act”) before the Debts Recovery Tribunal (‘DRT’) having jurisdiction, or

(3) Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (for short “Securitisation Act”).

(i)Civil Court

            (1) Recovery through Civil Court is done either by filing money suit under Order 37 (Summary Procedure) or mortgage suit under Order 34 (Mortgage of immovable property) of the Civil Procedure Code, 1908 (‘CPC’).

(2) Plaint is to be supported by statement of account, bank will make an averment in the plaint that interest/compound interest has been charged at such rates, and capitalized at such periodical rests, as are permitted by, and do not run counter to, the directives of Reserve Bank of India (‘RBI’). The Court can act on assumption that transactions or dealings have taken place and accounts maintained by bank in conformity with RBI directives. [Central Bank of India Vs Ravindra and Ors. {2001 AIR 3095, 2002(1) SCC 367, 2001(7) SCALE 351, 2001(9) JT 101; Date of Judgment: 18/10/2001].

(3) The borrower, in his defence, is required to file a written statement (‘WS’) within 30 days from the date of service of summons {Order 8 Rule 1, CPC}.

(4) The borrower is entitled to plead and give particulars of set off {Order 8 Rule 6, CPC}, and also to file a Counter Claim against the Bank for violation of RBI Guidelines and any other wrongdoings done by the Bank {Order 8 Rule 6A, CPC}.RBI directives have not only statutory flavour, any contravention thereof or any default in compliance therewith is punishable under sub-section (4) of Section 46 of Banking Regulation Act, 1949 [Central Bank of India Vs Ravindra and Ors. (supra)]

(5) Therefore, it is important that all correspondence in writing with Bank should be made meticulously and preserved by the borrower in safe custody.

(6) It is to be noted that trial of suit and Counter Claim should be fought sincerely and vigilantly under expert advice, as the borrower would get full opportunity of defending his case, which is substantially cut short at appellate stage.

(7) In case the borrower is not satisfied with any decree or order of Court, he can file an appeal to higher courts as provided in CPC within the period prescribed in Article 116 and 117 of the Limitation Act, 1963.

(ii)DRT Act, 1993

(1) Pursuant to section 1(4) in case the amount is Rs. Ten lacs or more the Bank needs to file an Original Application (‘OA’) under section 19 of the DRT Act before the DRT having jurisdiction within the limitation as per the Limitation Act, 1963 (s.24).

(2) The borrower, in his defence, is required to file a written statement (‘WS’) within 30 days from the date of service of summons by DRT {s. 19(5)}.

(3) The borrower is entitled to file a Counter Claim against the Bank for violation of RBI Guidelines and any other wrongdoings done by the Bank {s. 19(8)}. RBI directives have not only statutory flavour, any contravention thereof or any default in compliance therewith is punishable under sub-section (4) of Section 46 of Banking Regulation Act, 1949 [Central Bank of India Vs Ravindra and Ors. (supra)].

(4) Therefore, it is important that all correspondence in writing with Bank should be made meticulously and preserved by the borrower in safe custody.

(5) It is to be noted that trial of OA and Counter Claim at DRT should be fought sincerely and vigilantly under expert advice, as the borrower would get full opportunity of defending his case, which is substantially cut short at appellate stage.

(6) In case the borrower is not satisfied with the order of DRT, he can file an appeal to DRAT (‘Debts Recovery Appellate Tribunal’) within 45 days of receipt of order of DRT (s.20).

(iii)Securitisation Act, 2002

(1) Pursuant to section 31(h) in case the borrower makes a default in repayment of secured debt and the amount exceeds Rs. One lac the Bank can invoke section 13(4) of Securitisation Act within the limitation as per the Limitation Act, 1963 (s.36).

(2) In case the borrower makes a default in repayment of secured debt for a continuous period of ninety days his account shall be classified as Non Performing Asset (‘NPA’) by the Bank {s. 13(2)}.

(3) The bank shall issue a notice of sixty days to the borrower to discharge his liability in full to the Bank {s. 13(2)}.

(4) The notice shall give details of the amount payable and the secured assets intended to be enforced by the bank in the event of non payment of secured debt {s. 13(3)}.

(5) On receipt of notice the borrower is entitled to make a Representation and raise objections regarding his alleged liability within 60 days after receipt of notice {s. 13(3-A)}.

(6) Such Representation should be prepared under expert advice for incorporating a Claim for loss and damages under the Law of Torts against the Bank for violation of RBI Guidelines and any other wrongdoings done by the Bank.

(7) The Bank is bound to consider such Representation and shall communicate the reasons for non-acceptance within 15 days of its receipt to the borrower {s. 13(3-A)}.

            (8) After the expiry of 60 days the bank can take possession of the secured assets of the borrower including the right to transfer by way of lease, assignment or sale for realising the secured asset {s. 13(4)(a)}.

            (9) However, if possession is not given voluntarily by the borrower, the Bank is not entitled to use force and is bound to follow the procedure given u/s 14 {M/S.Clarity Gold Pvt.Ltd vs State Bank Of India (AIR 2011 Bom 42), Bom HC (DB) judgment dated 20.01.2011}

            (10) Where the possession is not given voluntarily by the borrower, as per s. 14 the Bank may request in writing to the Chief Metropolitan Magistrate (‘CMM’) accompanied by an affidavit of the Authorised Officer of the Bank in the prescribed format (under first proviso to s.14), then CMM shall--

(a) take possession of such asset and documents relating thereto; and

                        (b) forward such assets and documents to the secured creditor.

(11) The borrower should present his case before CMM and make a Representation highlighting the misstatements in the affidavit {under clause (ii) of first proviso to s.14 (1)}—

(12) Such Representation should be prepared under expert advice by highlighting the misstatements in the affidavit, as well as incorporating a Claim for loss and damages against the Bank for violation of RBI Guidelines and any other wrongdoings done by the Bank. 

            (13) Aggrieved by the order of CMM authorising taking possession of the secured assets, the borrower is entitled to file appeal to DRT within 45 days from date of order {SC judgment dated 07.02.2011 in Kanaiyalal Lalchand Sachdev & Ors. Vs. State of Maharashtra & Ors.(2011) 2 SCC 782}.

(14) Appeal to DRT against order of CMM should be prepared under expert advice for incorporating a Claim for loss and damages under the Law of Torts against the Bank for violation of RBI Guidelines and any other wrongdoings done by the Bank.

            (15) Aggrieved by the action of the bank for taking possession of the secured assets, including the steps to transfer by way of sale, the borrower is entitled to file appeal to DRT within 45 days after receipt of notice thereof {s. 17(1)}.

(16) Securitisation Appeal to DRT (including an application for grant of stay order against Bank) should be prepared under expert advice for incorporating a Claim for loss and damages under the Law of Torts against the Bank for violation of RBI Guidelines and any other wrongdoings done by the Bank.

(17) Therefore, it is important that all correspondence in writing with Bank should be made meticulously and preserved by the borrower in safe custody.

(18) It is to be noted that trial of Securitisation Appeal at DRT should be fought sincerely and vigilantly under expert advice, as the borrower would get full opportunity of defending his case, which is substantially cut short at appellate stage.

(19) In case the borrower is not satisfied with the order of DRT, he can file an appeal to DRAT (‘Debts Recovery Appellate Tribunal’) within 30 days of receipt of order of DRT (s.18).

 

Compiled & Authored by:

Narendra Sharma

Consultant (Business Laws)

(Mobile-9229574214),

E-mail: nkdewas@yahoo.co.in

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