SNDT WOMENS UNIVERSITY LAW SCHOOL GROUP: BUSINESS LAW LL.

M II YEAR SEMESTER III FOR ACADAMIC YEAR 2011 2012

SUBJECT DOCTARINE TOPIC DEVELOPMENT IN LOAN & ADVANCES

SUBMITTED BY Simmi Singh. ROLL NO: 15

SUBMITTED TO DR. Kiran Sharma Prof. Archana Padgonkar

ACKNOWLEDGEMENT This research project has become possible because of the valuable guidance and timely help of my teacher and research guide Prof. Kiran Sharma, who guided and showed me right throughout the completion of this project. The researcher is profoundly grateful and very much indebted to her for her suggesting the Non-Doctrinal Research topic, for her encouragement, timely advice and discussion inspite of her onerous teaching responsibilities and academic commitments. The researcher would also like to acknowledge her sincerest regards to the Principal of her revered institution Mrs. Krishnamurthy, who created a platform for law graduates by staring a Law School which is bound to carve its niche in the legal education fraternity in India and the researcher is also highly thankful to all teaching and non teaching faculty of Department of Law for providing all required academic facilities in accomplishing her research work. The researcher avails this opportunity as a privilege to express my humble thanks to God Almighty, my beloved parents and friends whose unfathomable faith in me, support, cooperation and motivation made this Project a

success.But not the least I will like to thank the almighty whose blessings helped me to complete the project.

Simmi Singh (Research Candidate)

Certificate It is certified that the work incorporated in this Doctrinal Research Development in Loans and Advances was carried out by Simmi Singh under my guidance and supervision.

The material obtained from other sources has been duly acknowledged in the Doctrinal Research. It is further certified to the best of my knowledge that this is original work.

Place: Mumbai Date:

Dr. Kiran Sharma (Professor)

OBJECTIVE OF THE STUDY The basic objectives of this project are: To understand what constitutes a Loan and Advances To understand how Loan and Advances in India have negative impact on Competitive Market. To understand the present regulatory framework to regulate loan and Advances in India. The Authorities and the manner or mechanism to carry out work as in form of system. The Ultimate Authority and its Decree. To analyze various cases and actions taken in past

To analyze the effectiveness of policy of Fines and penalties.

PREFACE This assignment is the part of the curriculum of LLM, Business Law Group, the III rd semester. I topic have been assigned the module from the Development in Loan & Advances sector . I have tried to explain the meaning of the aforesaid topics academically and also with reference of the senior eminent who have enlighten the subject and given the best knowledge in deepest sense for the better understanding and also references has been made to English and Indian cases which will enable to have a better insight to the aforesaid assignment. The present assignment has been written in a very simple language which is easy to understand the said assignment. I hope that this assignment will serve useful for reference to the readers of this assignment and it

Loan & Advances given in banking

will be a good feedback for my sincere efforts for completing the said assignment.

INDEX Title Chapter 1 Introduction Chapter 2 2.1.1 Loan and Advances 2.1.2 Restriction on loans and advances 2.1.3 Power of RBI to control advance by banking Co 2.1.4 Restriction on power to remit debts 2.1.5 Rates of Interest By banking Co

Chapter 3 3.1 Lending of Funds

3.1.1 Basic principal of Lending 3.1.2 Principle of Safety 3.1.3 Principle of Profitability 3.1.4 Principle of Liquidity 3.1.5 Principle of Purpose

3.1.6 Principle of risk spread 3.1.7 Principle of Security 3.1.8 National Interest 3.1.9 Bank, Credit, National Policy and objectives

Chapter 4 4.1 4.2 4.3 4.4 Forms of advances Cash Credit Overdrafts Loans

4.4.1 Classification of Loan and Advances 4.4.2 Secured Loans and Advances 4.4.3 Unsecured Loans and Advances 4.5 4.6 4.7 Precaution in case of Unsecured Advances Securities for bank Advances General Principle of Secured Advances Chapter 5 5.1 5.2 5.3 5.4 5.5 Classification of modes of Securities Rights of a banker as a Pledgee Mortgage Kinds of Mortgage Rights of Mortgagee

5.2.1 Duties of the Pledgee Bank 5.3.1 Essential features of Mortgage

Chapter 6 6.1 6.2 6.3 Charge Registration and Modification of Charge Registration and Modification and satisfaction of

6.1.1 Characteristic of Floating Charge

Charge

Chapter 7 7.1 7.2 7.3 Compromise of Lok Adalats R.B.I Guidelines on Lok Adalats Debt Recovery Tribunals DRT Lok Adalats

Chapter 8 8.1 8.2 8.3 8.4 8.5 Guarantee Economic functions of Guarantee Kinds of Guarantee Liability under Bank Guarantee Conclusion. DEVELOPMENT IN LOAN & ADVANCES. Chapter 1

8.2.1 Essential Features of Guarantee

Introduction The history of education in India is very rich and interesting. One can trace the ancient India education to the 3rd century BC. Research shows that in the ancient days, sages and scholars imparted education orally, but after the development of letters, it took the form of writing. Palm leaves and barks of trees were used for education, and this in turn helped spread the written literature. Temples and community centers often took major important role in school like guru schooling available to everyone and this led system. to the When Buddhism spread in India, education became establishment of some world famous educational institutions Nalanda, Vikramshila and Takshashila. These educational institutes in fact arose from the monasteries. History has taken special care to give Nalanda University, which flourished from the fifth to 13th century AD, full credit for its excellence. This university had around 10,000 resident students and teachers on its roll at one time. These students included Chinese, Sri Lankan, Korean and other scholars. It was in the 11th century that the Muslims established elementary and secondary schools. This led to the forming of few universities too at cities like

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Delhi, Lucknow and Allahabad. Medieval period saw excellent interaction between Indian and Islamic traditions in all fields of knowledge like theology, religion, philosophy, fine arts, painting, architecture, mathematics, medicine and astronomy. Later, when the British arrived in India, English education came into being with the help of the European missionaries. Since then, Western education has made steady advances in the country. With hundreds of universities and thousands of colleges affiliated to them, in fact scores of colleges in every discipline, India has positioned itself comfortably as a country that provides quality higher education to its people in specific and to the world in general.

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Chapter - 2 Loans and Advances in India. To primary functions of banks is accepting despite for the purpose of lending or investment. Lendings and investments are the primary source of income. Lending of funds to the constituents, namely, traders, businessmen and industrial enterprise, constitutes the main business of a banking company. The major portion of banks fund is employed by ways of loans and advances, which is most profitable employment of its funds. The major part of banks income is earned from interest and discount on the funds so lent. Advances comprise moneys lent in the form of loans, overdrafts cash credits as well as moneys employed in bills discounted or purchased. However there is difference in Advance and Loans. In loaning there are terms and conditions but advances does not require any term and condition. Loan is called a term loan where as advance is not a term loan. Advances reaches direct to beneficiary where as sometimes loans reached through a middle man. If any question arises whether any transaction is a loan or advance for the purposes of this section, it shall be referred to the RBI, whose decision shall be final section 20 (5). Banks enjoy a right to make advances or loans but this right is subject. So certain restrictions which have

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been provided under section 20, 20 A, 21 and 21- A of banking regulation act. They are as under: Restriction on loans and advances section 20. 1. Not with standing anything to the contrary contained in section 77 of the companies act 1956 no banking company shall a) Grant any loans or advances on the security of its own shares or b) Enter into any commitments for granting any loan or advances to or on behalf of i. ii. Any of its directors, Any firm in which any of its directors is interested iii. as partner, manager, employee or guarantor, or any company (not being a subsidiary of the banking company or a company registered under section 25 of the Companies Act 1956, or a Government company) of which, or the subsidiary or the holding company which any of the directors of the banking company is a director, managing agent, manger, employee or guarantor or in which he holds substantial interest or

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iv.

Any individual in respect of whom any of its directors is a partner or guarantor.

2. Where any loan or advances granted by a banking company is such that a commitment for granting it could not have been made if Clause (b) of sub section (1) had been in force on the date on which the loan or advance was made, or is granted by a banking company after the commencement of the section 5 of the Banking Laws (Amendment) Act 1968, but in pursuance of a commitment entered in to before such commencement, steps shall be taken to recover the account of the loan or advance together with interest if any due thereon with in the period stipulated at the time of the grant of the loan or advance, or where no such period has been stipulated before the expiry of 1 year from the commitment of the said section 5. Provided that the Reserve Bank of India may, in any case, on an application in written made to it by the banking company in this behalf, extended the period for the recovery of the loan or advance until such date, not being a date beyond the period of 3 years from the commencement of the said section 5, and subject to such terms and conditions, as the Reserve Bank of India may deem fit. Provided further that this sub section shall not apply if and when the director concerned vacates the office

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of the directors of the banking company, whether by death , retirement, resignation, or otherwise. 3. No loan or advance, referred to the sub section (2), or any part thereof shall be remitted without the previous approval of the Reserve Bank of India, and any remission without such approval shall be void and no effect. 4. Where any loan or advance referred to the sub section (2), payable by any person, has not been repaid to the banking company with in the period specified in that sub section then, such person shall if he is a director of such banking company on the date of the expiry of the said period, be deemed to have vacated his office as such on the said date. Explanation In this section. a) Loans and Advance shall not include any transaction which the Reserve Bank of India may having regard to the nature of the transaction the period with in which and the manner and circumstances in which any amount due on account of the transaction is likely to be realized the interest of the depositors and other relevant considerations specify by general or special order as not being a loan or advance for the purpose of the section.

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b) Director includes a member of any board or committee in India constituted by a banking company for the purpose of advising it in regards to the management of all or any of its affairs. 5. If any question arises whether any transaction is a loan or advance for the purpose of this section it shall be referred to the Reserve Bank of India whose decision there on shall be final. Comment on Section 20 The opening sentence of Section 20 starts with non obstante clause i.e. Section 70 of the Companies Act 1956 will have no application as to loan and advance made by the banking companies sub section (1) of the section 20 provides that no banking company shall a) grant any loan or advance on the security of its own shares or b) enter in to any commitment for granting nay loan or advance to or on behalf of i. ii. iii. any of its Directors any firm which any of its directors is interested as partner, manager, employee or guarantor , or any company ( not being a subsidiary of the banking company or a company registered under Section 25 of Companies Act 1956 or a

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Government company) of which any of the subsidiary or the holding company director, managing interest, or iv. Any individual in respect of whom any of its directors is a partner or guarantor. Power of Reserve Bank of India to control advance by banking companies 1. Section 21 where the Reserve Bank of India is satisfied that it is necessary or expedient in the public interest or in the interest the depositor banking policy so to do it may determine the policy in relation to advances to be followed by banking companies generally or by any banking company in particular and when the policy has been so determined, all banking companies or the banking company concerned, as the case may be shall be bound to follow the policy as so determined. 2. without prejudice to the generality of the power vested in the Reserve Bank of India under subsection (1) the Reserve Bank of India may give directions to banking companies, either generally or to the banking company or group of banking companies in particular as to agent, manager, employee or guarantor or in which he holds substantial

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a) b) c)

The purpose for which advance The margins to be maintained in The maximum amount of

may or may not be made. respect of secured advances, advances or other financial accommodation which, having regard to the paid up capital, reserves and deposits of a banking company and other relevant considerations, may be made by the banking company to any one company, firm , association of persons or individual, d) The maximum amount up to which having regards to the consideration referred to in clause (c) guarantees may be given by a banking company on behalf of any one company, firm, association of persons or individual and e) The rate of interest and other terms and condition on which advances or other financial accommodation may be made or guarantees may be given. 3. Every banking company shall be bound to comply with any directions given to it under this section. Restrictions on power to remit debts Section 20 A - Not with standing anything to the contrary contained in section 293 of the Companies Act 1956 a banking company shall not except with the

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prior approval of the Reserve Bank, remit in whole or in part any debt due to it by a) Any of its directors or b) Any firm or company in which any of its directors is interested as directors, partner, managing agent or guarantor or c) Any individual if any of its directors is his partner or guarantor. Any remission made in contravention of the provision of sub section (1) shall be void of no effects. Rates of interest charged by banking companies not to be subject to scrutiny by Court. Section 21 A Not with standing any contained in the Usurious Loans Act 1918 (10 of 1918) or any other law relating to indebtedness in force in any state, a transaction between a banking company and its debtor shall not be reopened by any court on the ground that the rate of interest charged by the banking company in respect of such transaction is excessive.

Chapter - 3

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Lending of Funds. Lending of funds to constitute mainly traders, business and industrial enterprises constitutes the main business of a banking company. The major portion of the banks fund is employed by the way of loans and advances, which is the most profitable employment of its funds. The major part of the banks income is earned from the interest and discount on the funds so lent. The business of lending nevertheless is not without certain inherent take undue risks in lending. While lending his funds, a banker can not afford to take undue risk in lending. While lending his funds, a banker therefore follows a very caution policy and conducts his business on the basis of the well known principles of sound lending in order to minimize the risk.

Basic Principle of Lending. While lending bank has to follow certain principle which includes principles of 1. Safety 2. Profitability 3. Liquidity 4. Purpose 5. Risk spread

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6. Security 1. Principle of Safety Safety funds mean that what ever is but should come back with interest through repayment of the loan. It is the first and the foremost principle of lending. The repayment of loan depends upon the borrowers i. ii. Capacity to pay and Willingness to pay The former depends upon his tangible assets and the success of his business. If he is successful in his efforts, he earns profit and can repay the loan promptly otherwise the loan is recovered out of the sale proceeds to the tangible assets. The willingness to pay depends upon the honesty and character of the borrower. The banker should take utmost care in ensuring that the enterprise or business for which a loan is sought is a sound one and the borrower is capable of carrying it out successfully. He should be person of integrity, good character and reputation. In addition to the above the banker generally relies on the security of tangible assets owned by the borrower to ensure the safety his funds. 2. Principle of profitability While granting loans, it must be borne in mind that whatever loan is given it should generated income to

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the bank in form of profit (which means it should cover the cost of funds, cost of its administration and risk cost) Hence the price of the loan products i. e. interest and other charges, should be such that it should amount to profit. Commercial banks are profit earning institutions; nationalized banks are no exception to this. Thus, they must employ their funds profitability but only for sake of higher profitability the basis principle of safety and liquidity is not to be ignored or sacrificed that is to say the bank should not grant advances to unsound parties with doubtful repaying capacity, even if they are ready to pay a very high rate of interests of the bank and its depositors.

3. Principle of Liquidity. Banks are essentially intermediaries for short term funds as their deposits are largely repayable on demand or at a short notice. They lend funds for short periods and mainly for working capital purposes. The loans are therefore largely repayable on demand. The banker must ensure that the borrower I s able to repay loan on demand or within a short period. This depends on the nature of assets owned by the borrower and pledged to the banker. For example

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goods and commodities are easily marketable while fixed assets like land and building and specialized type of plants and equipments can be liquidated after a time interval. Thus the banker regards liquidity as important as the safety of the funds and grants loans on the security of assets which are easily marketable without much loss. 4. Principle of Purpose. While lending his funds, the banker enquires of the borrower the purpose for which he seeks loans. Banks do not grant loans for each and every purpose they ensure the safety and liquidity of their funds by granting loans for productive purpose only, viz. for meeting working capital needs of a business enterprise. Loans are not advanced for ceremonies or for pleasure trips or for the repayment of a prior loan. Loan for capital expenditure for establishing business are of long term nature and the banks now grant such term loan also. After the nationalization of major banks loans for the initial expenditure to start small trades, businesses, industries etc, are also given by the bank. 5. Principle of risk spread.

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This is a cardinal principal of sound lending. A prudent banker a tries to select the borrower very carefully and takes tangible assets as security to safe guard his interest. Tangible assets are no doubt valuable and the banker feels safe while granting advances on the security of such assets, yet some risk is always involved therein. An industry or trade may be faced depressionary conditions and the prices of the goods and commodities may sharply fall. Natural calamities like floods and earthquakes, and political disturbances in certain parts of the country may ruin even a prosperous business. To safe guard his interest against such unforeseen contingencies, the banker follows the principles of diversification of risk based on famous maxim do not keep all the eggs in one basket. It means that the banker should not grant advances to a few big firms only or to concentrate them in few industries or in a few cities or regions of the country only. The advances on the other hand should be spread over a reasonable wide area distributing amongst a good number of customers belonging to different traders and industries. The bankers thus diversify the risk involved in lending. If few big customer meet misfortune or certain traders

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or industries are affected adversely, the overall financial position of the bank will not be in jeopardy.

6. Principle of Security Loan given by the bank should be secured ones so that in case of need the bank should fall back upon for repayment by enforcing the securities available to it. The unsecured can result in to loss of the banks since in the event of willingness or capacity of the banker becomes unavailable the bank will not be able to recover the loans granted. Due precautions must be taken while selecting securities for the loans.

7. National Interest The development of banking has reached a stage where the bankers are required to identify his business with national policies. Banking industry has a significant role to play in the economic development of a country. The savings of the people which is mobilizes by bank must be distributed to those sectors which require development in the countrys planning programmed. Our country has been engaged in the task of developing agriculture, small industries and

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exports for many years. The country is also conscious of the need to promote retail trade, transport business, and small business and to render financial assistance to enterprising persons who may not have sufficient means, in this way, the country can solve the problem of unemployment and also accelerate the growth of trade, industry and commerce. With this end in view, commercial banks have formulated schemes to finance agriculture, small scale industries, exports and small borrowers. The Reserve Bank of India issues directions to commercial banks to maintain ceilings on credit limits or higher marginal against certain essentials commodities which are in short supply. The directives are issued with a view to preventing the hoarding of stocks by unscrupulous borrowers and maintaining the price level. These directives must be strictly followed. Bank Credit, National Policies and Objectives Banking institution is amongst the commanding heights of an economy. They must be served the national policy and objectives. 14 major banks in India were nationalized to serve better needs of development of the economy in conformity with the national policy and objectives. Necessary changes in the banking policies and practices were thus urgently necessitated in the wake of nationalization to serve

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the wider social purpose of establishing democratic socialism in the country. Significant changes have taken place in the concept of security observed by the bankers in their attitude towards the hither to weaker and neglected sections of society during the last decade. The banks have been directed to finance on a large scale agriculturists, small industrialist, professional persons and transporters, etc. security of funds lent is not sought exclusively in the tangible assets of the borrower but also in his technical competence, marginal ability, honesty and integrity. Loans are being given in large number for setting up of small businesses or for starting practice by professional persons. The deposits insurance and credit guarantee corporation such loans. It is to be noted that bank credit has to act as an important instrument for achieving wider social purpose, national policies and objectives. However, the basic principle of sound lending is fundamental and is observed even by the nationalized banks. The ways in which the basic principles are followed of course may be modified to suit the needs of the hour. To sum up a lending banker has to keep in mind a number of factors while employing funds in advances and decide whether the proposal on hand is calculated

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risk acceptable to him. In addition there may be reason like insufficient of funds with the lending bank in Reserve Banks directives prohibiting particular type of advances etc. for which the particular bank or banks in general may not entertain an advance.

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Chapter - 4 Forms of Advances The bankers take into account the credit requirements of his requirements of his customer while advancing them funds. The advances are traditionally divided into two board categories, viz. i. ii. Loans, cash, credit and overdrafts, and Purchase and discount of bills. The terms and conditions, the rights and privileges of the borrower and the banker differ in each case. In India the category of loans, cash and credits and advances, account for the bulk of bank credit, about 82 % of the total outstanding credit sanctioned by Indian scheduled Commercial banks as on April 25, 1975, was in the form of loan, advances, etc. purchase and discounting of bills not as popular a means of bank credit in India as it is in foreign countries. Efforts have recently been made to popularize the use of bill of exchange for extending bank credit. This script describes existing practices in relation to loans, cash and credits and also over drafts in India as follow:

1. Cash Credit

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Cash credit is the main method of lending by banks in India and accounts for about 70 percent of the total bank credit. Under this system, the banker specifies a limit, called the cash credit limit for each customer, up to which the customer is permitted to borrow against the security of tangible assets or guarantees. The customer withdraws from his cash credit account as and when he needs the funds and deposits any amount of money which he find surplus with him on the day. The cash credit account is thus an active and running account to which deposits and withdrawal may be affected frequently. The customer is required to provide tangible assets as security to cover the amount borrowed from the banker. The borrower is charged interest on the actual amount utilized by him and for the period of actual utilization only. Other features of cash and credit arrangements are as follows: 1) The banker fixes the cash credit limit after taking into account several features of the working of the borrowing concerns such as production, sales, inventory levels, past utilization of such limits, etc. the banks credits are thus inclined to relate the limits to the security offered by their customer. This system is not without its drawbacks. Bankers may sanctions excessive limits to a specified customer because of their accent on security. The heavy reliance on bank credit in industry arises mainly out of the way in which

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the system of cash and credit has been operated in recent years.1 2) The advances sanctioned under the cash credit arrangement are technically repayable on demand and there is no specific date of repayment, but in practices they roll over a period of time. Cash accruals arising from the sales are adjusted in a cash credit account arising from the sales are adjusted in a cash credit account from time to time but is found that on a large number of accounts no credit balance emerges or debit balance fully wiped out over a period of years as the withdrawals are in excess of receipts. 3) Under cash credit arrangements the banker keeps adequate cash balances so as to meet the demand of the customer as and when it arises. But the customer is charged interest only on the actual amount utilized by him. To neutralized the loss of interest on the idle funds kept by the banks within credit limit sanctioned a commitment charge on the utilized limits was charged by the banks from April 1970 to October 1975.

1. Commitment Charge
1

Report of the Study Group on the Credit Needs of Industry, Reserve Bank India No 1969

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Under the cash credit system banks prescribe the cash credit limits for the customer on an annual basis. Customer is at liberty to draw against such limits as per their actual requirements. Banks charge interest from the day of withdrawal only. Therefore to avoid the loss caused to the bank by the non- utilization of cash credit limit fall to the full extent, a charge known as the commitment charge, is made by the banks. This charge is imposed on the utilized portion of the cash credit limit only and its rate happens to be nominal one. In India the Reserve bank of India made it obligatory for all scheduled commercial banks to levy a commitment charge @ 1 percent per annum on the unutilized portion of the credit limits in excess of Rs 10 lakhs with effect from 1st April 1970. The levy of commitments charge was with drawn by the Reserve Bank of India with effect from 1st November 1975. Now there is no commitment charge under the cash credit arrangements like by the term The Reserve Bank of India has constituted a Working Group to review the operation of cash credit system in recent years, particularly with regard to the gap between sanctioned credit limits extent of their utilization and to suggest modifications in the system. 2. Over Drafts.

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When a current account holder is permitted by the banker to draw more than what stands to his credit such an advance is called an overdraft. The banker may take some collateral security or may grant such advances on the personal security of the borrower. The customer is permitted to withdraw the amount as and when he needs it and to repay it by means of deposit in his a count as and when it is feasible for him. Interest is charged on the exact amount overdrawn by the customer and for the period of its actual utilization. 3. Loans In case of loan a specified amount is sanctioned by the banker to the customer, who may either draw the amount in cash immediately or may like the amount to be credited to his current account but legally it is presumed that he was withdrawn the amount from the bank and has deposited it in his current accounts. He is required to pay interest on the full amount from the date of sanction. A loan may be repayable in instruments or in lump sum. The distinction between cash credit and a loan lies in the continuing nature of the former which is not the case with the latter. A loan once repaid full or in part cannot be drawn again by the borrower unless the banker sanctions a fresh loan.

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Classification of Loans and Advances. The loans and advances granted by the banks are broadly classified in to: i. ii. i. Secured and UN secured.

Secured loans and advances section 5 (n) defines secured loans and advances means a loan or advances made on the securities of assets the market value of which is not at any time less than the amount of such loan and advances. Such security may be in the form of mortgage, pledge, charge or hypothecation. The distinguishing feature of secured loans and advances are: a. The loan must be made on the security of tangible assets of the borrowers by the way of mortgage, pledge, charge or hypothecation. b. The market value of such security must be not less than the amount of the loan at any time till the loan is repaid.

ii.

Unsecured

loans

and

advances:

loan

or

advances not secured as above called unsecured loan and advances section 5 (n) Banking Regulation Act. Where the market value falls below the loan, the loan in consideration as partly secured. The designation

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between secured and unsecured loans is made on the basis of legal title or charge created in favor of the lender. Under the traditional principles of lending the borrowing capacity of a person is judged on the basis of the tangible assets in the possession of the borrower, i.e. the larger is the creditworthiness of the borrower than larger is the value of his tangible assets. How ever it should not be understood that unsecured loans also called clean loans or advances are granted to person without observing the above mentioned criterion of creditworthiness. In fact unsecured loans are also granted to person of sufficient means possessing tangible assets and with sound financial position, but no charge or right is created on any such assets of the borrower in favors of the banker. In such case surety happens to be the personal obligation of the borrower which is sometimes supported by a guarantee given by the third party regarding the repayment of the loan. Cleans advances are obliviously granted to parties enjoying high reputations and sound financial position. Unsecured advances are granted with caution and with certain liabilities only because in case of default by the borrower the banker stands at par with other unsecured creditors.

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In case of secured advances, the legal status of the banker is that of secured creditor, he gets a the first absolute right to recover his dues out of the sale proceeds of the assets over which a charge is created in favors of the banker. Precautions in case on Unsecured Advances The business of sanctioning unsecured advances are comparatively more risky and needs special care and attention on the part of the banker. In the absence of a charge over any specific assets the safety of the advance depends upon the honesty and integrity of the borrower as much as upon the worth of his tangible assets. The banker has therefore to make proper enquires not only about his capacity to pay but also about his willingness to pay the amount. Though such enquiry is also necessary in case of a secured advance but its urgency is greater in case of unsecured advance for obvious reasons. The creditworthiness of a person means that he deserves a certain amount of credit which may safely be granted to him. Such creditworthiness is judged by the banker on the basis of his i. ii. iii. Character Capacity and Capital

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i.

Character in assessing the creditworthiness of a person the first consideration is that of the character of the person concerned. The word character implies and includes a number of personal characteristics of a person e.g. his honesty, regularity and promptness in fulfilling his promises and repaying his dues, senses of responsibility, good habits and the reputation and goodwill which he enjoys in the eye of others. If a person possesses all these qualities, without any doubt or suspicion in the minds of other, he possesses an excellent character and will be considered creditworthy by the banker.

ii.

Capacity the success of the enterprise largely depend upon the ability, competence and experience of the entrepreneur. If the borrower possesses necessary technical skill, marginal ability and experience to run a particular industry or trade, success of such unit may be taken for granted and the banker will consider him a deserving case for granting and advance. It should be noted that the significant of this factor is growing as the banks are willing to grant unsecured ;loans to technicians and competent person on the basis of soundness of their business project, irrespective of their own capital.

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iii.

Capital the importance attached by the banker to the adequacy of capital of the borrower is not without significance. Banks are the repositories of the public money and lend the borrowed money. The banker therefore does not lend money to an entrepreneur without adequate funds of his own. In case of failure of the business enterprises the banker will be able to realize his money if the borrowers own capital is sufficient. Though all the above mentioned factors are important and taken into account by the banker at the time of assessing the creditworthiness of a borrower to borrower. The consideration of security is now undergoing change in favor of grater emphasis on the ability and the competence of the borrower and the soundness of his project. However person of doubtful integrity and without good character are not granted unsecured advances. Securities for Bank Advances The banker safeguards his interest by granting loans and advances on the security of tangible assets i.e. large variety of goods and commodities, documents and immovable property. Section 5 (4) of Banking Regulation Act says that secured loans and advance

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means a loan or advance made on the security of assets. General principles of Secured Advances While accepting security on loan and advance a banker should observe the following basic principles: 1. Adequacy of margin There must be difference between the market value of the security and the amount of advantages granted against it. 2. Marketability of securities Marketability of securities means in case of default by the borrower, such securities must be easily marketable without loss of time and money .i.e. liquidity of the security. 3. Documentation Documentation means that necessary documents e.g. agreement of pledge or mortgage, charge, hypothecation etc. are prepared and signed by the borrowers at the time of securing loan. Such the securities pledged, mortgaged with him. Advances against Documents of Title to Goods A document to title to goods is a document used in the ordinary course of business as a proof of the possession or control of goods and authorizes either by endorsement or by delivery, the possessor of the document to transfer or receive the goods represented by such document.

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Section 2 (4) of Sales Goods Act 1930 defines: Document of the title of goods includes a bill of lading, warrant, warehouse keepers certificate, railway receipt multi model transport document, warrant or order for the delivery of goods and any other document used in the ordinary course of business as proof of possession or control of goods or authorizing or purporting to authorize, either by endorsement or by delivery, the possessor of the document to transfer or receive goods thereby represented Some important Documents of Title of Goods are: 1. Bill of Lading 2. Warehouse Receipt 3. Railway Receipt 4. Wharfingers certificate 5. Dock Warrant 6. Delivery order 1. Bill of Lading A bill of lading is a document issued by the shipping companies acknowledging the receipt of goods for carrying to a specific part. It also contains the conditions for such goods and full description of the goods. The shipping company gives an undertaking to deliver the goods to the consignee or to his order in same condition is which it has been

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received on payment of the freight and other charge due thereon. A Bill of Lading is a Prima Facie evidence of the fact that the packages as specified therein were put on board for transportation. A Bill of Lading though not negotiable instrument but transferable by endorsement and delivery like negotiable instrument. 2. Warehouse Receipt A Warehouse Receipt is a document issued by the owner of warehouse certifying the facts that goods mentioned therein have been kept for safe custody. Reserve Bank of India has granted some concession as to advances in order to promote warehousing in too country. 3. Railway Receipt Railway Receipt is the document issued by the Railway Administration acknowledging the receipt of goods specified therein for transportation to place mentioned therein. Thought it is not a negotiable instrument by transfer. Similarly Wharfingers certificate and dock warrant are also document of titles. Risk in case of Advances against Documents The documents of the title of goods represent actual goods and hence they are presumed to be as good ad the goods. Advances against them are subjected to the following risks in addition to the risk involved in advances against goods: 1. Greater risk of fraud and dishonesty

41

2. Not Negotiable document 1. In case of Railway Receipt the borrower may take delivery in period or on indemnity bond making charges ineffective. Advances against Life insurance policies A life Insurance policy is a contract between the insured and the insurer (company) wherein the latter promises to pay a specified amount after the expiry of certain period or on occurrence of death of the assured. The primary objective of the insured is large number of cases happens to make a provision for his old age or to secure protection to his dependants in case of his untimely death.

Merits of Life Insurance policy as Security A Life Insurance Policy is deemed a suitable security by a banker because of the following merits: 1. The policy can be legally assigned to the banker. 2. The policy has a Guaranteed Surrender Value 3. There is no any problem for supervision of the security to the banker 4. It is an easily realizable asset. Since its value can be easily realized by the banker on the death of the customer. Demerits of Life Policy

42

1. Life Insurance is a contract of utmost good faith. The insured is required to disclose to the insurer all material facts relating the contract which might affect the decision of the insurer to accept the proposal or not. The policy shall be void and all claims to any benefits shall cease in following cases: i. ii. If there are any untrue or incorrect statement A Life Insurance Policy requires regular payment by the insured. of premium. Default in payment may render the policy lapsed. iii. If any of the matters have not been truly and fairly stated or that any material information has been concealed. 2. Under the contract of insurance, the insured promises to pay the insurer the premium regularly failing which the policy will lapse. The minimum period. Thus, there will be risk in security. 3. Life Policy sometimes contains some special condition also. For example, a suicide clause may be incorporated therein to the effect that the policy shall become invalid if the assured commits suicide within the given initial period. Precaution to be taken by the banker.

43

1. The insurable interest must be identified and verified. 2. Surrendered value of the policy must be ascertained. A margin of 5 to 10 percent of the surrender value of the policy is to be maintained. 3. Charge over the policy is created. 4. An Endowment policy is to be preferred. 5. Regular payment of premium is to be ensured.

44

Chapter - 5 Classification of modes of securities Pledge Section 172 of the Indian Contract Act 1872 defines pledge as bailment of goods as security for payments of a debt or performance of a promise. The person who offers the security is called the Pawnor or Pledger and the bailee is called the Pawnee or the Pledgee. Thus in case of a pledge i. Bailment of Goods Section 148 of the Indian Contract Act 1872 defines bailment as the delivery of goods from one person to another for some purpose upon the contract that the goods are returned back when the purpose is accomplished or otherwise disposed of according to the instructions of the bailor. There are two important requisites of a bailment: a. Delivery of Goods Delivery of goods is essential for a contract of bailment. Delivery may be either physical delivery or constructive symbolic) delivery. Physical transfer of goods from the custody of the bailor to that of the bailee is not necessary. There may be constructive or symbolic delivery, which means anything having the legal effects of putting the goods in possession of the bailee or any person authorized by him for e.g. if the bailee puts his own

45

lock on the door of the godown storing the goods pledged, it would be treated as transfer of possession. Even the handling over of the key of the lock on the door of the godown amounts to delivery. Similarly handing over the documents of the title to goods like bill of lading or railway receipt, duly endorsed will also mean delivery of the goods. If the warehouse man is in possession of the goods is authorized to hold the goods on behalf of the bailee and he accepts it the transfers of possession will be deemed to be complete. This is called delivery by attornment. But distinction should be made between a mere custody of goods and possession which may be called judicial possession. Goods might be in the custody of a servant or a guest but they do not hold possession of the goods. ii. Returns of Goods To constitute a contract of bailment it is essential that the bailee should return the same goods to the bailor or dispose them according to his instructions after the purpose for which the goods were delivered is fulfilled. The deposits of the money in a bank account is not bailment because of Money is not goods and

46

The banker is under no obligation to return

the same currency notes and coins which was handed over to him. 2. Bailment as Security for Payment of Debt It is essential that the bailment of the goods is done with the object to secure the payment of a debt or the performance of a promise. If the goods are left with the banker for safe custody or for any other purpose, it does not constitute a pledge. Banks therefore take a declaration in case of pledge to safeguard their interests. Who can pledge? The goods can be pledged by anyone who is in legal possession of them namely i. ii. iii. iv. v. The owner of the goods himself. The mercantile agent of the owner Section 178 The Joint owner with consent of other co Pledge by pledge himself section 179 of Indian Person in possession of goods under voidable

Indian Contract Act 1972 owner. contract Act 1972 contract Section 178 A of the Indian Contract Act.

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Rights of a banker as a Pledgee. Pledge 1) can exercise following rights under the provision on Indian Contract Act 1872, namely: Right of retainer1 section 173 of the Act The Pawnee may retain the goods bailed an\d for the interest. According to section 174 his right if retainer is not general but specific i.e. only for the loan for which the pledge is created but in case of express agreement general right of retainer may also be given to the banker. 2) 175. 3) Right of sale where Pawnor makes default in payment of loan under section 176. Duties of the Pledgee Bank 1) To return the goods along with accretion to goods if any, once the money is paid back to the pledger 2) him. Mortgage When a customer offers, immovable property like land and building as security for loan, a charge is created
1

Rights of extra ordinary express under section

To take that much care of the goods which he

would have been taking had the goods belonged to

Section 173 of the Following act

48

by means of mortgage section 58 of the Transfer of property Act 1882 defines mortgage as the transfer of interest in specific immovable property for the purpose of securing payment of money, advance by the way of loan, an existing or future debt, or performance of an engagement which may give rise to pecuniary liability. The transferor is called the mortgage, the transferee mortgage the principle money and interest thereon the payment of which secured are called the mortgage money and the instrument if any by which the transfer is effected is called a mortgage deed Case law of Debi singh v/s Bhim singh and others A.I.R. 1971, Delhi 316 Essential Features of Mortgage 1) A mortgage is the transfer of an interest in the specific immovable property and differs from sale wherein the ownership of the property is transferred. Transfers of an interest in the property means that the owner transfers some rights to ownership to the mortgagee and retains the remaining rights with in himself. E.g. a mortgager retains the right of redemption of the mortgaged property.

49

2) If there are more than one co- owner of an immovable property, every co owner is entitled to mortgage his share in the property1. 3) The property intended to be mortgaged must be specific i.e. it can be describes and identified by its location, size boundaries etc. A mortgager must mention which of his property is intended to be mortgaged. 4) The object to transfer of interest in the property must be secure a loan or to ensure the performance of an engagement which results in monetary obligation. Thus the property may be mortgaged to provide security to the creditor in respect of the loans already taken by the mortgager or in respect of the loans which he intends to take in future. An existing overdraft can be secured by the mortgage of the property. But if a person transfer his property for a specific purpose other than the above, it will not be called a mortgage e.g. a transfer of property in discharge of a debt is not a mortgage \. 5) The actual possession of the property need not always be transferred to the mortgages. 6) The mortgagee gets, subject to the terms of the mortgage deed and the provision of the Transfer of Property Act 1882 the right to recover the amount of
1

Debi Singh v Singh and Others, A.I.R. 1971, Delhi 316.

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the loan out of the sale proceeds of the mortgaged property. 7) The interest in the mortgage property is reconvened to the mortgager on the payment of the amount of the loan along with interest thereon. Kind of mortgages Section 58 recognizes the following forms of mortgages and specifies different rights and liabilities of the parties thereto: 1. Simple mortgage 2. Mortgage by conditional sale 3. Unsufructuary mortgage 4. English mortgage 5. Mortgage by deposit of title deeds 6. Anomalous mortgage 1.Simple mortgage In a simple mortgage the mortgager binds him personally to pay the mortgage money. He does not give possession of the property but aggress, expressly or impliedly that if he fails the mortgagee shall have a right to cause the mortgaged property to be sold and the proceeds of sale to be applied in payment of the mortgage money to be extend necessary. The words cause the mortgaged property to be sold mean that the mortgage shall have to seek invention of the court for selling the

51

mortgaged property. He himself is not authorized to sell the property. As the possession over the property remain with the mortgager, such mortgage is called non- possessor. The mortgager takes upon himself a personal obligation to repay amount failing which the mortgagee gets two options : 1. 2. To apply to the court for permission to sell To file a suit for recovery of the whole the mortgaged property, or amount without selling the property. 2. Mortgage by Conditional Sale Under this form of mortgage, the mortgager ostensibly sells the mortgaged property with any one of the following conditions : i. That the sale shall become absolute if the mortgager fails to pay the mortgage money on a certain date. ii. iii. That the sale shall become void if the That the buyer shall transfer the property mortgager pays the mortgage money. to the seller if the latter makes payment of the mortgage money on a certain date. 3. Unsufructuary Unsufructuary Mortgage the In case of mortgage mortgager gives

possession of the property or binds himself, either expressly or by implication, to give such possession to

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the mortgagee. The mortgagee is authorized to retain his possession over the property until the payment of the mortgage money is made and to receive rents and profits accruing from the property and to appropriate the same in lieu of interest or in to payment of the mortgage money or in both. 4. English Mortgage In case of English mortgage the mortgager binds him to repay the mortgage money on a certain due and transfers the mortgage property absolute to the mortgagee on the condition that the mortgagee will re transfer the same to the mortgager upon the payment of the mortgage money. The mortgagee under the English Mortgage is entitled to immediate possession and to retain possession until he is repaid. Thus the mortgager 1. Incurs personal liability to pay and 2. In addition transfers the mortgages property absolutely i.e. with all interest and the rights in the property. In case of default by the mortgager the mortgagee is entitled to sell the property without seeking permission of the court in special circumstances mentioned in Section 69. 5. Mortgage by Deposits of Title Deeds Where a debtor delivers to the creditor or his agent documents to tile to immovable property with intent to create a

53

security thereon the transaction is called a mortgage by deposits of title deeds. It is also known as Equitable Mortgage. But the Act restricts such mortgage by deposit of title deeds to the town of Calcutta, Madras and Mumbai and any other town which the State Government concerned may specify in his behalf. 6. Anomalous Mortgage A mortgage which is not a simple mortgage, a mortgage by conditional sale, an Unsufructuary mortgage, an English mortgage by deposits of title deeds within the meaning of section 58 is called an anomalous mortgager and the mortgage do not strictly conform to those specified under section 58 for the above types of mortgages and there is even a slight variation from the same, the mortgage mortgage. 7. Legal Mortgage v. equitable Mortgage From the point of view of transfer of title to the mortgaged property, mortgage are divided into two categories : i. ii. Legal mortgages and Equitable mortgage. In case of legal mortgage the mortgager transfer legal title to the mortgaged property in favor of the mortgage by deed. According to Section 59 of the Transfer of Property Act 1882, a legal mortgage can be affected only by a registered instrument if the falls in the category of anomalous

54

mortgage

money

is

Rs

100

or

more.

On

the

repayment of the mortgage money, the title to mortgaged property is re transferred to the mortgager. In legal mortgage transfer of legal title to the mortgage involves expenses in the form of stamp duty and registration charges. In case of an equitable mortgage, the mortgage transfers the document of title to the mortgage property to the mortgagee or the purpose of creating an equitable interest of the mortgagee in the property it means that the legal title to the property is not passed on the mortgagee but, the mortgager undertakes through a Memorandum of deposit, to execute a legal mortgage in case fails the mortgage money. The mortgagee is thus empowered to apply to the Court to convert the equitable mortgage in to legal mortgage if the mortgager fails to pay the mortgage vis a vis legal mortgage are as follows: Rights of Mortgagee The mortgagee can exercise the following rights under the provision of Transfer of Property Act 1882. 1. Right to foreclosure or sale The mortgagee has a right to obtain from the Court a decree that the mortgager shall be absolutely debarred from his rights to redeem the property or a decree that the property be sold. The former is called a suit for foreclosure.

55

This right can be exercised by the mortgagee at any time after the mortgage money has become due to him and before a decree has been made for the redemption of the mortgaged property and in the absence of a contract to the contrary. The right of foreclosure may be exercised by (i) (ii) A mortgagee by conditional sale or A mortgagee under an anomalous mortgage,

which authorizes the mortgage which authorizes the mortgagee to exercise such right. A unsufructury mortgagee or a mortgagee by conditional sale is not authorized to file a suit for sale. The right of the mortgagee is absolute and cannot be postponed in preference to other debts of the principal debtor. 2. Right to sue for mortgage money Under section 68, the mortgagee has a right to sue for the mortgage money in the following cases: i. ii. Where the mortgager binds himself to pay the money or Where the mortgaged property is wholly or partially destroyed or the security is rendered insufficient and mortgager has failed to provide security is rendered insufficient and mortgager has failed to provide further security to render the whole security sufficient or

56

iii.

Where the mortgagee deprived of the

whole or a part of his security by or in consequence of the wrongful act or default of the mortgager or in consequences of the wrongful act or default of the mortgager or iv. Where the mortgagee being entitled to possession of the mortgaged property, the mortgager fails to deliver the same to him. 3. Right of sale without the invention of the court Section 68 the mortgagee has a right to sue for mortgage money in following cases: i. ii. Where the mortgage is in English mortgage and Where the power of sale without the intervention of the Court is expressly conferred on the mortgagee by the mortgage deed and the mortgagee is the Government or the mortgaged property or any part thereof was on the date of the execution of the mortgage deed situation within the town of Calcutta, Madras, Mumbai or in any other town or area which the State Government may specify in this behalf. The right of sale shall be exercised after giving a notice in writing to the mortgager requires payment of the principal money and if the mortgager defaults in making such payment with in 3 months of the service of such notice or when the interest under the

57

mortgage amounting at least to Rs 500 is in arrears and remains unpaid for 3 months after becoming due. The amount of the sale proceeds of the mortgaged property shall be held by the mortgagee in trust and will be applied by him in the following order: i. In payment of all coasts charges and expenses properly incurred by him in order to sell the property. ii. In discharge of the mortgage money and coast and other money, if any due under the mortgage and iii. The balance to be paid to the person entitled to the mortgaged property. Section 69 A authorizes the mortgage having right of sale under section 69 to appoint, by righting a receiver of the income of the mortgaged property or any of its part. 4. Right to the accession to mortgage property Section 70 enables the mortgagee to hold for the purpose of security and accession to the mortgage property which occurs after the date of the mortgage if a contract to the contrary does not exist. a. Examples A mortgage to B a certain field bordering on a river. The field is increased by alluvia. For purpose of his security, B is entitled to increase. b. X mortgages a plot of land to Y and afterwards constructs a house on the plot. For the

58

purpose of his security Y is entitled to the house as well ass the plot. Right to sue and right to relies the Security are distinct Rights, 5. Right in case of renewal of mortgage lease when the mortgage property is a lease and the mortgager obtains a renewal of the lease, the mortgagee in absence of a contract to the contrary shall for the purpose of the security be entitled to the new lease (Section 71) 6. Right to recover money spent on mortgage property Under section 72 a mortgage may spend such money as is necessary for the following purpose and may add such money to the principal money in the absence of a contrary. Interest on such shall be payable by the mortgager at the rate payable on the principal and if no such rate is fixed at the rate of 9 % per annum: i. ii. property iii. For making his own title thereto good against the mortgager and renewable leasehold one. For the preservation of the mortgaged For supporting the mortgagers title to the property from destruction forfeiture or sale

59

7. Sub Mortgage. The mortgagee may himself like to sub mortgage the property mortgaged to him by the mortgager. Such sub mortgages are accepted by banks in circumstances when a customer is unable to furnish any better security to the banker. The banker should take the following precautions in this regards: 1) A notice should be given to the mortgager who should be required to confirm the amount due from him to the mortgagee. 2) The banker should direct the mortgager not to make payment to the mortgagee but to the bank being the sub mortgagee. 3) mortgage mortgagee. 4) The sub mortgager shall be subject to the terms and condition stipulated in the original mortgage deed entered into between the mortgagee and mortgager. The banker should therefore scrutinize these terms very carefully. The deed banker and should the title take the original the deed from

8. Assignment Assignment is another mode of providing security to the lending banker. Assignment means transfer of a

60

right, property or a debt existing or future. The borrower may assign any of his rights, properties or debts to the banker to secure a loan from the latter. The transferor is called the assignor and the transferee the assignee. The borrowers generally assign the actionable claims to the banker, Section 130 of the Transferable property Act 1882 permits such assignment to anyone except to a Judge, a legal practitioner or an officer of the Court of Justice. Section 3 of the act defines an actionable claim as a claim to any debt other than a debt secured by mortgage of immovable property or by hypothecation or pledge of movable property or to any beneficial interest in moveable property not in the possession, either actual or constructive, or the claimant, which the Civil Courts recognize as affording grounds of relief, whether such debt or beneficial interest be existent, accruing, conditional or contingent. In banking business, a borrower may assign to the banker i. ii. iii. i. The books of debts Money due from Government department Life insurance policies A legal assignment or

or semi government organizations and Assignment may be either

61

ii.

An

equitable

assignment.

legal

assignment is an absolute transfer of actionable claim and must be in writing, signed by the assignor. The latter informs his debtor also in writing intimating the assignees name and address. The assignee also serves a notice on the debtor of the assignor and seeks a confirmation of the balance so assigned. If all these requirements are not fulfilled the assignment is called an Equitable assignment. Case law In Bharat Nidhi Ltd. v Takhatmal and anothers
1

The Supreme Court considered the issue whether the Power of Attorney together with the endorsement on the bill in favor of the bank. In this case a contractor executed an irrevocable letter of attorney in favor of his banker to collect his bills and to appropriate such receipts towards and in repayment of the advances made or to be made by the banker and all other money due from the contractor to the banker. It was also declared that all powers granted to the bank were irrevocable as long as any claims of the attorney remained outstanding. Before the banker could receive the payment the amount due under the bill was attached by a creditor of the contractor in

(969) 39 Comp. Cas. 114 (S.C)

62

execution of a money decree obtained by him against the contractor. Similarly the case of Palmer v Carey meaning of an equitable assignment: The extent of the principal to be deduced is that an agreement between debtor and a creditor that the debit owing shall be paid out of a specific funds coming to the debtor or an order given by a debtor to his creditor upon a person owing money or holding funds belonging to the giver of the order directing such person to pay such funds to the creditor will create a valid equitable charge upon such funds. In other words it will operate as an equitable assignment of the debts/ funds to which the order refers. HELD the Supreme Court observed the obvious intention was to provide protection to the lender and to secure payment of the loans and with that objective in view the bank was authorized to receive payments of the bills and to appropriate the receipts towards repayment of the loans. The Court concluded that there was an agreement between the lender and the borrower that the debts owning to the lender would be paid out of a specific funds of the borrower that the debts owing to the lender would be paid out of
1 1

to explain the

1926 A.C 703 at 706

63

specific funds of the borrower in the hands of the Government authorities. Hence it is clear engagement to pay the bank out of the money received under the bill and it amounted to an equitable assignment of the funds by the way of security. Loans to Companies Borrowing of the company has been regulated by the Companies Act 1956. A company can not borrow money unless it is so authorized by its memorandum. In case of a trading company, it is not however necessary that the object clause of its memorandum should expressly authorize it to borrow. As borrowing is incidental to trading such accompany has implied power to borrow. Other companies must have a borrow power clearly specified in the memorandum. Borrowing without express or implied authority is not valid. Companies borrow large sums of money by issuing debentures. Generally debentures create charge on assets of the company. Chapter - 6 Charge When some property is assigned to any loan as security is called charge. It is usual though not essential for debentures to create a charge on companys assets. The charge which a company may create on its assets is of 2 kinds namely:

64

1. Fixed Charges and 2. Floating Charge When concept a mortgage / charge are that it is created on some definite or specified assets. Such charge is suitable for property which is more or less fixed. But it is quite impracticable where that asset to be charged is of circulating or liquid nature. Such assets keep charging and a fresh charge would have to be created every time they were turned over in the course of business. This would hinder business. Hence there was the necessity of charge that would not paralyze the companys business and at the same time give a safe security to the money lender. In the words of GOWER1 the ingenuity of equity practitioner led to the evolution of an unusual but the highly beneficial type of security known as the FLOTING CHARGE. A floating charge is a charge of ambulatory nature floating with the property it is indented to cover. It attaches to the subject charge in the property, it is intended to cover. It attaches to the subject charged in the varying conditions in which it happens to be form time to time. It is a charge which floats like a cloud over the whole assets from time to time failing within a generic description .. it does not get
1

the principles of modern company law 78.

65

attached to any specific property until it crystallizes. The advantage of the charge unlike specific charge is that the company can use the assets charged in the ordinary course of business. Characteristics of Floating Charge A mortgage or charge by a company which contains the 3 following features is a floating charge: 1) It should be a charge upon the class of assets both present and future 2) The class of assets charged must be one which in the ordinary course of business of the company would be charging from time to time. 3) It should be contemplated by the charge that until some step is taken by the mortgagee the company shall have the right to use the assets comprised in the charge in the ordinary course of its business. Crystallization of Floating Charge In the following cases Floating charge crystallizes and becomes specific: i. ii. iii. When a company makes a default or When a company comes to be wound up or The creditor takes steps for enforcing the claim.

Registration and Modification of Charges Documents to be obtained

66

Banks must obtain and verify the copies of Memorandum of Association, Articles of Association, Certificate of Incorporation of Business and (for Certificate public of Commencement limited

company only) to see that the borrowing is for the objective of the company and that the Board of Directors has power to borrow. Board Resolution A resolution passed in a duly convened meeting of Board of Directors and signed by Chairman of the meeting and countersigned by the Secretary should be obtained, authorized an official of the company to sign documents on behalf of the company.

Borrowing Capacity Borrowing powers of the company arise due to objective clause in Memorandum of Association. The borrowing powers of the Board of Directors are stated in Articles of Association. A company may borrow money for and on behalf of the company if resolution in this regard has been passed in the meeting at the Board Section 292 of The Companies Act 1956. Such resolution should specify the total amount which can be outstanding at one point of time.

67

Where total borrowing of a company exceeds power of the Board, the Board has to seek approval of its shareholder under section 293(1) (d). Common seal Loan documents bear the common seal of the company where the Memorandum and Article stipulated so. Affixation of common seal should be in the manner prescribed in Article of Association or Board Resolution. REGISTRATION, MODIFICATION AND

SATISFACTION OF CHARGE Under the provision of Companies Act 1956 , a company is considered a legal person and the banks have to deal carefully with a company and for that purpose have to obtain copies of various documents such as Memorandum of Association, Articles of Association, Certificate of Incorporation and Certificate of Commencement of Business to see that the borrowing is in line with the objectives of the company and that the Board of Directors has power to borrow. Registration of Charges created on the assets of a company Under Section 125 of Companies Act 1956 every charge (details given below) created by a company on

68

its assets shall be held void against the liquidator and any creditor of a company unless the prescribed particulars of the charge (together with copy of instrument by which the charge is created) are filed with the Registrar, for registration with in 30 days, after date of its creation. In case of charge crated outside India, 30 days shall begin on receipt of instrument in India. Under Section 127, if a property is required by a company subject to a charge, the particulars are required to be filed with in 30 days after the date on which the acquisition is completed. The Registrar can extend the time period by 30 days. Charge required registration The Charge for which the Particulars are required to be filled are: a) Charge on uncalled share capital of the company. b) Charge for purpose of securing any issue of debentures c) Charge on any immovable property or any interest therein. d) Charge on any book debts of the company. e) Charge not being pledge on any movable property. f) A floating charge on the undertaking or any property of the company including stock in trade. g) Charge on calls made but not paid. h) Charge on ship or any share in a ship.

69

i) Charge on goodwill, trade mark or copy right or license under a copyright, patent or license under a patent. This means that banking loans such as a Term loan, Cash Credit Hypothecation, Bills discounting, Pre shipment / Post shipment facilities require registration of charge. Certificate of Registration Under Section 132, the registrar shall give a certificate of registration of any charge charge. registered, stating the amount thereby secured. The certificate is conclusive evidence of

Chapter 7 COMPROMISE ADALATS Creation of Lok Adalats - Lok Adalats are created under Legal Services Authority Act 1987. Decisions & Appeals Their decisions are in the form of consent decrees and no appeals lies against their judgment and decision is binding on all parties. Procedure and Powers Civil Procedure code is applicable, i.e. these can send summons, take SETTLEMENT THROUGH LOK

70

evidence on oath, initiate, ex party proceedings, and determine Court procedures. Lok Adalat on bank request Banks can call Lok Adalat by requesting the High Court of the State. Advantages There are no Court fees involved when fresh disputes are referred to it. It can take cognizance of any existing suit in court as well as look into and adjudicate upon fresh disputes. If no settlement is arrived at the parties can continue with Court proceedings. Its decrees have legal status and are binding. Reserve Bank of India Guidelines on Lok Adalats With a view to making increasing use of the forum, of :Lok Adalats to settle banking disputes involved smaller amounts, Reserve Bank of India during April 2001 advised banks and financial institutions to follow the following guidelines for implementation, with immediate effect: 1. Amount Cases involving an amount unto Rs 20 lakhs (Reserve Bank of India enhanced it from Rs 5 lakhs, Aug 3, 2004) may be referred to Lok Adalats. 2. Borrowers All NPA accounts, both suit filed and non suit filed, which Adalat are in doubtful and loss category. No cut off date is suggested since Lok Adalat is an on going process.

71

3. Settlement Formula The settlement formula would be flexible Certain essential parameters, as under, should be kept in view: a) A decree should be sought from Lok Adalat for the principal amount and interest claimed in the suit and after full payment of decree amount a discharge certificate should be issued by the bank / financial institution. b) c) The repayment period should be with in 1 The negotiation agreement with the borrower year to 3 years. should contain a default clause in terms of which if borrower does not pay installments due regularly with in the repayment period, entire debt will fall due for payment and bank may initiate legal proceedings. d) should The have Officers representing powers the to institution the sufficient accept

compromises worked out with in the policy frame work laid down by the Board of Directors of each institution, while attending Lok Adalat and should respond pro actively to the suggestion of the Presiding Officer of the Lok Adalat. DRT LOK ADALATS Banks can take up matters where outstanding exceeds the above ceiling with the Lok Adalats

72

organized by the Debt Recovery Tribunals / Debt Recovery Appellate Tribunals. HYPOTHECATION AS PER Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002 Section 2 (n) hypothecation has been defined as a charge in or upon any moveable property existing or future created by a borrower in favor of a secured creditor without delivery of possession of the moveable property to such creditor as security for financial assistance and includes floating charge and crystallization of such charge into fixed on moveable property. A cash credit amount account like an overdraft account is a running account but with a fixed drawing limit is fixed with the sanctioned limit. Drawing limit is fixed periodically on the basis of value of the security. In such advances the ownership as well as possession of the security remains with the borrower. A cash credit account is very convenient for the borrowers. Securities Cash, credit accounts may be against hypothecation of stocks of raw material, stock in process or finished goods or stores, spares etc. Stock statement and margins - The borrower are required to submit to the bank a statement of stock

73

and other securities charged to the bank on pre fixed intervals, say fortnightly or monthly. Margin The banks maintain margins on the security which differs from case to case depending upon the nature of security and other considerations. Renewals Cash credit limits are sanctioned by the banks for a period of 1 year where after it can be extended for further period also on review. LEGAL ASPECTS IN HYPOTHECATION Possession and Sale Hypothecation is an equitable charge, where the borrower keeps the possession of the security on behalf of the creditor. The borrower keeps the possession of the security on behalf of the creditor. If the borrower fails to return the advance against the hypothecation of securities the bank can take possession of the securities with consent of the borrower and becomes a Pledgee. On becoming Pledgee the bank get all the rights of the pledge including right to sell without intervention of the court. Under Securitization Act the bank also has got the right to sell the hypothecation securities without intervention of the Court subject to compliance of certain legal formalities.

74

Shortages If there is shortage of securities the bank can bring criminal proceedings under Section 405 of Indian Penal Code.

Chapter - 8 GUARANTEE Guarantee as a security for Bankers advance Contract of guarantee have special significance in the business of banking as a mean to ensure safety of funds lent to the customers. When bankers advances are not secured by means of collateral securities and the personal security of the borrower is in adequate, guarantee plays an important role. The need for this form of security arises not only when an applicant for loan cannot offer any tangible security but also when the banker finds that the position of the customer indebted to him has weakened as a result of the

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depreciation in the value of the collateral security deposited. A guarantee is in fact the personal security of the third person who must command the confidence of the banker. Economic Functions of the Guarantee The function of a contract of guarantee is to enable a person to get a loan, or goods on credit or an employment. Some person comes forward and tells the lender or the supplier or the employer that he the person in need may be trusted and in case of any default, I undertake to be responsible. E.G. in Birkmyr v Darnell1 The Court said If 2 persons come to shop and one buys and the other to give him credit promises the seller. If he does not pay you, I will. This type of collateral promises undertaking to seller be liable for the default of another is called a contract of guarantee. Significance of guarantee as a security has greatly increased in recent years. Since the introduction of social control on banks and after Nationalization of major or banks, greater attention is being paid towards augmenting bank advances for small and neglected borrowers who are unable to provide sufficient tangible assets as a security. Presently
1

(1704) 91 E.R. 27.

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under social welfare scheme Government is taking guarantee for borrowers. Definition Section 126 of the Indian Contract Act 1872 defines a contract of guarantee as a contract of perform the promise or discharge the liability of a third person in case of his default. The person of guarantee is thus a secondary contract being between the creditor and the principal debtor themselves. The existence of a principal contract is essential for entering into a contract of guarantee. It is a tripartite agreement which contemplates the principal debtor the creditor and the surety1. Kinds of guarantee The contract of guarantee may be: 1) Specific guarantee and 2) Continuing guarantee. 1) Specified guarantee Where guarantee is given for a specific or a particular debt is specific guarantee. The guarantors liability will come to an end as soon as the particular debts are repaid. 2) Continuing Guarantee Where guarantee extends for series of transaction between the banker

Mahabir Shumser v Lloyd Bank, A.I.R.1968 Cal. 371.

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and his debtor Section 129 to Indian Contract Act 1872. A guarantee of this kind is intended to recover a number of transactions over a period of time. It is open for many transactions as distinguished from a single transaction. The old case Kay v Groves (1829) 80 E.R 1274. Explains continuing guarantee: I hereby agree to be answerable to K for amount 5 sacks of flour to be delivered to T payable in 1 month. 5 sacks were actually supplied and T paid for them. Further supplies were made during the same month for which T failed to pay. The surety was then sued. The Court held that it was not a continuing guarantee. The essence of continuing guarantee is that it applies not a specific transaction only but to a series of transaction and makes the surety liable for unpaid balance at the end of guarantee. Liability under bank guarantee A bank guarantee is a sort of an absolute undertaking on the part of the bank under an arrangement with its customer to pay to the creditor when ever the latter invokes the guarantee. In a matter of this kind before the Calcutta High Court1.
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(Road Machine India P.Ltd v P. & E.Corp. of India,

A.I.R 1983 Cal. 91.)

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The contract was to ship goods. Performance was assured by means of a bank guarantee. The vendee could invoke the guarantee if the vendor failed to perform his obligation. The guarantee was irrevocable and the vendees declaration that performance was not satisfactory was to be conclusive and binding. The vendor did not ship the goods with in the stipulated time. The guarantee was invoked by the vendee by means of a letter which without giving any details only stated that the vendor had defaulted in satisfactory execution. The vendor tried to stay the invocation of the guarantee. The Court refused to oblige. The details of the relation between the vendor and the vendee were irrelevant to the obligation of the bank to pay the amount on demand1 Where also an interim injunction was refused2. . A similar stay was refused where the ground alleged by the contractor was that the work allotted to him was impossible and vital facts were suppressed from him. The court refused to follow a decision of the Delhi High Court in Harprasad & Co v Sundaran Mills,

1
2

Bird & Co v Tribunal Jute Mills 1979 83 Cal. W.N. 802 Texmaco Ltd v SBI, 1979 83 Cal. W.N. 807

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A.I.R 1980 Del. 174. to effect for invoking a bank guarantee the bank should be informed of all the facts which go to show that the payment had really become due under the guarantee. The Court said that a bank guarantee is a commercial document. It can be invoked in a commercial manner. The invocation would be sufficient and proper if the bank concerned understand that the guarantee is being invoked1.

Shreeram Cloth Stores v Trading Corpn. Of Bangladesh 1980 1

Cal. H.C Notes 132, United Commercial Bank v Bank of India (1981) 2 S.C.C. 766 : A.I.R. 1981 S.C. 1426

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Criticism Interest only loans allow you to pay interest only. In contrast, a traditional amortizing mortgage requires you to pay some interest and some principal in each monthly payment. By eliminating the need to pay principal, an interest only loan option keeps your monthly payments lower. This page covers how fixed rate interest only loans work. Benefits of Interest Only Loans There are a variety of reasons you might want to have a lower monthly payment:

Buy a more expensive home with a smaller To free up money that you have a better use for To keep your monthly obligations smaller To make your own custom amortization schedule

monthly payment

Interest only loans can work very well when you intend to use them properly. For example, your income might be variable (because of bonuses or commission based work). In this case, you might save on your monthly payment (by paying interest only) and make larger payments against the

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principal when you have extra money. Of course, you have to actually make those larger payments. You can also customize your amortization schedule with an interest only loan. See How Amortization Works for details on how amortization affects on your mortgage. In many cases, your additional payment against principal will result in a lower required payment in following months (because the principal amount that youre paying interest on has decreased). Pitfalls of Interest Only Loans Interest only loans also have some drawbacks. The main problem is that you dont build any equity in your home. This can be a problem because:

You arent building wealth for yourself If your home loses value you may have to write a You wont increase equity that you could borrow Youll have to do something to pay the mortgage

check to sell it

against later with a second mortgage

sooner or later

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Because youre only paying interest, you dont reduce the balance on your loan. Instead, youre just servicing a debt or treading water if you only make the required interest payments. Imagine that you buy a home for RS.300,000, and you borrow 80% (or RS.240,000). If you make interest only payments, youll always owe Rs.240,000 on that home. If the home loses value and is worth only Rs.280,000 when you sell it, you wont get your full $60,000 from the down payment back. If the price drops below Rs. 240,000 when you sell, youll have to pay out of pocket to unload the house. Of course, you have to pay the money back at some point. Usually, you end up selling the home or refinancing the mortgage to pay off your interest only loan. If you end up keeping the loan, the bank might make you pay principal back after 10 years or so. Your lender should explain when and how this occurs.

Interest Only Loan Calculations

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You can see how your payments will differ with an interest only loan calculator. Compare the payment on your interest only loan to the payments required for an amortizing loan:

Interest Only Loan Calculator Mortgage Amortization Calculator

An interest only loan may be right for you. Just make sure you understand the pitfalls before you decide to pay interest only. Choosing an interest only loan for the sole purpose of buying a more expensive home is not a good idea.

Conclusion Loan is a form of debt, often with interest. There are several reasons why people apply for loans. Usually they borrow money to purchase a house, buy a car, or start a business. Often, applying for a loan is necessary because most do not have available financial resources they need to make a purchase. Other forms of loans, like the student loans have helped a lot of students get through school. Those who use student loan debt consolidation clearly have multiple student loans. They do this to manage their obligations better.

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Since loan is borrowed, the lender expects to receive payment with the interest specified. In addition, borrowers should make the payments at the specified due date for a certain period. This is where most people have problems. Most problems start when people cannot make the monthly payments required due to different circumstance. Some finds it difficult to pay their loan because of the many other debts they have. Some encounter additional problems such as medical emergencies and job loss. Since getting a loan is a commitment, you have to be very careful with your decisions. Choose the right lender. There is more to picking a lender than just looking for one with the least interest. Keep in mind that those with low interest require longer period. Remember, when choosing a lender, check its stability, its flexibility, repayment schemes, and interest rates. Before you decide to get a loan, it is only right that you review its advantages and disadvantages.

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