RESERVE BANK OF INDIA COLLEGE OF AGRICULTURAL BANKING UNIVERSITY ROAD, PUNE 411 016

LEGAL ASPECTS AND DOCUMENTATION IN RESPECT OF URBAN BANKS ADVANCES TO ARTISANS, SMALL SCALE INDUSTRIES ETC.

Granting advances and documentation are the two sides of the same coin, as they are closely related. It may not be an exaggeration that there cannot be any lending without documentation and vice-versa. A good advance would invariably require proper documentation, which involves the niceties of law. Traditionally, lending has been security-oriented. However, the modern trend has radically changed from security orientation to purpose orientation, which is a social and economical need of the day. A question arises as to whether this change in the concept of lending has reduced the importance of documentation. The answers is categorically no. 2. Introduction of mass banking, with its concomitant emphasis on small lending, soft lending, short lending, priority sector lending, weaker section lending etc., has not undermined the importance of documentation. On the other hand, introduction of the purpose oriented lending has enlarged its importance in the achievement of the purpose behind such lending. 3. Urban cooperative banks have a very important specified role to play amongst the galaxy of financial intermediaries in the society. Unlike the large financial institutions and commercial banks lending in millions to the heavy industries, the urban cooperative banks are required to cater to the needs of millions of small borrowers like farmers, artisans, small scale industries etc,. Compared to the large borrowers, security-wise-soundness in such lending is more critical. A document, to be effective, should to be legally enforceable.

4.

Necessity of documentation

The need for documentation is mainly two-fold. One is the requirement of law and the other is the record of evidence of the fact of transaction. The relationship between the banker and customer, being contractual in nature, it is fundamental to have proper documents to support the operations and transactions of a cooperative bank. Experience shows that some borrower may tender improper or defective documents
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2 that might jeopardise the banks interests as reflected in longer litigation and avoidable loss. To avoid such an eventuality proper documentation is of crucial necessity for a banker. 5. Documentation involves various aspects like drafting, stamping, execution, registration and interpretation or invocation. Legal aspects of documentation imply clothing of a particular document with the requirements of relevant law, depending upon the facts and circumstances of each case. Besides, application of law depends upon various factors like the nature of the creditor / debtor, the nature & purpose of credit, etc. It would not be possible to generalise the specific requirements of law in respect of all types of documentation. It would be more instructive and useful to look at a few specific instances and to note the legal aspects of such documentation. 6. Types of borrowers i) A borrower may be an individual, a group of individuals, a partnership firm, a Hindu undivided family or a limited company. It is necessary to ascertain the legal status of a borrower before drafting a document relating to any borrowing. In case of limited companies, it is necessary to obtain a certified copy of the resolution of the Board of Directors authorising such borrowing. ii) In case of partnership firms, the bank should obtain a copy of the partnership agreement and signatures of all the partners on the documents. In case of Hindu undivided family, a joint Hindu family letter duly signed by the Karta and all other adult members of the family would suffice. In case of a group of individuals, the bank has to obtain signatures of all the members of the group. iii) A secured loan, as defined under Section 5 (n) (i) of the Banking Regulation Act, 1949 means a loan or advance made on security of assets, the market value of which is not at any time less than the amount of such loan or advance and; unsecured loan means a loan or advance not so secured. Urban cooperative banks generally sanction loans and advances against personal securities, pledge, and hypothecation of goods or raw material, stock in trade, finished goods or mortgage of machinery and other fixed assets. 7. Personal security In case of personal security, the bank has to ensure the competence of such a person under his personal law to stand as surety. Therefore, it would be necessary to examine the individual status of such a surety before accepting the surety. An

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3 agreement of guarantee can be drafted thereafter as required under the transaction in question. 8. Pledge A pledge of goods is the best form of security. The bank has to obtain a letter from the borrower with complete description of the goods/securities as an evidence of possession by way of pledge. One caution in this context is that the bank should know the nature of the pledged goods before accepting the same. For example, in case of pledge of gold ornaments etc., the bank should ascertain restrictions, if any, imposed by the relevant legislation like the Gold Control Act before accepting such a pledge. It is advisable to obtain a letter from the borrower regarding the title or the ownership of the pledged goods to rule out the possibility of the pledged goods being stolen property. 9. Hypothecation Documentation in case hypothecation is similar to that of pledge except the fact of possession of goods. 10. Mortgage In case of fixed assets offered as security, it is necessary to have the mortgage of such assets. Before accepting any such mortgage, proper investigation of title to such property is an absolute necessity. Without the mortgagor having a mortgageable interest, it is not possible to create a mortgage. Another caution to be taken in case of mortgage is in respect of transferability of such property under the special status like Urban Land Ceiling Act etc. Besides, the proper form of mortgage should be decided which again depends upon the applicability of various laws to such property. Popular and simple form of mortgage is equitable mortgage. It is simple in procedure, less expensive and less time-consuming. However, it has several restrictions. First, as per the provisions of Section 58 of the Transfer of Property Act, an equitable mortgage can be created only in a place notified by the concerned State Government. Second, if a memorandum of deposit of title deed is prepared, it has to be duly stamped and registered. To overcome this difficulty, banks have the practice of recording the factum of creation of mortgage by way of deposit of title deeds in a book regularly maintained by the mortgagee bank. The mortgagor should not sign the memorandum. Before preparing such a memorandum, it is preferable to enter into an agreement with the borrower wherein the latter agrees to create a mortgage by way of deposit of title

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4 deeds. The bank should carefully preserve the document and should never part with it until the borrower fully clears the banks dues. Parting with the document to the borrower is fraught with risk as courts may interpret it as discharging such a charge. 11. Stamping of documents After drafting a document, one has to get it adequately stamped. Section 17 of the Indian Stamp Act requires that all instruments chargeable with duty and executed by any person in India shall be stamped before or at the time of execution. Therefore, a banker has to get such a document duly stamped before its execution. It is not out of context to state here that the practice prevailing in some banks of obtaining borrower's signature on blank documents would very often affect the bank prejudicially. The banker has to ascertain the requisite stamp duty from the relevant State Stamp Act and the Rules there under. 12. Execution of documents After duly stamping the document wherever required as per legal requirements, the banker has to obtain the signature of the borrower or the surety, as the case may be, on such document. One or two witnesses should attest the signature of the executants, unless it is verifiable with the earlier signature of the same person. In case where attestation is not permissible on the document, such an execution can be effected in the presence of some responsible person known to the bank. If the executant is executing such a document in his representative capacity as Karta of a HUF or as a guardian of a minor, such a remark should be made on the document itself. If the executant is a pardanashin woman, the identification of such executant by an independent person should be recorded. If the executant is a limited company, the common seal of the company with the signature of the authorized person with the specific or general resolution of the company should be obtained. To rule out the possible plea of substitution, addition or deletion of portion of the document, a document should be property paginated and signature of the executant be obtained on each page of the document. Date and place of such execution should be invariably mentioned either at the beginning or at the end of the document. 13. Registration of documents If the borrower is a company, the lending banker has to take steps to register all charges, except pledge, created on the companys assets. As per Section 125 of the

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5 Companies Act, 1956 a charge created on a companys assets has to be registered with the Registrar of Companies within 30 days from the date of creation. 14. Law of Limitation Law of Limitation limits the period within a bank must initiate action in a court of law against a borrower for recovery of its dues. When the period of limitation as applicable in a particular case expires, the advance becomes time-barred. However, acknowledgement of debt by the borrower and guarantor will mean fresh limitation period from the date of acknowledgement. Similarly, where the borrower himself makes or authorises part payment of either interest or principal, such payment will result in fresh limitation period from the date of part payment. The banker should initiate prompt action for obtaining letter of acknowledgement or part payment or fresh set of documents from the borrower and guarantor to ensure that the advance does not become time-barred. In conclusion, a lending banker can protect the banks interest by obtaining proper documents in conformity with the relevant legal provisions. He has to ensure that proper documents are available for filing recovery suits in case of default by the borrower. Documentation ensures the safety of funds lent by the bank.

Revised by Shri R.R.Borbora, Member of Faculty, CAB

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