Hypothecation and Mortgage Property in India

Hypothecation legally means providing something as collateral for any form of debt. However, although a collateral security is provided the debtor usually does not have to turn over physical custody of the collateral although the lender is “hypothetically” in control of the collateral.

The Indian Contract Act does not define the term ‘hypothecation’, however, section 2 (n) of Securitization and Reconstruction of Financial Assets & Enforcement of Security Interest Act 2002) defines Hypothecation as:

 “’Hypothecation’ means a charge in or upon any movable property, existing in 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”.

Hypothecation is to be registered under Section 125 of the Indian Companies Act, 1956 before the Registrar of Companies by filing Form No. 8, when the hypothecator is a company.

Hypothecation is a way of creating a charge against the security of movable assets, which is quite similar to pledge.

a) The assets remain in the custody of the borrower.

b) Assets are not kept under the lock and key of the banker.

c) The borrower has to submit a stock statement at prescribed intervals as per terms of sanction to the bank.

d) Without Bank’s consent, no person can utilize the hypothecated assets for his own benefit or sale by the borrower or any person connected thereto.

Difference Between Hypothecation and Pledge

Hypothecation is a way of creating a charge against the security of movable assets, which is much similar to pledge. However, pledge is a charge, which is defined by law whereas it is not so in the case of hypothecation. Under Section 172 of the Indian Contract Act, 1872: “Pledge is a contract where, by way of deposit of goods a security for a debt is created and the right to property vests in the pawnee so  far  as it is necessary  to secure the debt.”

In case of pledge, the assets are in the custody of the lender, real or constructive, whereas in the case of hypothecation the assets are in the custody of the borrower.

Hypothecation is  to  be registered  under Section  125  of  the Indian Companies Act,  1956  when the hypothecator is  a  company,  whereas  no  such provision  exists in  case of charges by  way of pledge. 

In hypothecation, goods are not kept under the lock and key of the banker. The borrower, however, will have to submit a stock statement at prescribed intervals as per terms of sanction to the bank. In addition  to  the  fact  that  the  bank  does  not  have  the physical  possession  of  the  goods  under  hypothecation,  the  fact  remains  that  no  statutory  status  is given to a hypothecation transaction. In this regard, it is, however, to be noted that hypothecation has a close link to floating charge. It must be noted that without the consent of the Bank, no person can utilize the hypothecated goods for his own benefit or sale by the borrower or any person connected thereto.

In P. Ramanatha Aiyar’s Advanced Law Lexicon (Third (2005) Edition, Vol.2, Pages 2179 and 2180) are relevant:

“Hypothecation: It is the act of pledging an asset as security for borrowing, without parting with its possession or ownership. The borrower enters into an agreement with the lender to hand over the possession of the hypothecated asset 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.”

It was held in Indian Oil Corporation v. NEPC India Limited [(2006) 6 SCC 736] that:

“hypothecation does not mean ‘entrustment of the property’ or ‘entrustment of dominion over the property’ by the hypothecatee (creditor) to the hypothecator (debtor). When possession has remained with the debtor/owner and when the creditor has neither ownership nor beneficial interest, obviously there cannot be any entrustment by the creditor.”

It was further held in Indian Oil Corporation v. NEPC India Limited [(2006) 6 SCC 736]:

“If the observations relied on by the appellant are to be interpreted as holding that the debtor holds the hypothecated goods, in trust for the creditor, then they are contrary to the decision of this Court in Central Bureau of Investigation v. Duncans Agro Industries Ltd., Calcutta [1996 (5) SCC 591] which specifically holds that when goods are hypothecated, the owner does not hold the goods in trust for the creditor. A charge over the hypothecated goods in favour of the creditor, cannot be said to create a beneficial interest in the creditor, until and unless the creditor in exercise of his rights under the deed, takes possession. The term ‘beneficial interest’ has a specific meaning and connotation. When a trust is created vesting a property in the trustee, the right of the beneficiary against the trustee (who is the owner of the trust property) is known as the ‘beneficial interest’. The trustee has the power of management and the beneficiary has the right of enjoyment. Whenever there is a breach of any duty imposed on the trustee with reference to the trust property or the beneficiary, he commits a breach of trust. On the other hand, when the owner of a goods hypothecates a movable property in favour of a creditor, no ‘beneficial interest’ is created in favour of the creditor nor does the owner become a trustee in regard to the property hypothecated. The right of the creditor under a deed of hypothecation is the right to enforce the charge created under the deed of hypothecation in the manner specified in the deed and by no stretch of imagination can such right be equated to a beneficial interest of a beneficiary in a property held in trust. Therefore, the first contention that a creditor has a beneficial interest in the hypothecated property and the owner is in the position of a trustee with reference to the creditor is liable to be rejected.

23. The second ground on which learned counsel for the appellant sought to distinguish Duncan Agro (supra) is that the said case dealt with a hypothecation deed creating a floating charge, whereas the case on hand related to a fixed charge and therefore, the principle laid down in Duncan Agro (supra) will not apply. This contention is also without basis. The principle stated in Duncan Agro (supra) will apply in regard to all types of hypothecations. It makes no difference whether the charge created by the deed of hypothecation is a floating charge or a fixed charge. Where a specific existing property is hypothecated what is created is a ‘fixed’ charge. The floating charge refers to a charge created generally against the assets held by the debtor at any given point of time during the subsistence of the deed of hypothecation. For example where a borrower hypothecates his stock-in-trade in favour of the Bank creating a floating charge, the stock-in-trade, held by the borrower as on the date of hypothecation may be sold or disposed of by the debtor without reference to the creditor. But as and when new stock-in-trade is manufactured or received, the charge attaches to such future stock- in-trade until it is disposed of. The creditor has the right at any given point of time to exercise his right by converting the hypothecation into a pledge by taking possession of the stock-in-trade held by the debtor at that point of time. The principle in Duncan Agro is based on the requirement of ‘entrustment’ and not with reference to the ‘floating’ nature of the charge. The second contention also has no merit.”

In J.K. (Bombay) Private Limited v. New Kaiser-I-Hind Spinning & Weaving Co. Ltd. & Others [(1969) 2 SCR 866], explained the difference between the charge and the mortgage as follows :-

“While in the case of a charge there is no transfer of property or any interest therein, but only the creation of a right of payment out of the specified property, a mortgage effectuates transfer of property or an interest therein. No particular form of words is necessary to create a charge and all that is necessary is that there must be a clear intention to make a property security for payment of money in praesnti.”

8. Section 100 of the Transfer of Property Act, 1882 defines “charge” as follows :-

“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.”

The above-mentioned Section clearly indicates the following types of charges :

1) Charges created by act of parties; and

2) Charges arising by operation of law.

9. An ordinary charge created under the Transfer of Property Act is compulsorily registerable. The first portion of Section 100 of the TP Act lays down that 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. The words “which apply to a simple mortgage shall, so far as may be, apply to such charge” in this Section were substituted by Section 53 of the Transfer of Property (Amendment) Act, 1929, for the words “as to a mortgagor shall, so far as may be, apply to the owner of such property, and the provisions of Sections 81 and 82 shall, so far as may be, apply to the persons having such charge.” Evidently, the effect of the amendment was that all the provisions of the TP Act which apply to simple mortgages were made applicable to charges.

10. Section 59 of the Transfer of Property Act refers to the mode of transfer which reads as follows :-

“59. Mortgage when to be by assurance.- 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. Where the principal money secured is less than one hundred rupees, a mortgage may be effected either by a registered instrument signed and attested as aforesaid, or (except in the case of a simple mortgage) by delivery of the property.”

11. A conjoint reading of Section 100 with Section 59 of the TP Act makes it clear that if by act of parties, any immovable property is made security for the payment of money to another and it does not amount to mortgage, then all the provisions which apply to a simple mortgage, as far as may be, apply to such charge. Consequently, in view of Section 59 of the TP Act when there is a mortgage other than a mortgage by deposit of the title deeds, it can be effected only by a registered instrument.

Equitable Mortgage in India.

Equitable mortgage is not defined under Indian law but it can be surmised from Section 58(f) and section 59 of the Transfer of Property Act, 1882, as reproduced below:

58(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.

59. Mortgage when to be by assurance.—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.

Where the principal money secured is less than one hundred rupees, a mortgage may be effected either by a registered instrument signed and attested as aforesaid or (except in the case of a simple mortgage) by delivery of the property. (capitals mine)

As aforesaid, Section 59 of the Transfer of Property Act, 1882 provides that a mortgage, other than a mortgage by deposit of title deeds, can be effected only by a registered instrument.

The Hon’ble Supreme Court in United Bank Of India Ltd. vs. Lekharam Sonaram And Co. And Ors. {AIR 1965 SC 1591; 1965 (0) BLJR 480}, held:

“A mortgage by deposit of title deeds is a form of mortgage recognised by Section 58(f) of the Transfer of Property Act which provides that it may be effected in certain towns (including Calcutta) where a person “delivers to a creditor or his agent documents of title to immovable property with intent to create a security thereon.” In other words, when the debtor deposits with the creditor title deeds of his property with an intent to create a security, the law implies a contract between the parties to create a mortgage and no registered instrument is required under Section 59 as in other classes of mortgage. It is essential to bear in mind that the essence of a mortgage by deposit of title deeds is the actual handing over by a borrower to the lender of documents of title to immovable property with the intention that those documents shall constitute a security which will enable the creditor ultimately to recover the money which he has lent. But if the parties choose to reduce the contract to writing, this implication of law is excluded by their express bargain, and the document will be the sole evidence of its terms. In such a case the deposit and the document both form integral parts of the transaction and are essential ingredients in the creation of the mortgage. It follows that in such a case the document which constitutes the bargain regarding security requires registration under Section 17 of the Indian Registration Act, 1908, as a non-testamentary instrument creating an interest in immovable property, where the value of such property is one hundred rupees and upwards. If a document of this character is not registered it cannot be used in the evidence at all and the transaction itself cannot be proved by oral evidence either.

Generally, banks execute memorandum of entry recording the deposit of title deeds on grant of loan; however quite often in practice, the memorandum is not in full compliance with the applicable stamp and registration laws and this area needs to be strengthened by many lenders.

In T.V.ALWAR V. BANK OF TAMIL NADU, THIRUNELVELI THROUGH ITS BRANCH MANAGER, 1997 (III) CTC 28, it was held:

“Therefore, the cumulative effect of these circumstances would go to show that the document in question is at best only a list of title deeds and that the document can never be said to form an integral part of the transaction nor it can be stated to evidence the bargain between the parties. On the other hand, it is at best an instrument recording the particulars of document and nothing more. The document was not intended to and did not operate to create any right in or over any property nor has the effect of creating any charge over the property and therefore it is not a document which requires to be registered. Therefore it follows that the conclusion of the courts below that the document is admissible in evidence and that is not hit by section 17 of the Registration Act is a proper conclusion.”

In B.R.SHAMALA AND B.R.SHYAMALA DEVI AND ANOTHER VS. KUNDAN S.BHAYAANI AND OTHERS, 1999 (3) MLJ 74, it was held:

“The document Ex.P.16 shows that it only records a past transaction etc. and further the said exhibit shows that the document has already been handed over. So long as Ex.P.16 is not bargain but only evidences the intention to create a mortgage, it will not require registration.”

Thus, equitable mortgage or mortgage by deposit of title deeds does not require registration unless the transaction is put down as a written agreement, which if executed, would require registration vide United Bank Of India Ltd. vs. Lekharam Sonaram And Co. And Ors. (supra)

The basic requirements for hypothecation and mortgage:

Asset Type	Security Type	Conditions To Be Satisfied To Make The Security Valid and Enforceable
Plant and Machinery	Hypothecation (for movable property)Mortgage (for immovable property)	Filing of Form 8 with the relevant Registrar of Companies and of duly stamped document with the relevant Sub-Registrar of Assurances. (Section 125 Companies Act)Mortgage must be in writing.
Trading Stock	Floating Charge	Filing of Form 8 with the relevant Registrar of Companies. (Section 125 Companies Act)
Other movable property	Pledge, hypothecation, fixed or floating charge	Except in case of pledge, filing of Form 8 with the relevant Registrar of Companies and of duly stamped document with the relevant Sub-Registrar of Assurances. (Section 125 Companies Act)Pledge requires delivery of pledged asset (actual or constructive).