DR.

RAM MAHOHAR LOHIYA NATIONAL LAW UNIVERSITY

LAW OF CONTRACTS
(PROJECT ON)

HYPOTHECATION AGREEMENT: VARIOUS ASPECTS

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SUBMITTED BY: UNDER THE GUIDANCE OF:

Jyoti Chaudhary Dr. V. Visalakshi

Roll No.- 66 Assistant Professor
Section ‘A’ Dr. Ram Manohar Lohiya
B.A. LLB (Hons.), Semester III National law University

SIGNATURE OF STUDENT SIGNATURE OF PROFESSOR

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 Acknowledgement

I, Jyoti Chaudhary, a First Year Law scholar at Dr. Ram Manohar Lohiya National Law
University, Lucknow, am highly grateful towards our lecturer Dr. V. Visalakshi, who gave
me the opportunity to study this topic and because of her help and support, this project has
reached its completion.

I would also like to thank the library staff of Dr.Ram Manohar Lohiya National Law
University, Lucknow, for their patient and diligent support in the making of this project.

I would like to thank my parents who encouraged me to work hard and motivated me to give
my best. Last, I would like to acknowledge my friends who helped me in the research needed
for this project.

I have tried my best to include all the aspects discussed in the given case, yet, ignorance or
any mistake is deeply apologized.

Thanking you,

Yours sincerely,

Jyoti Chaudhary.

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 Index
1. Introduction...................................................................................................................4
2. Insurance………............................................................................................................4
3. Receiver..........................................................................................................................5
4. Security to remain unaffected........................................................................................5
5. No liability…………………………………………………………………………......5
6. Display of marks………………………………………………………………………6
7. Joint and Several Liability…………………………………………………………….6
8. Severability……………………………………………………………………………6
9. Assignment…………………………………………………………………………....6
10. Other Provisions…………………………………………………………………...….7
11. Rehypothecation…………………...…………………………………………………8
12. Judicial Interpretation………………………………………………………………...8
13. Bibliography.................................................................................................................12

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 Introduction
‘Hypothecation’ is defined under Section 2 (n) of The Securitisation and Reconstruction of
Financial Assets and enforcement of security interest act, 2002 as a charge created 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.

This is offering something as collateral for a debt. In hypothecation, the debtor usually does
not have to turn over physical custody of the collateral although the lender is “hypothetically”
in control of the collateral.

An agreement between a borrower and a lender where by the borrower pledges asset as collate
ral on a loan without the lendertaking possession of the collateral. It especially applies to mort
gages; the borrower hypothecates when he/she pledges the house ascollateral for payment of t
he mortgage, or he/she may hypothecate the mortgage in order to borrow against the value of
the house. Inboth situations, the borrower retains possession of the house, but the lender has t
he right to take possession if the borrower does notservice the
debt. Hypothecation agreements also occur in trading; a broker will allow an investor to borro
w money in order topurchase securities with those securities as collateral. The investor owns t
he securities, but the broker may take them if the debt isnot serviced or if the value of the secur
ities falls below a certain level.

"Deed of Hypothecation" means the particular joint deed of hypothecation executed by the
Borrower in favour of the particular Consortium of Lenders for the purpose of securing the
Assets for the Facility.

Insurance
The Borrower shall at its expenses keep the Assets in good and marketable condition and, if
stipulated by the Lenders under the Facility Agreement, insure such of the Assets which are
of insurable nature, in the joint names of the Borrower and the Lenders against any loss or
damage by theft, fire, lightning, earthquake, explosion, riot, strike, civil commotion, storm,
tempest, flood, erection risk, war risk and such other risks as may be determined by the
Lenders and including all marine, transit and other hazards incidental to the acquisition,
transportation and delivery of the relevant Assets to the place of use or installation

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 Receiver
The Lenders, at any time after the security created under the Deed of Hypothecation has
become enforceable and whether or not the Lenders shall then have entered into or taken
possession of and in addition to the powers hereinbefore conferred upon the Lenders after
such entry into or taking possession of, may have a receiver(s) appointed of the Assets or any
part thereof.

Security to remain unaffected

The security created under the Deed of Hypothecation shall continue and remain in full force
and effect till such time the Borrower repays/pays in full the Facility together with all
interest, commission, costs, charges, expenses and all other monies including any increase as
a result of revaluation/ devaluation/fluctuation or otherwise in the rates of exchange of
foreign currencies involved, whatsoever stipulated in or payable under the Facility
Agreement and/or the other Transaction Documents and termination of the Facility
Agreement and the Borrower’s liability in respect of the Facility and/or under the Deed of
Hypothecation shall not be affected, impaired or discharged by winding up/insolvency/death/
dissolution/merger or amalgamation/reconstruction or otherwise of the Borrower and/or the
Borrower or takeover of the management or nationalisation of the undertaking of the
Borrower and/or the Borrower, as the case may be.

No liability
The Lenders shall not be under any liability whatsoever towards the Borrower or any other
person for any loss or damage to the Assets from or in whatever cause or manner arising
whether such Assets shall be in the possession of the Lenders or not at the time of such loss
or damage or the happening of the cause thereof. The Borrower shall at all times indemnify
and keep indemnified the Lenders from and against all suits, proceedings, costs, charges,
claims and demands whatsoever that may at any time arise or be brought or made by any
person against the Lenders in respect of any acts, matters and things lawfully done or caused
to be done by the Lenders in connection with the Assets or in pursuance of the rights and
power of the Lenders under the Deed of Hypothecation, the Facility Agreement and /or the
other Transaction Documents.

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 Display of marks
The Borrower shall display/mark the Lenders’ name on the factories, premises, godowns and
other places where the Assets and / or all documents / records in respect thereof are
stored/kept/installed/used/lying, indicating that such Assets are hypothecated to the Lenders.
The Borrower shall also keep the Lenders informed of the locations / place(s) where such
Assets / documents / records etc. are kept and notify all concerned third parties of the
Lenders’ security interest on the Assets and ensure protection of the Lenders’ interest in
relation to or pertaining to the security on the Assets.

Joint and several liability

In case there are more than one Borrower, each of the Borrower shall be jointly and severally
liable to the Lenders for performance of all obligations under the Deed of Hypothecation.

Severability
Any provision of the Deed of Hypothecation which is prohibited or unenforceable in any
jurisdiction shall, as to such jurisdiction, be ineffective to the extent of prohibition or
unenforceability but that shall not invalidate the remaining provisions of the Deed of
Hypothecation or affect such provision in any other jurisdiction.

Assignment
A borrower’s rights against third parties, such as the right to receive payment for debts on its
own books, can be assigned to a third party as a way of selling those rights. Assignment
means to put the other party (in whose favour assignment is done) in yours shoes. An
assignment of contract occurs when one party to an existing contract (the “assignor”) pass
over the contract’s rights, obligations and benefits to another party (the “assignee”) in order
to assume all of his contractual obligations and rights and to do that, the other party to the
contract must be properly notified.

In Common Law countries, until or unless the contract has any restrictive clause or
prohibition for assignment, the contract may be assignment in faovur of assignee without any
approval or notice. However, where prior approval of the counter party is required as per the
procedure given in the contract, failure to obtain consent may lead to assignment being a
nullity.

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 Other provisions
The Borrower makes the following representations, warranties and confirmations :

(a) The Borrower has the competence and power to execute the Deed of Hypothecation;
(b) The Borrower has done all acts, conditions and things required to be done, fulfilled or
performed, and all authorisations required or essential for the execution of the Deed of
Hypothecation or for the performance of the Borrower’s obligations in terms of and under
the Deed of Hypothecation have been done, fulfilled, obtained, effected and performed
and are in full force and effect and no such authorisation has been, or is threatened to be,
revoked or cancelled;

(c) The Deed of Hypothecation has been duly and validly executed by the Borrower or on
behalf of the Borrower and the Deed of Hypothecation constitutes legal, valid and binding
obligations of the Borrower;

(d) The entry into, delivery and performance by the Borrower of, and the transactions
contemplated by, the Deed of Hypothecation do not and will not conflict : (i) with any
law; (ii) with the constitutional documents, if any, of the Borrower; or (iii) with any
document which is binding upon the Borrower or on any of its assets;

(e) All amounts payable by the Borrower under the Deed of Hypothecation will be made
free and clear of and without deduction / withholding for or on account of any tax or levy
and without any setoff;

(f) (i) To the extent applicable, the execution or entering into by the Borrower of the Deed
of Hypothecation constitutes, and performance of its obligations under the Deed of
Hypothecation will constitute, private and commercial acts done and performed for
private and commercial purposes; (ii) The Borrower is not, will not be entitled to, and
will not claim immunity for itself or any of its assets from suit, execution, attachment or
other legal process in any proceedings in relation to the Deed of Hypothecation;

(g) Except to the extent disclosed to the Lenders, no litigation, arbitration, administrative
or other proceedings are pending or threatened against the Borrower or its assets, which,
if adversely determined, might have a Material Adverse Effect;

(h) (i) All information communicated to or supplied by or on behalf of the Borrower to

the Lenders from time to time in a form and manner acceptable to the Lenders, are true
and fair correct and complete in all respects as on the date on which it was communicated
or supplied; (ii) Nothing has occurred since the date of communication or supply of any
information to the Lenders, which renders such information untrue or misleading in any
respect;

(i) The Deed of Hypothecation shall be governed by and construed in accordance with the
laws of India;

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 (j) Any legal action or proceedings arising out of the Deed of Hypothecation may be
brought by the Lenders, in its absolute discretion, in any competent court, tribunal or
other appropriate forum having jurisdiction.

Rehypothecation
Re-hypothecation occurs when banks or broker-dealers re-use the collateral posted by clients
such as hedge funds to back the broker's own trades and borrowing.
In the UK, there is no limit on the amount of a clients assets that can be
rehypothecated, except if the client has negotiated an agreement with their broker that
includes a limit or prohibition. In the US, re-hypothecation is capped at 140% of a client's
debit balance.

Judicial Interpretation
It was stated by the Hon’ble High Court of Andhra Pradesh in the matter of Md. Sultan v.
Firm Rampratap Kannyalal (AIR 1964 AP 201) that hypothecation only creates general
lien, but possession of the property is not transferred, whereas in case of a pledge a special
interest and not special property is transferred to the pawnee who is impliedly authorized to
sell the goods pledged in case of default in accordance with the provisions of the Contract
Act. In case of mortgage, however, a general but limited property is transferred to the
creditor, but the possession may or may not be transferred to the mortgagee.

Few years later the distinction between pledge and hypothecation has been restated in the
matter of State Bank of India vs. S.B. Shah Ali (Died) and Ors. (AIR 1995 AP 134), that in
case of hypothecation the hypothecator can be in possession of the goods hypothecated and
enjoy the same without causing any damage to the rights of the hypothecatee whereas in the
case of pledge the possession of goods will be transferred to the pawnee and he will be in
possession and the pawnor will not be able to enjoy the same as the possession has already
been parted with.

In Murugan v State (2013 (2) MLJ(Crl) 803) it was held that although, it was represented
that car in question was under hypothecation agreement and company had advanced sizable
loan to Petitioner/owner of vehicle, yet in Law, Petitioner/registered owner of vehicle had
precedence over Financier in regard to interim custody of vehicle as per ingredients of s. 451
of CrPC - Therefore, as order of disposal passed by trial Court suffered from material
irregularity and patent illegality, order of trial Court was set aside in interest of justice. The
Trial Court was directed to restore Petition on its file and to return vehicle in question to
Petitioner/owner of vehicle.

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 In Ideal Bank Limited (In Liquidation) v Pride of India Pictures Limited (In
Liquidation) and Another (AIR 1983 DEL 546) it was held that in any event, mortgage of
movable property was recognised form of hypothecation and such hypothecation conferred
good title upon persons in whose favour it was made even in absence of possession and law
recognised transaction as security and equity gave effect to it - Therefore, it could not be said
that there was no valid pledge or that debt was not fully secured - However, it was true that
there could be no pledge or hypothecation in respect of share money, booking money and
uncalled capital of company and only effect of agreement in relation to these assets was
creation of charge in favour of bank over those rights - Thus, all assets of company were
pledged/hypothecated or charged, excluding leasehold rights in various cinemas and debt was
fully secured.

In Premier Auto Industries, Gwalior and others v Bharat Raj Goyal and others (1991
Indlaw MP 179) Appellant/plaintiffs entered into agreement for sale of machinery to
respondent/defendants and in case of breach of terms of agreement, plaintiff entitled to
permanent injunction. Further, machinery was hypothecated with the bank. Plaintiff filed suit
seeking injunction, which was allowed and subsequently defendant/bank was restrained from
reversing the credit in respect of sale of machinery.

It was held that plaintiffs/appellants have prima facie failed to establish their legal right
against the defendant/Bank to restrain the Bank from reversing the credit. The credit was
conditionally given, subject to the plaintiffs' liquidating their separate liability and also
arranging delivery, as already agreed between parties, at Faridabad, of the machineries in
question, through the Bank. Both conditions, the plaintiffs breached and cleverly suppressing
the injunction, they had obtained the credit. Bank still took care to make that credit
conditional to guard against any pitfall. Because of the hypothecation of the machineries, that
condition could be lawfully imposed by the Bank dehors parties agreeing to deal with the
machinery otherwise. Although there is difference between a 'pledge' and 'hypothecation', in
the latter case, it would be a case of constructive possession as opposed to physical
possession of pledgee of the goods pledged. There is, therefore, no difference in so far as the
right to follow the goods is concerned as that right is equally available to the pledgee and also
to any other lender who has obtained hypothecation and not pledge of the goods. The right to
retain possession, whether physically or constructively is common to both and in both cases
the lender suffers the common disability of not maintaining suit for recovery of the debt and
retain, at the same time, possession of the pledged property. That conduct per se of the
plaintiffs/appellants disentitled them, notwithstanding Bank's careful handling of its interest,
to the equitable relief of injunction against the Bank. Prima facie, they failed to establish their
claim either. 46 of the Act, as rights of an "unpaid seller" which plaintiffs/appellants could
exercise in terms of s. 46(2) for withholding delivery lawfully. For that, they had to establish
that they had not defaulted in performance of their own duty contemplated. 44. Hence,
impugned order is confirmed. Appeal was dismissed.

In Vimla Pradhan and others v United Commercial Bank Calcutta and others (1989
Indlaw MP 264). Respondent No. 2 borrowed sum of Rs. 30,300/- from respondent Bank for
purchasing pick-up van - Original defendant guaranteed loan by executing document of

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guarantee - Amount could not be paid by borrower - Account between respondents nos. 1 & 2
was settled and fresh contract regarding hypothecation of goods was signed - Pick-up van
was hypothecated by respondent Bank to secure amount of Rs. 21,000 - Respondent Bank
filed suit & Hypothecated vehicle was sold in public auction and a sum of Rs. 12, 700
recovered - Suit was amended to obtain a decree of Rs. 14,084.56 p. only - Appellants denied
their liability as guarantor - Trial Court held that subsequent agreement was only an
acknowledgment of previous debt and therefore, liability of appellant was not terminated -
Decree was passed by making appellants jointly and severally liable - Hence, instant appeal -
Whether liability of earlier guarantor ceased to exist because of subsequent arrangement by
agreements.

It was held that there is no reference to either earlier liability or agreements Exs. P-3 and P-4
in these documents, nor do they state that there was in existence the relationship of debtor
and creditor between the borrower and the Bank. These documents, on the contrary, create
new conditions relating to rate of interest and mode of payment. These documents reflect
settlement of old account and promise to pay the same with higher interest. These documents
do not contain any admission of past existing liability and do not amount to
'acknowledgment' within the meaning of s. 18 of Limitation Act. Since agreements amount to
fresh contracts based on past consideration, the parties to these agreements alone would be
liable to the respondent Bank. These agreements would validly terminate contracts Exs. P-3
and P-4 and consequently discharge earlier guarantor. Respondent Bank not only secured
fresh agreement with the borrower varying substantially the terms of agreement Ex. P-3, they
also secured fresh guarantee. Having compelled respondent-borrower to give fresh guarantee,
they must be deemed to have agreed to release the earlier guarantor. The Bank cannot now
turn back and plead to contrary. Guarantee furnished by earlier guarantor stood discharged
with the execution of agreements Ex. P-18 & Ex. P-20, and consequently appellants cannot
be held liable for the amount of debt. Impugned judgment and decree are held legal and valid
in relation to respondents nos. 2, 3 & 4, the appellants are discharged from their liability. This
would, therefore, entitle respondent Bank to execute decree on other respondents only.
Appeal allowed.

Ratio - Promise to pay past debt with interest would amount to execution of a fresh and valid
contract under law.

In Syndicate Bank v Commercial Tax Officer and Others (1995 Indlaw KAR 116)
Agreements were executed between petitioner and borrower company whereunder goods
were hypothecated in favour of petitioner-bank. Hypothecated plant and machinery were
liable to be sold by petitioner-bank in event of default in payment by borrowing company.
Borrower committed default resulted in powers available
under hypothecation agreement petitioner sold goods. While goods were moved outside State
by purchaser, Commercial Tax Officer and Deputy Commissioner issued notices to petitioner
not to deliver goods sold by it to purchasers. The question was whether by reason of
insurance/banking company selling salvaged goods, it can be treated to be 'dealer' within
meaning of the Act.
It was held that sale of pledged or pawned articles, value of which is more than Rs.10
becomes incidental or ancillary to business of pawnbroker and as such sale and purchase also

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becomes his business. While there is a general prohibition against petitioner-company
carrying on any activity by way of buying or selling or bartering of goods, there is exception
in so far as any such activity is connected with realisation of any security given to banking
company or otherwise held by it. However, it is not in dispute that sale effected by petitioner
was for realisation of securities provided to it and therefore such activity is clearly outside
prohibition. There is no distinction between petitioner's case and case of Insurance Company
or Pawn Brokers, both of which activities were held to be trading activities, bringing them
within definition of term 'dealer' under the Act. Thus, there is no error of law or jurisdiction
in notices impugned and petitioner can be treated as dealer under the Act - Petition dismissed.

Ratio - Sale of goods by banking company is incidental or ancillary to main business of in-
surance carried on by it and can be treated as 'dealer'.

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 Bibliography
 http://indiankanoon.org/
 http://www.livelaw.in/security-interest-shield-hands-lenders/
 http://financial-dictionary.thefreedictionary.com/hypothecation+agreement
 https://www.testopedia.com/definition/2014/hypothecation-agreement
 https://en.wikipedia.org/wiki/Hypothecation
 http://www.livelaw.in/security-interest-shield-hands-lenders/
 http://www.westlawindia.com/

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