CHARGING OF SECURITIES

AND DOCUMENTATION

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.
!he securities may primarily be divided in two categories as under

"rimary security.
#ollateral security.

!he 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. !he 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. #ollateral 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.$bip 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. %&'''. In other cases it is left to the
mutual agreement of the borrower with the bank.

BASIC CHARACTERISTICS OF SECURITIES AND CONCEPT OF MARGIN

!he securities acceptable to banks either as primary or collateral must have certain basic
characteristics as under(

Ascertainment of vale! ) 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. #ertain articles may be valuable but may not be accepted as
security if the value cannot be ascertained such as paintings*antiques etc.
Mar"eta#ilit$. ) good security must have a ready market. Raw materials articles of
necessity other primary commodities are easily marketable and are considered good
security. Semi+finished goods may be more valuable than raw material for the borrower
but may not be marketable at all and will thus be considered inferior to raw material in as
much as its acceptance as a security is concerned.
Sta#ilit$ in vale! ) 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 an% transfera#ilit$! )n asset can be accepted as security by the
bank only when the title over that asset can be ascertained. ,urthermore the title should
be easily transferable. !he purpose of obtaining a security is to apply the sale proceeds of
the security if the customer fails to repay the advance. But if the security is not easily
transferable the very purpose of obtaining a security may be defeated. Immovable
property located at a prime location may be very stable in value has a ready market and
the value can also be ascertained but may still not be considered as a good security due to
difficulty in ascertaining the title and elaborate legal process involved for effecting its
sale through a court of law.
Dra#ilit$! !he security accepted by the Bank must be durable. -o bank advance is
granted against perishable commodities.
In case loan or advances to .uslims 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 .uslim /aw like 'waqf+ul+ulad' and*or '0aq+rnehr' in
favour of their wives or for the benefit of their heirs since it will 1eopardise the interest of
the banker as lender.
!here 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. !o avoid such an
unpleasant situation the borrower should be asked to furnish income tax clearance
certificate*clearance from local authorities.
!here 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. !he 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. /ower 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. .argin 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. !he usual margin on advances against life policies is $'2 on
surrender value as compared to margin of &'2 on shares. !his is explained by the fact
that life policies have a stable value which in fact increases with passage of time whereas
share prices are sub1ect to wide fluctuations.
!he 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.

T&PES OF CHARGES

Security is obtained by the bank as an additional cover against default by the borrower in
repayment of bank's dues. #harging of security means making such security available to the bank
and involves certain formalities. #harging should be legal and perfect so that it is possible to
realise the security if such a need arises. !here are six different modes of charging a security as
under(

Ple%'e! "ledge 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
#ontract )ct $34% 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(
!here should be bailment of goods which implies that goods should be delivered the
debtor 5pledger6 to the creditor 5pledgee6. !he delivery may nevertheless be actual
physical delivery or constructive delivery as in case of documents of title to goods.
!he bailment must be by the debtor or on behalf of the debtor.
!he 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. !he 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 $47 of the Indian #ontract )ct$34%. -otice 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. 0owever if there is any shortfall die bank can proceed against the borrower in a
court of law for recovery of the balance.

!his 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. !he borrower however is put to great disadvantage as he losses coned over the goods
and the account involves operational difficulties. 8enerally 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.

!he goods pledged to the bank may sometimes be required by the borrower for undertaking a
small process. !he 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 '!rust Receipt'. !he possession of
goods legally remains with the bank and the borrower keeps those goods 'in trust' for the bank
during that temporary period. !his facility is sometimes given by the bank as a sub+limit of
pledge account for operational convenience.

H$(ot)ecation! "ledge 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.
)n equitable charge in favour of the bank over the goods is created in such cases without
parting with the possession of the goods. ) charge on a property for a debt where neither
ownership nor possession is passed on to the creditor is known as 9hypothecation charge:
0ypothecation agreements obtained by banks generally have a clause under which
hypothecation can be converted into a pledge at a later date.

!his 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. !he bank will have to move a court of law for taking physical possession of
goods or their attachment before 1udgement.

0ypothecation 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.
0ypothecation may however be created as a fixed charge over a particular
machinery*vehicle etc.

Assi'nment! )ssignment means transfer of a right property or debt by one person to
another person. !he person transferring the right is known as assignor and the person to
whom the right is transferred is known as assignee. !he 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.
!his form of charge is generally adopted for charging of book debts monies due from
8overnment 5supply bills6 and life insurance policies etc. Banks generally go in for legal
assignment and insist for obtaining an acknowledgement of assignment from the debtor.

Mort'a'e! .ortgage is a mode of charge associated with immovable property.
Immovable property has been defined by Section ;5%76 of 8eneral #lauses )ct $334 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 = of 8eneral #lauses )ct $334 further provides that the above definition of
immovable property shall hold good under the !ransfer of "roperty )ct $33% as well.

Section ; of !ransfer of "roperty )ct $33% 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(
5a6 rooted in the earth as in case of trees and shrubs
5b6 imbedded in the earth as in case of walls or buildings or
5c6 attached to what is so imbedded for the permanent en1oyment of that to which it
is attached.

) similar definition of immovable property has been given by Section %576 of the Registration
)ct $>'3 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<.

) point in case may arise in respect of machinery. .achinery 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 &3 of '!ransfer of "roperty )ct $33% defines mortgage: as a transfer of an interest in a
specific immovable property for the purpose of securing an existing or future debt. !he 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 (

Mort'a'e #$ %e(osit of title %ee%s or e*ita#le mort'a'e! Section &35f6 of the
!ransfer of "roperty )ct $33% defines equitable mortgage as mortgage created by
depositing title deeds of an immovable property to secure a debt existing or future. !hree
basic conditions to constitute a valid equitable mortgage are

5i6 ?elivery of title deeds 5original6 by the mortgagor to the bank.
5ii6 @xistence of a debt existing or future.
5iii6 Intention of the mortgagor to create a mortgage on that property to secure the
debt.

-o equitable mortgage can be created if any of the above three conditions' is not complied with.

!his 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. .ortgage 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. @quitable mortgage can however be created only
at places as notified by government in this regard.

Sim(le Mort'a'e! Section &35b6 of !ransfer of "roperty )ct $33% 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. !he possession of
mortgaged property however still remains with the mortgagor. !he mortgagee does not
have an absolute right to sell the property in case of default but has to seek intervention
of the court.

) 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. )ll 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. !he 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.

+ien! /ien 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. !he 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. !he 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.

!he 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. )
banker:s lien is thus more than a general lien it is an implied pledge. !he bank therefore has a
right to sell the goods in his possession after giving a reasonable notice. !he 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.
!he bankers lien however does not extend to(

5i6 Securities or valuables lying in the locker rented to the customer.
5ii6 Securities deposited upon a particular trust.
5iii6 Securities deposited to secure a specific loan.
5iv6 Securities left with the banks after an advance against them has been ad1usted.
5v6 Securities left inadvertently with the bank.

-o specific letter of lien agreement is necessary as the banks en1oy the right of lien under the
#ontract )ct. 0owever 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.

Ne'ative +ien

!he borrower may sometime be having non+encumbered assets which are not charged to the bank
as security. !he borrower is thus free to deal with these assets and may even sell them if he so
desires. !o 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. !his type of an
undertaking obtained by the bank is known as '-egative /ien'. -egative 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. !he right may not be considered as absolute and the bank may
be required to give a notice for exercising his right of set off. !he right of set off can be
applied by the bank only if the following conditions are met(
5a6 !he liability of the borrower is for a sum which is certain
5b6 !he repayment of debt is due and
5c6 Both the accounts are held by the customer in the same capacity.

!he 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.

DIFFERENT T&PES OF BORRO,ERS-E.ECUTION OF
DOCUMENTS

Banks generally grant advance to persons having legal capacity to enter into a contract.
.inors*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.

!he 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. !his
information is very essential for the banks while getting the documents executed from the
borrowers. !he documents can be executed only by the persons who can validly bind the
borrower. !he position regarding obtaining of undertaking*information may differ from bank to
bank. #hart 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.-A. #onstitution of )dditional papers required "ersons authorised to
execute the document
Borrower
$. Individual ++++ Individual in his personal
capacity
%. Boint
++++
)ll the borrowers in their
personal capacity binding
themselves 1ointly and severally.

;. Sole ?eclaration regarding his sole Sole proprietor in his capacity as
"roprietorship interest in the business. sole proprietor. 0e is however
personally liable for all the
dealings and obligations in the
name of business.

=. Boint 0indu
,amily
$. /etter of Boint 0indu ,amily
giving details of all the
male members including
minors
%. ?eclaration to the effect
that the advances will
be utilised only for the
family business to be signed
by Carta D all other ma1or
coparceners.
)ll documents to be signed by
Carta of 0E, and all ma1or
coparceners in their capacity as
Carta D coparceners and also in
their individual capacity.

&. !rusts $. #opy of trust deed.
%. /egal opinion regarding the
power of trustee to
borrow.
)ll the trustees in their
representative capacity or as per
trust deed and supported by the
legal opinion.

7. "artnership firm $. #opy of partnership deed.
%. ?eclaration from all
partners to
inform the bank of any
change in constitution.


)ll partners in their
representative capacity i.e. as
partner and also in their
individual capacity.
4. /imited
#ompanies
$. )rticles and .emorandum
)ssociation
%. #opy of #ertificate of
incorporation.
;.#opy of #ertificate of
commencement of business
5only in case of public
limited companies6
=.#opy of Board Resolution
empowering the company
to borrow from the bank
and also authorising
?ocuments to be signed by
authorised persons in terms of
board resolution in their
representative capacity. !he
common seal of die company is
also required to be affixed
wherever necessary.
!he charge created by the
company over its assets will also
require registration under Section
$%& of #ompanies )ct $>&7.
managing director*
directors*other officers to
execute the documents as
required by the bank.
&.#opy of the resolution of
general body meeting of the
company under Section %>;
5$6 5?6 authorising the
company to borrow in
excess of its own paid up
capital and free reserve.
7.?eclaration from the
company that borrowings
will remain within the
powers conferred on it as in
5&6 above