Pledge

By Raghavendra Pratap Singh, National University of Advanced Legal Studies, Kochi

Editor’s Note: Pledge is a way in which goods are delivered to be a security for a loan or the fulfilment of an obligation. It is governed by the Indian Contract Act, 1872. This article deals with the various provisions related to pledge.

Pledge

A pledge is only a special kind of bailment, and chief basis of distinction is the object of the contract. Where the object of the delivery of goods is to provide a security for a loan or for the fulfilment of an obligation, that kind of bailment is pledge.[i] Under Indian Contract Act, 1872 the ‘Pledge’ has been defined in section 172 as:

S 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 the “Pawnee”.

In case of Lallan Prasad v. Rahmat Ali[ii], Supreme Court of India defined Pledge as:

“Pawn or pledge is a bailment of personal property as a security for some debt or engagement. A pawner is one who being liable to an engagement gives to the person to whom he is liable a thing to be held as security for payment of his debt or the fulfilment of his liability”.

The property pledged should be delivered to the Pawnee. Delivery of possession may be actual or constructive. Delivery of the key of the go down where the goods are stored, is an illustration of constructive delivery. Where the goods are in the possession of a third person, who, on the direction of the pledger, consents to hold them on pledgee’s behalf, that is enough delivery. It is sometimes called delivery by attornment. Delivery of documents of title which would enable the pledgee to obtain possession is equally effective to create a pledge.[iii] In case of Morvi Mercantile Bank Ltd v. Union of India[iv], the Apex Court held that- “delivery of railway receipts was the same thing as delivery of goods, the pledge was therefore valid and the pledgee was entitled to sue for the loss”.

Sometimes the goods are allowed to remain in the custody of the pledger for a special purpose and that constitutes pledge by hypothecation. Thus, in case of default by the pledger, the Pledgee will have to first take possession of the security and then sell the same. The best example of this type of arrangement are Car Loans.   In this case Car / Vehicle remains with the pledger but the same is hypothecated to the bank / financer.   In case the pledger defaults, banks take possession of the vehicle after giving notice and then sell the same and credit the proceeds to the loan account.[v]

Rights of Pawnee:-

  1. Right of Retainer :-

The Pawnee has got a right to retain the goods till the payment of the debt, or any interest due upon the debt.[vi] The right of retention has been given to Pawnee in Section 173 of the Contract Act.

S 173. Pawnee’s right of retainer –

The Pawnee may retain the goods pledged, not only for payment of the debt or the performance of the promise, but for the interests of the debt, and all necessary expenses incurred by him in respect to the possession or for the preservation of the goods pledged.

The Pawnee has a right to retain the goods pledged for

  • the payment of the debt or the performance of the promise for which the goods were pledged;
  • the interest of the debt; and
  • All necessary expenses incurred by him in respect of; the possession or for the preservation of the goods pledged.[vii]

The pledgee can retain the goods only for the payment of that particular debt for which the goods were pledged and not for any other debt or promise unless there is contract to contrary. He can, however retain the goods for subsequent advances, in which case such a contract is presumed. Section 174 of the Act describes:

S 174. Pawnee not to retain for debt or promise other than for which goods pledged – presumption in case of subsequent advances –

The Pawnee shall not, in the absence of a contract to that effect, retain the goods pledged for any debt or promise of other than the debt or promise for which they are pledged; but such contract, in the absence of anything to the contrary, shall be presumed in regard to subsequent advances made by the Pawnee.

The provisions of S 171, being a specific provision, overrides the general provisions of S 174. The Banker’s lien under S 171, will therefore extend to all other pledges with the bank, and the banker can retain the pledged goods, even if the debtor has not cleared his amount in connection with another loan.[viii]

  • Special and Paramount Interest of Pledgee:

The right of retainer is thus in the nature of a particular lien. Yet lien is different from pledge. “A lien is merely a personal right, whereas a pledge gives to the pawnee a ‘special property’ in the goods pledged. A lien gives no power of sale or disposition of the goods, whereas a pawnee has the power to sell in case of default. Lien is not transferable, but a pledge is assignable.”[ix] The pawnee gets a special property in the goods pledged. The general property remains in the pawner and wholly reverts to him on discharge of the debt. The right to property vests in the pledgee only so far as is necessary to secure the debt.[x]

Thus so long as the pawnee’s claim is not satisfied no other creditor of the pawner has any right to take away the goods or their price. In case of Bank of Bihar v. State of Bihar[xi], the goods which were under the pledge of a bank were seized by the State of Bihar. It was held that the seizure could not deprive the pledgee of his right to realise the amount for which the goods were pledged and, therefore, the State was bound to indemnify him up to the amount which would have been realised from the goods. The court also pointed out that the Indian Law in this respect was not different from the English law.

  • Hypothecate has no direct right of seizure:

The definition of pledge refers to a ‘bailment’, and hence can be no pledge of goods unless there is an actual delivery of the goods. A loan however may be secured by a hypothecation of the goods.[xii] Hypothecation is transaction under which goods are made available as security for a debt without actual transfer of either the property or the possession thereof to the creditor. The owners are under an obligation to discharge the debt within the stipulated time and if they fail to do so, the creditor has the right to recover his dues, if need be, by the sale of the security.[xiii]

Where the pledge is by way of hypothecation, the creditor cannot directly seize the goods by entering premises or otherwise. He has to do so either with the consent of the borrower or through a court order. The creditor does not have the right to enter the premises, lock and seal the same. In Union of India v. Shenthilnathan[xiv], the most conspicuous feature of the agreement was that in case the borrower committed default in payment of the debt as stipulated, the lender was at liberty to seize the goods. The court held that this power was not directly exercisable. No possession was delivered on the date when the hypothecation deed was entered into. What was contemplated was a future overt act on the part of the creditor to sequester the goods, if so desired and that too by a process known to law. At best the right which the plaintiff had under the agreement was to file a suit on the debt and after obtaining a degree to proceed against the property specified in realisation of the decree.

  1. Right to Extraordinary Expenses :-

The pawnee is entitled to receive from the pawner extraordinary expenses incurred by him for the preservation of the goods pledged. For such expenses, however, he does not have the right to retain the goods. He can only sue to recover them.[xv] This right of recovery is provided in Section 175 of the Act as follows:

S 175. Pawnee’s right as to extraordinary expenses incurred

The pawnee is entitled to receive from the pawnor extraordinary expenses incurred by him for the preservation of the goods pledged.

The word used in this section is not ‘retain’, as in two preceding sections, but ‘receive’. A pawnee has therefore, no right of lien for ‘extraordinary’ expenses, as he has in the case of ‘necessary’ expenses under section 173, but has only a right of action in respect of them.[xvi]

  1. Right of Sale:-

On the debtor’s default, the pawnee has the right to sell the goods pledged for the repayment of the debt or the performance of the promise. Section 176 which provides for this important right is as follows:

S 176. Pawnee’s right where pawnor makes default –

If the pawnor makes default in payment of the debt, or performance, at the stipulated time, or the promise, in respect of which the goods were pledged, the pawnee may bring as suit against the pawnor upon the debt or promise, and retain the goods pledged as a collateral security; or he may sell the thing pledged, on giving the pawnor reasonable notice of the sale.

If the proceeds of such sale are less than the amount due in respect of the debt or promise, the pawnor is still liable to pay the balance. If the proceeds of the sale are greater that the amount so due, the pawnee shall pay over the surplus to the pawnor.

Upon a default being made by the pawner in the payment of the debt or performance of the promise, the pledgee gets two distinct rights under section 176 of the Act. Firstly, the pledgee may sue upon the debt and retain the goods as a collateral security[xvii]. Secondly, he may sell the goods after reasonable notice of the intended sale to the pawner.[xviii]

The House of Lords in case of Trustees of the Property of Ellis & Co v. Dixton Johnson[xix], held that:

“If a creditor holding security sues for the debt, he is under an obligation on payment of the debt to hand over the security, and that if, having improperly made away with the security he is unable to return it to the debtor he cannot have judgement for the debt.”

In Lallan Prasad v. Rahmat Ali[xx]:

The defendant borrowed Rs 20,000 from the plaintiff on a promissory note and gave him aero scrapes worth about Rs 35,000 as security for the loan. The Plaintiff sued for repayment of the loan, but was unable to produce the security, having sold it, and, therefore his action for the loan was rejected.

In Central Bank of India v. Abdul Mujeeb Khan[xxi], the bank took over the possession of the hypothecated truck but thereafter neither sold it according to the agreed terms nor took care of it, leaving it in open place, the bank was liable for the extraordinary depreciation in the value of the vehicle.

The pawnee’s two rights, namely the right to sue the pawnor for the personal recovery or resort to sell the security after the reasonable notice, are disjunctive, being independent of each other. The fact that a period is prescribed for filing suit would not mean that the prescribed period would also apply to the alternative remedy of selling the goods.[xxii]

Requirement of Notice:-

Before making the sale, the pledger is required to give to the pawner, a reasonable notice of his intention to sell. The requirement of ‘reasonable notice’ is a statutory obligation and, therefore, cannot be excluded by a contract to the contrary.[xxiii] In a case of Prabhat Bank v. Babu Ram[xxiv], before the Allahabad High Court:

One of the terms of an agreement of loan enabled the lending banker to sell the securities without any notice to the pawner. The pawner defaulted in the payment. The bank sent a reminder, but the pawner asked for more time. The bank thereupon disposed of the securities.

The sale was held to be bad in law. The court said, “what is contemplated by section 176, is not merely a notice but a reasonable notice, meaning thereby a notice of intended sale of the security by the creditor within the certain date so as to afford an opportunity to the debtor to pay an amount within the time mentioned in the notice.” The court refused to agree with the bank’s contention that the sale notice should be inferred from the pawner’s request for time. “A notice of the character contemplated by section 176 cannot be implied. Such notice has to be clear and specific in language…”.

If the proceeds of such sale are less than the amount due in respect of the debt or promise, the pawnor is still liable to pay the balance. If the proceeds of the sale are greater that the amount so due, the pawnee shall pay over the surplus to the pawnor.[xxv]

When the pawnee sells the pledged goods, he does not do so as full owner, but by virtue of an implied authority from the pawnee to do so. The sale must be for the benefit of both the parties.[xxvi] After sale, it is the pawnee’s ordinary right ‘to recover the balance of the loan unsatisfied on the sale of the pledge’.[xxvii] And if there is any surplus amount from such sale, it must be accounted for and refunded to the pawner. The words ‘such sale’ in the second paragraph indicate that no liability can be fastened on the pawnor for loss, if the pawnee does not exercise his right of sale according to section 176.[xxviii] Before a sale, the goods are the property of the pawnor in pawnee’s custody. If there arises dispute regarding the quality of the goods, the pawnee cannot proceed in the matter without referring to the pawnor. In such a situation, pawnee is the agent of the pawnor.

Loss of Security due to Pledgee’s Negligence:

Where goods are lost due to the negligence of the pledgee, the liability of the pledger is reduced to the extent of the value of such goods which are lost. In a case of Gurbax Rai v. Punjab National Bank[xxix], before the Supreme Court:

Certain goods in the go down of a firm were under the pledge of a bank. The go down was insured against fire. A part of them was damaged by fire. The bank received insurance money to the extent of the fire.

Sale by Hypothecatee:

A hypothecatee is not in actual possession of the goods. He grants the right of use to the borrower. He naturally has a right to take possession of the goods if the borrower makes default. He can then sell them in his capacity as a pledgee. Intervention of the court is not necessary.

Pawner’s Right to Redeem:-

Section 177 of the Act provides for the most valuable right of the pawner:

S 177. Defaulting pawnor’s right to redeem-

If a time is stipulated for the payment of the debt, or performance of the promise,for which the pledged is made, and the pawnor makes default in payment of the debtor performance of the promise at the stipulated time, he may redeem the goodspledged at any subsequent time before the actual sale of them; but he must, in thatcase, pay, in addition, any expenses which have arisen from his default.

This provision is supplementary to the earlier section. Even after the time for payment of the debt or the performance of the promise has expired, the pawnor is entitled to redeem the goods pledged until they are actually sold; but he must then also pay any expenses which arise from his default.[xxx] It has been pointed out by the Supreme Court in a case of Jaswantrai Manilal Akhaney v. State of Bombay[xxxi], that:

“The special interest of the pledgee comes to an end as soon as the debt for which the goods were pledged is discharged. It is open to the pledger to redeem the pledge by full payment of the amount for which the pledge had been made at any time if there is no period fixed for redemption, or at any time after the fixed date and the right continues until the thing pledged is lawfully sold.”

Redemption means the enforcement of the right to have the title to corpus of the pledged property restored to the pledger free and clear of the pledge. A suit for redemption has to be filed for exercising this specific remedy and not just for a declaration of the right of redemption.[xxxii]

Heritable Right:

Certain gold ornaments were pledged with a bank as a security for a gold loan. The pawnor died. His wife sought to redeem the pledge by repaying the loan. She produced a ‘will’ of her husband to show her right. The court said that she was entitled to redeem. The bank could not ask her for submitting a probate of the will or a succession certificate. Her son and daughter raised no objection.[xxxiii]

Premature Redemption:

Where the pawner redeems before expiry of the specified period, he would remain bound by the terms of the loan, if any, which require that a premium would be leviable on premature payment.[xxxiv]

Statutory Right:

Where the property of an employer was pledged with a bank as security for repayment of a loan, the court said that it could be attached and sold for recovery of employee’s Provident Fund dues.[xxxv](Section 11(2) of the Provident fund Act, 1952 operates against mortgage and pledge executed by employer to give priority to employees Provident Fund claims.)

Conclusion

Pledge is a kind of bailment where a thing is delivered as security for the repayment of a debt or performance of any promise. Delivery of the possession to the pawnee may be actual delivery or constructive delivery. Ownership of the pledged article does not pass to the pledgee. The pawnee has the right to retain goods till the payment, of the debt, any interest on the debt, and any other necessary expenses incurred for preservation of the goods. Where pawnee incur any other extraordinary expenses on goods for preservation, he is entitled of the same from pawnor. In case of the default of the pawnor, in the debt or performance, the pawnee has the right to sell the goods pledged.

The pawnor has also the right to redeem the goods before the actual sale, but after the payment of the debt or performance of promise and any other expenses which have arisen from his default.

Edited by Sinjini Majumdar

[i] Avtar Singh, Contract and Specific Relief, (11th Edition), p.689

[ii] AIR 1967 SC 1322

[iii] Avtar Singh, Business Law, (9th Edition), p.226

[iv] AIR 1965 SC 1954

[v] “Pledge vs Hypothecation”, retrieved from http://www.allbankingsolutions.com/

[vi] T.S. Venkatesa Iyer’s, The Law of Contracts & Tenders, Vol.1, (9th Edition), p. 651

[vii] Pollock & Mulla, Indian Contract and Specific Relief Acts, Vol. 2, (12th Edition), p.2022

[viii] State Bank of India v. Deepak Malviya, AIR 1996 All 165

[ix] ‘Pledges and pawns’, Halsbury’s Laws of England, (4th Edition), Reissue, Vol.36, para 104

[x] Sarvopari Investments (P) Ltd v. Soma Textiles and Industries Ltd, (2003) 4 ICC 604 (Cal)

[xi] (1972) 3 SCC 196

[xii] Supra Note 7, p. 2016

[xiii] Bank of Baroda v. Rubari Bachubhai Hirabhai, AIR 1987 Guj 1.

[xiv] (1977) 2 MLJ 499

[xv] Supra Note 1, p. 696

[xvi] Supra Note 7, p. 2026

[xvii] S.K. Engg Works v. New Bank of India, AIR 1987 P&H 90.

[xviii] Mahalinga Nadar v. Ganapathi Subbien, ILR (1903-05) 27 Mad 528.

[xix] 1925 AC 489, at p. 1325

[xx]  AIR 1967 SC 1322

[xxi] 1997 AIHC 299 (MP)

[xxii] K.M. Hidayathulla v. Bank of India, AIR 2000 Mad 251

[xxiii] Supra Note 1, p. 700

[xxiv] AIR 1966 All 134

[xxv] 2nd Paragraph, (Section 176)

[xxvi] Supra Note 7, p. 2035

[xxvii] Jones v. Marshall, [1889] 24 QBD 269 at 271.

[xxviii] Surilal v. Shyamlal, AIR 1956 MB 74

[xxix] (1984) 3 SCC 96

[xxx] Supra Note 7, p. 2036

[xxxi] AIR 1956 SC 575

[xxxii] Nabha Investment (P) Ltd v. Harmishan Dass Lukhmi Dass, (1995) 58 DLT 285

[xxxiii] Kamali Sarojini v. Indian Bank, AIR 2008 AP 71

[xxxiv] Hotel Vrinda Prakash v. Karnataka State Financial Corporation, AIR 2007 Kant 187

[xxxv] Maharashtra State Cooperative Bank Ltd v. Provident Fund Commissioner, (2009) 10 SCC 123

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