Study of contract of pledge and position of financial Institutions

BUSINESS LEGISLATION 

Study of contracts of pledge and

position of financial institutions

Submitted to: Dr. Hardik Parikh sir 

Submitted by:

19M40: Sapna Joshi

19M41: Saurabh Makwana

19M42: Sejal Bundela

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Study of contract of pledge and position of financial Institutions

Preface
For the fulfilment of the requirement of the Assignment of subject Business legislation under
M.B.A in G.H. Patel Postgraduate Institute of Business Management, this report named
“Study of contract of pledge and position of financial Institution” has been prepared.

The beginning part of the report gives introduction of the concept of pledge and legal issues
pertaining to this topic is also been stated. In this report we have also mentioned the
applicable acts pertaining to this topic and also the rights and duties of pawnee and pawnor.

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Study of contract of pledge and position of financial Institutions

Acknowledgement
We sincerely thank the college G.H. Patel postgraduate Institute of Business
Management S.P. University, for giving us this wonderful opportunity of preparing the
Business legislation assignment report on study of contract of pledge and position of financial
Institution. We are also thankful to Dr. Hardik Parikh sir to who helped us as a project
guide in completing our project. It was a good experience for all of us to work together for
this project report.

Sincerely,

19M40: Sapna Joshi

19M41: Saurabh Makwana

19M42: Sejal Bundela

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Study of contract of pledge and position of financial Institutions

Sr. No. Table of Contents Page No.

1 Preface i
2 Acknowledgement ii
3 Introduction 1
4 Legal Issues pertaining to topic 2
5 Application legal Provisions 6
6 Court Judgement 8
7 Conclusion 9
8 References 10

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Study of contract of pledge and position of financial Institutions

INTRODUCTION:

 In Law, the two terms i.e. bailment and pledge are examples of the same specific
contract. Bailment used in a technical sense which means one person transfers the
goods to another person. Whereas pledge is a kind of bailment in which one person
transfers goods to another person as security against loans. 

 Bailment - Section 148 of the contract act

Pledging- Section 172 of the contract act  

 “Contract of pledge” in simpler terms is a transferring of the ownership of the goods

to another person for satisfying the debt or obligation or needs. 

 The party who deposits the goods is the bailor, called as “pawnor”, whereas the party
who takes possession of the goods or the one to whom the goods are deposited is the
bailee, called as “pawnee”.

 Banks or financial institutions or money lenders in the market provide loans against
the “collateral or security”. 

 Securities are in three categories namely, Lien, Mortgage and pledge.

 Example: 
1. Maya was in urgent need of money so she deposited her jewellery to his friend,
Ramesh who is a money lender as a security for the money lent. Here, maya is the
pawnor and Ramesh is the pawnee. 
2. In an organization or firm, when promotor wants to raise funds or development of the
firm or personal needs, he will pledge his shares or securities with the non banking
institutions (NBFCs).

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Study of contract of pledge and position of financial Institutions

Legal issues pertaining to topic

(1) Essentials of the pledge:

1. Delivery of good to be pledged 

The goods pledged need not actually change hands; there can be a valid contract of pledge in
spite of the good still remaining in the possession of the pawnor.

2. The valid contract 

Contract of pledge comes under the head of special contracts yet it is necessary that for it to
be valid there must be contract with all the essentials as mentioned in the provisions of the
Indian contract act 1872.

3. Right on the pledge 

Another major ingredient of pledge is that the pawnee merely possesses possessory rights
and not juristic rights over the pledge. The pawnee only has the special property while the
general property stays with the pledgor. When the pledge comes to an end by way of
repayment the special rights are also transferred back to the pledgor.

4. Time of pledge 

Under a contract of pledge the delivery of possession and the payment of money need not
always be simultaneous. A pledge can even be given subsequently after advance has been
made.

(2) Rights of Pawnee under the contract of pledge 

1. Right to retain 

Until and unless the loan has been repaid or the obligation has been performed, the pawnee
has the right to retain the goods. This is illustrated in section 173 of the Indian Contract Act
1872, 173. Pawnee's right of retainer.-The pawnee may retain the goods pledged, not only for
payment of the debt or the performance of the promise, but for the interests of the debt, and
all necessary expenses incurred by him in respect of the possession or for the preservation of
the goods pledged.

Thus a pawnee can retain the goods for-

a) Payment of the debt or performance of the promise,

b) Interests on the debt,

c) All other expenses incurred by him in respect of the pledged goods

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Study of contract of pledge and position of financial Institutions

2. Right to retain the subsequent advances 

Section 174 provides that the pawnee is not entitled to retain the goods for debt or promise
other than that for which goods for pledged for.[16] However it is presumed that the pawnee
has the right, if he makes subsequent advances to the pawnor, to retain the goods unless it is
otherwise provided in the contract. Thus it is the terms of the contracts which decides the
rights of the pawnee in this case.

3. Right to extraordinary expenses 

The pawnee has further rights of claiming form the pledgor extraordinary expenses as
provided under section 175, Pawnees right as to extraordinary expenses incurred.-The
pawnee is entitled to receive from the pawnor extraordinary expenses incurred by him for the
preservation of the goods pledged. This includes the expenses which the pledgee has incurred
by virtue of preserving the goods under his possession by way of pledge. The pertinent thing
to note here is the usage of the word receives which states the position that the pledgee
cannot retain the goods for the extraordinary expenses. In other words it can be said that his
lien over the pledged goods does not extend to cover the rights of extraordinary expenses.
Thus what the pledgee has is the right of action for recovering these expenses

4. Pledges rights in case of default 

The pawnee is entitled to the exercise of this right when there is a default from the side of the
pawnor or the debtor.

(3) Rights of Pawnor under the contract of pledge 

1. Right to Enforce:

If the pawnee neglects in any one of his duties, the pawnor has a right to enforce them by
filing a suit against the pawnee.

2. Right to Avoid the Contract:

If the pawnee does any act, which is inconsistent with the terms of the bailment as regards
the goods bailed, the pawnor can terminate the pledge.

3. Right to Return the Goods Lent Gratuitously:

When the goods are lent gratuitously, the pawnor can demand back the goods at any time
even before the expiry of the time fixed or the achievement of the object.

4. Right to Get Compensation:

If any third person does some injury to the goods bailed or deprives the pawnee of the use of
the goods, then the pawnor may file a suit against the wrong-doer, and recover compensation
from him.

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Study of contract of pledge and position of financial Institutions

(4) Who can Pledge?

1. Pledge by a mercantile agent

2. Pledge by person in possession under a voidable contract
3. Pledge by person who is having a limited interest in the property

1. Section 178 provides that a pledge made by a mercantile agent, acting in the ordinary
course of business is valid. It reads as, 178. Pledge by mercantile agent.-Where a
mercantile agent is, with the consent of the owner, in possession of goods or the
document of title to goods, any pledge made by him, when acting in the ordinary
course of business of a mercantile agent, shall be as valid as if he were expressly
authorised by the owner of the goods to make the same; provided that the pawnee acts
in good faith and has not at the time of the pledge notice that the pawnor has no
authority to pledge.

Explanation: In this section, the expressions mercantile agent and documents of title
shall have the meanings assigned to them in the Indian Sale of Goods Act, 1930 (3 of
1930).] Consent of the owner of the goods is assumed to exist in case where the
mercantile agent pledges a good. A mercantile agent is one who has the authority on
behalf of the owner to sell, consign or raise money out of the goods by keeping them
as security.

The present section 178 came into force after the earlier wordings of it were repealed
in 1930. In the earlier section any person in possession of goods or documents of that
good can affect a pledge but after the new section has been enacted this right of
pledging on behalf of goods whose ownership rests with another is only given to a
mercantile agent. This section has been enacted with an objective to protect those
dealing in good faith with persons who are mercantile agents. The new section is an
improvement in another sense that it provides that those in possession and not in mere
custody are entitled to make pledge the goods owned by a third party.

2. This type of pledge has been provided under section 178A of the Act which states that
even when the pawnor has obtained the goods under a voidable contract by the virtue
of section 19 and 19A, and when the contract has not been rescinded at the time of
pledge, the pawnee will acquire a good title to the pledged goods.
However it is required that the pawnee must act in good faith and must have been
unaware of the presence of a voidable contract. The principle here is that though there
is a de facto contract even if it is voidable due to the reason of fraud,
misrepresentation and alike. For instance if a person buys good without paying for
them, there is consent, though not free and the contract in spite of being voidable will
enable the party receiving the good to make a valid pledge. Thus what matters here is
the possession of the tile of the goods to be pledged.

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Study of contract of pledge and position of financial Institutions

3. Under section 179, it is provided that a person is eligible to make pledge to the extent
to which he has interest in it. Whenever a party to pledge has interest, he has
unconditional authority to charge at least that interest. While the cases where the
pawnor has no interest and only possession are governed by section 178 and 178A of
the Act, the cases where the pawnor has, even a limited interest, falls within the ambit
of section 179.

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Study of contract of pledge and position of financial Institutions

Applicable legal provisions

It is mainly covered under three laws, i.e. 

(1) The Indian Contract Act, 1872, 

(2) The Banking Regulation Act, 1949 and
(3) External Commercial Borrowing Guidelines.

(1) Indian Contracts Act, 1872

Section 172 of the Indian Contract Act, 1872 gives us the definition of a Pledge. It states that
the bailment of goods as security for payment of a debt or performance of a promise is called
‘pledge.’ The bailor is in this case called the ‘pawnor.’ The bailee is called ‘pawnee.’

According to this definition, a pledge creates only the right of possession while the pawnor
has the title of the property.

The Companies Act, 2012 does not place any restriction on amount or manner of pledging of
shares. The Act has not prescribed any minimum percentage of shares to be held by the
directors. But the Article of Association of a company can prescribe the qualification shares
of a director. It is a very nominal figure which is immaterial to the movement of the share
price.

Regulation 36 of the SEBI Regulations, 2009 provides that when a company is making a
public issue, the promoters or directors should be holding at least 20% of the shares with a
lock in period of minimum three years. After the lock-in period of 3 years, the promoters or
directors are free to sell their shares. So if the holding of promoters is below 20% after the
lock-in period, it will not violate the norms of SEBI.

(2) Banking Regulations Act, 1949

Section 19(2) of the Banking Regulations Act, 1949 provides that no banking company
should hold the shares of any other company whether in the form of pledge, mortgagee or
absolute ownership that is more than 30% of the paid up capital of the respective company or
30% of the company’s paid-up capital and reserves, whichever happens, to be less. The
shares of a company are taken by a bank or any other financial institution as security in the
following cases:

 Overdraft facility against recorded and affirmed shares of any open restricted
organization.
 Overdraft of shares of a listed company against recorded and affirmed shares of any
open restricted organization.

Nowadays most of the shares are held in the form of Demat. There are two main depositories
in India – NSDL and CDSL and both have equally competent software’s to create a pledge
and its invocation that are listed in the statement as two columns named “Free” and
“Pledged.”

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Study of contract of pledge and position of financial Institutions

(3) Availment of Loans by NRIs through Pledging of Shares

NRIs can take a loan by pledging shares, though they have to take the permission of the RBI.
The application has to be made through the same bank in which the NRO/NRI account is
opened or being held.

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Study of contract of pledge and position of financial Institutions

Court judgement 
Dauntless the learned counsel for defendant No. 4 still submitted that the plaint does not
allege the loan amount having been actually tendered by the plaintiff to the defendant No. 1
and the amount also not having been tendered in the court also suit for redemption of pledge
would not lie and so also the plaint ought to be rejected. No specific statutory provision has
been relied on in support of the contention but heavy reliance has been placed on the ratio of
Division Bench decision of AP High Court in the case of Sri Raja Kakarlapudi v. Andhra
Bank Ltd AIR 1960 AP 273 and as the Madras Bombay and Patna view referred to in
paragraphs 65 to 68 of the report.22.1 Para 68 of the Andhra Pradesh High Court Division
Bench decision is extracted and reproduced hereunder(68) In AIR 1947 Bombay 217 Chagla,
J, after a review of English authorities held as follows:

that although the pledgee may sell the goods unauthorised or unlawfully, the contract of
pledge is not put an end to and the pledgor does not become entitled to the possession of the
goods pledged without tendering the amount due on the pledge; or, in other words, without
seeking to redeem the pledge, and;

that without a proper tender of the amount due on the pledge, the only right of the pledgor in
respect of an unlawful or unauthorised sale is in tort for damages actually sustained by him.
We are in accord with the view of Chagla J., that in case of an unauthorised sale by a Pledgee
the relief that the pledgor can seek is to file a suit for redemption by depositing the money,
treating the sale as if it had never taken place, or where the suit for redemption is not filed, to
ask for damages on the foot of conversion. The present suit is neither the one nor the other. It
is a suit merely for declaration with an ancillary relief for an injunction restraining the 3rd
defendant from registering the shares in the name of the 2nd defendant. We are of the opinion
that the suit as framed is not sustainable.

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Study of contract of pledge and position of financial Institutions

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

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References

 http://www.legalserviceindia.com/legal/article-1361-contract-of-pledge-features-and-
distinctiveness.html
 https://www.amu.ac.in/emp/studym/100000748.pdf
 https://indiankanoon.org/doc/101400541/
 https://blog.ipleaders.in/pledging-shares-overview/
 https://www.researchgate.net/publication/307816861_Legal_Issues_on_Pledge_Share
_Agreement
 https://www.manilatimes.net/2018/04/13/legal-advice/dearpao/constitution-of-a-
contract-of-pledge-to-secure-a-loan/392159/
 https://www.casemine.com/search/in/contract%2Bof%2Bpledge

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