MODULE 3: UNDERSTANDING LOANS AND LOAN DOCUMENT: Class Notes: Banking and Finance Law UpGrad Blended LLM Programme (2022) Faculty Instructor: Prof. Shuchi Sinha Note on overview of legal framework: In these Class Notes, various provisions of the legal framework have been referred to / summarised / described — please note that these are set out to provide an indicative idea only for purposes of reference & revision, Please refer to the bare act of the relevant statute / law for the actual text and content of the statutes & laws referred to herein.BENEFITS OF DEBT FINANCE Banks as Financial Intermediaries + The deposits that banks get from their depositors or customers are a reliable source of money for the loans that they provide to various borrowers including individual and corporate borrowers. + Bank earns profit through such loans — the interest charged by them on loans that they provide is generally higher than the interest that they pay to customers and depositors. * This differential in the interest charged and interest paid represents their profit (often referred to as ‘net interest margin’*) * While banks give out various types of loans, they generally earn higher revenues in commercial loans. * calculated by standard methodologies, usually taking into account other income generating assets of the bank* This is because while consumer lending tends to be more of standardized financial product, commercial lending tends to be more of a “tailored” or specialized financial product for the borrower, business project or business need. + In current times, banks also get funds through other sources such as borrowing from each other or borrowing from the money markets, in addition to traditional method of taking deposits.Nature of deposits accepted by banks from their customers (‘depositors’) — deposits fall under the category of ‘liabilities’ (as opposed to loans given by banks, which fall under the category of ‘assets’). This is because such deposits operate in a manner similar to a debt that is given by the customer to the bank, that the bank pays interests on, in return for the customer putting their money with the bank in the form of deposits. On the other hand, the bank earns income & profits from the interest payments made by borrowers on the loans given by it — thus a loan is an ‘asset’. Moreover, given that banks accept “demand deposits” (i.c., customers of the bank can choose to withdraw their deposits at any time)*, banks are required to retain some of their funds in a manner that they can meet the liabilities or obligations to their depositors as well as their other lenders. This forms the basis for the legal and statutory requirements on banks to maintain cash reserves, statutory liquidity ratio and so on. Banks need to maintain a proportion of their deposits as a cash-reserve ratio as provided under the regulations of the Reserve Bank of India (RBI). They also need to maintain a statutory liquidity ratio as per such regulations. ‘As per RBI's Maser Direction - Reserve Bank of Inia (Interest Rate on Deposits) Direston, 2016 (updated as on Noverber 11, Dodi: ‘Demand deposit” means a deposit received by the bank, which is withdrawable on demandCredit Deposit Ratio (CDR) Credit-deposit ratio (CDR) is obtained by dividing total loans disbursed by banks by the total deposits that the banks have on any given date. Impact of the Pandemic (as reported in the media/news) + The CDR which was healthy at about 76.4% started to fall beginning March-end of 2020 + By 11" of September, 2020 it fell to 71.8%. * This was primarily because the loans disbursed by banks shrunk by 1.4% to 102.3 tril the deposits in banks during this period expanded by 5% to 2142.5 trillion. [approx.] * By June of 2021, the CDR stood at 70.5% [Press release by RBI at https://www.rbi.org.in/scripts/BS_PressReleasel)isplay.aspx? prid=52150] * The shrinking of overall loans with the increase in deposits essentially explains why the credit- deposit ratio has reduced. It tells us that in the current pandemic situation, both corporates and individuals are looking to go slow on borrowing, given the seriousness of the economic impact. Prospective borrowers do not want to end up with loans they will not be able to repay. mn, while + It remains to be seen how the approach of banks as well as borrowers is impacted further by the current pandemic situation,EQUITY vs DEBT FUNDING EQUITY FUNDING * It involves issuing or selling a portion of the company’s share capital to an investor, who then becomes a shareholder of the company and consequently has proportionate ownership in the company. Unlike the case of debt funding, here is no obligation to repay the such equity funding, which may be perceived as a positive aspect of equity financing in comparison to debt finance. + Example: Company X can offer to issue shares for an amount of 1 lakh rupees to an investor, say Investor Y, who subscribes to such shares and acquires, let’s say, 10% of shareholding in Company X ~ this will of course, give Investor Y some rights as a shareholder under law, and in many cases, special negotiated rights as an investor bringing much needed funds into the company. So, investor Y could well have a say in the business decisions of Company X going forward from here.+ Disadvantages of Equity Financing * While listed companies can do further public offers (but would need to consider the costs involved in such process), there are numerous challenges in finding an investor willing to fund a small to mid-sized unlisted private company. In such cases, there are likely to be additional costs involved with the appointed of investment bankers or merchant bankers to the company in identifying and approaching potential equity investors. = Such financing could also lead to governance and business-related restrictions from investors so that if they later wish to exit and sell off their shareholding, the Company’s shares would have increased in value = Public offer is not realistic for such unlisted companies unless the company has matured to a certain size, reputation and profitability in the market.Owners/promoters will have to dilute their percentage ownership of their company. They will have to share the profits and consult or (depending on the rights negotiated by the investor), even require specific approval from their investor for various company related decisions The investors might require a seat on board, thereby giving them a voice in the board decisions. The promoters may feel pressure to conform to the investor’s expectations of how the company should grow Investors may also require the target company to provide a profitable exit. In which case they might want an IPO from the company, which involves a lot of cost and increases burden through a web of regulatory obligations.DEBT FINANCING + It refers to various forms of borrowing or taking on of debt, e.g.: loan, debenture, bond, line of credit ete, + In its common form, the borrower takes on debt in the form of a loan that has to be paid back along with interest and other charges. ADVANTAGES * Lenders do not require control over the Borrower’s busine: + Element of predictability with pre ~ decided principal and interest payments. = Many jurisdictions confer tax benefits on the interest paid on such business loans and is tax deductible. in most standard loan transactions.= Easier access to suitably tailored loans as opposed to equity financing with a large pool of lenders that specialize in various industries, stages of business and types of assets, ASSOCIATED RISK + Debt can be an intimidating prospect when a company hits hard times, or the economy experiences a recession. + Repayment of loan and Interest payments are required to be made even when the projected growth is not achieved, which put pressure on the company. + Default in payment can also lead to taking over of secured assets of the borrower company. However, for most businesses, the above would be seen as standard risks that do not inhibit them from accessing the reliable funding route of debt finance (particularly in light of the fact that no transaction would be entirely risk free, and some associated risks are normal in every funding scenario).Loans - Overview Understanding the Standard Terms to Describe Loans * Secured vs. Unsecured * Project vs. Corporate + Term Loans vs. Working Capital + Domestic vs. ECB + Bilateral vs. Consortium (or Syndicated)Secured vs. Unsecured + Secured loans -lender’s interests protected by creating a security interest on an asset of appropriate value that is, some collateral. * Collateral addresses the risk associated with the lender if the borrower does not repay. * The items purchased through loan or other existing assets of the borrower entity, can be used as collateral Corporate Loan vs Project Finance * Corporate loans refer to the loans that a business entity may require for various aspects of its business and commercial needs. + Project Finance refers to a long term, highly capital-intensive project (e.g.: infrastructure projects, resource extraction projects like oil exploration, power projects etc.) with very long gest period before the project becomes operational or generates revenue, where the payments due under the loan are made using the revenues from the project.Working Capital Loan vs Term Loans + Working Capital loan seeks to supplement short term financial shortfalls with outside funding tends to be for relatively lower amounts than terms loans / project finance. + Itis Step 1: Borrower appoints lead arranger bank (sometimes called “lead bank”, “arranger” or “lead arranger”) & discusses basic terms of proposed loan: appointment letter for lead arranger > Step 2: Lead arranger approaches potential participants to the consortium (“participant banks”), terms broadly agreed: term sheet signed > Step 3: Legal advisors appointed and diligence exercise conducted: Due diligence report> Step 4: Upon factory diligence outcome and internal approval by each of the consortium’s participant banks, preparation of loan documentati mn Y to include appointment terms of “administrative agent” Y can take the form of common terms agreement + bilateral loan agreements OR joint loan agreement > Step 4A: Security creation and perfe: Y appointment of security trustee & recording of terms: Security Trustee Agreement Y security documents to be executed in favour of security trustee who will hold such security on behalf of and “in trust” for the lenders, and will also be responsible for security enforcement, if required. > Step 4B: Guarantees (corporate and /or personal guarantee agreements (if required by lender) executed > Step 5: Inter-creditor terms finalised & signing of inter creditor agreement. This is an agreement among all the lenders, setting out how they will conduct themselves in relation to each other (as part of the lender group) and describing their respective rights and obligations with respect to the borrower and each other in implementing the financing arrangements with the borrower. It can include provisions specifying the manner in which a default may be declared, how the security will be enforced and proceeds applied among the lenders, the process to grant waivers, or to make amendments to the loan agreements and security documents etc. This agreement would also specify how payments from the borrower are to be applied among the lenders.ANATOMY OF A LOAN AGREEMENT Introductory Section + Preamble, Recitals, Definitions, Interpretation etc. + Provide basic factual information, meaning of the commonly used terms and some principles on how to interpret various types of clauses in the agreement. Action Section * Describes and elaborates the commercial details of the actual trans: Section Containing Substantive legal provisions + Sets out the rights and obligations that parties must comply with for the transaction to be implemented. + Example: Representations made by the Borrower to the Lender, Conditions to be met by the Borrower, Covenants of the Borrower, Events of DefaultEndgame Section * Details about timeline of the arrangement and dispute resolution among parties. + Includes — Term of the agreement, Dispute Resolution & Governing Law, Indemnity (if required by lender) Miscellaneous/General Clauses or “BOILERPLATE” Clauses * Guides the parties on implementation of their commercial relationship and administering of the loan contract + Examples include: Notices, Assignment, Severability, Amendment etc. ignature Page, Schedules/Annexures/ExhibitsPRACTICAL NOTES + Since loans are contractual and the form of the agreement depends on parties, the form and content of loan contracts may vary depending on the parties’ preferences. + Certain contract-drafting terminology are used to describe different categories of provisions under the head of various “Sections” for the convenience of understanding the flow and structure of loan agreements. + However, such terminology or “drafting jargon” (e.g.: Introductory Section, Action Section, Endgame etc. is not actually used in the contract itself — instead, the standard headings for the various clauses (¢.g.: Conditions of Disbursement, Representations, Covenants etc.) that fall within such “Section” are included in the agreement.CONCERNS OF THE PARTIES Borrower + Obtaining the loan in exchange for as few as possible liabilities, obligations and restrictions on its ability to conduct its business. + Negotiations from borrower's end will be directed at reducing all lender-imposed liabilities, obligations and restrictions through the use of representations, conditions, covenants, the events of default, etc. and the borrower's counsel will try to reduce the scope of all such clauses. + Some negotiated positions that the borrower's counsel may propose: + Reducing the number of representations, CoDs, covenants and Events of Default, + Modifying the language of representations to “qualify” and reduce the scope + Incorporating “Disclosures” against representations % Introducing “cure periods” or “grace periods” for any default / breach by the borrowerConcerns of Lender ~ Since the Lender is the party undertaking a financial risk by providing the loan (risk that the borrower may not repay the principal amount of the loan, or may not be able to pay interest and other charges due under the loan), the loan agreement as a whole is primarily formulated to mitigate such risks (often referred to collectively as “Lender’s Risk”). Accordingly, it is no coincidence that the lender’s counsel often prepares the first draft of the Joan agreement (which may then be reviewed, marked up and negotiated by the borrower’s counsel). Some key risk mitigation clauses include: 1, Purpose Clause — Ensuring the amount is used for the stated purpose by Borrower — purpose/use of proceeds provision is often baked into more than one clause of the Loan, e.g. * A Representation in the loan agreement that in all of the Borrower’ internal plans for utilising the loan proceeds and that there is no plan to use it in any other way or purpose than what is set out in the loan. * Additionally, the loan agreement can include a Condition of Disbursement imposed on the Borrower that in order to receive all future instalments of the loan, it shall have used the previous instalments as per the prescribed purpose. + Further, it can be an Event of Default if at any time during the term, the borrower uses the Joan proceeds for a purpose other than what is agreed under the loan agreement.= Importance of purpose provision — Example ~A company takes loan ostensibly for the purpose of purchasing some machinery to expand its existing business = Instead of using it for this purpose, it without informing the Lender transfers it to its group company, who uses it to start a real estate project — which ends up failing. Now, the machinery for the existing business was not purchased — so that business did not benefit from upgraded machinery and may lose potential profits. = Thus, in this example, the loan amount was misused and for all practical purposes has been lost — and the Borrower, having made losses, may no longer be in a position to repay the loan, 2. Representations Clause — Obliges the Borrower to make factual statements on which the lender will rely for making its decision to give the loan. = Representations (“Reps”) are a set of factual statements made by the Borrower about itself and its business and included in the loan agreement. Another provision (“Reliance clause”) is often included, which states that the lender is relying on the Reps for making its decision to enter into the loan agreement. = Examples of aspects covered by Reps — the borrower would represent, for example: that borrower is a validly incorporated company under Indian law, that there is no prohibition in its MOA or AOA that prevents it from undertaking the loan transaction, that it is not facing bankruptey or insolvency, that its financial health is not adversely affected, that itis not facing any serious litigation, ete.* Reliance Clause: Records information in Representation Clause and gets obligation on Borrower. Covenants: These are obligations on the borrower to do (i.e., “positive” or “affirmative” covenants) OR not to do (i.e., “negative covenants”) certain things. Types of covenants: + Positive (or Affirmative) Covenants: require the borrower to do certain things / take certain actions (c.g.: pay all its taxes, follow good corporate governance practices, comply with laws, etc.) + There are two important sub-categories of Positive Covenants: * Information Covenants: periodically provide information to the Lender about various aspects of its business, financial health, the project for which it has taken the loan etc. ~ these enable the Lender to maintain oversight on whether the borrower is complying with its obligations under the loan agreement, + Financial covenants - Borrower is obliged to comply with and satisfy certain minimum thresholds of financial health indicators that the Lender specifies, e.g.: the ratio of its equity capital to its debt, debt to EBITDA, current assets to current liabilities etc. + Negative Covenants: require the borrower to NOT do certain things take certain actions (e.8 not deviate from its financial plan and annual budget, invest in risky schemes, dispose of its secured assets etc.)4, Consequence Clauses > Conditions of Disbursement (“CoD”) clause* — these are stipulations which, if not met or satisfied by the borrower, gives the lender the right to not proceed with the loan, not remit the loan funds and simply walk away from the loan transaetion (note that unsatisfied CoDs can be waived or postponed by the lender at its discretion). + Includes conditions such as (i) loan documents are validly executed, (ii) Reps are true & updated, (iii) no material adverse change to borrower's business / operations or ability to make payments under the Joan agreement, (iv) security validly created in favour of the lender, etc. > Event of Default (“EoD”) clauses ~ Acts as a contractual remedy to the lender in the event of certain scenarios occurring (which pose an increased risk from Lender’s perspective). + Note that: unlike CoD clause (which are effective only till such time as the loan funds have not been disbursed), the EoD clause provides the lender with remedy for defaults and risk events at all times during the term of the loan + Includes a list of events (each of which constitutes an “event of default”) and provides that if any such event takes place, Lender has sweeping rights, including cancellation of the loan, withdrawing the loan and enforeing security (taking over the secured assets of Borrower). ¥ also called “Conditions Precedent”.STANDARD LOAN AGREEMENT 3 BROAD CATEGORIES OF PROVISIONS, 1. Provisions Relating to Amount & Flow of Cash ~ this includes provisions such as + loan amount, tenure (which is the life of the loan), disbursement (or drawdown) mechanism by which borrower receives each instalment of the loan, + interest rate & interest period, + fees and other charges + repayment schedule + tax gross-up2. Risk Mitigation Provisions — this Risk such as ¢, Purpose of Loan (Use of Proceeds Clause), + Representations & Reliance Clause, Positive & Negative Covenants, Financial Covenants, + Information / Reporting Covenants AND “Consequence Clauses” i.e. Events of Default and Conditions of Disbursement. an indemnity may be included as a back-up contractual mechanism to addre ue that has been identified about the prospective borrower. In some high-risk3. Supporting Framework provisions These support the other two categories of provisions by establishing how the loan agreement’s provisions are to be read, how the agreement will apply/ be interpreted and put into effect and how the parties’ relationship with each other will be conducted — e. * definitions & interpretation clauses, * governing law &dispute resolution, * Miscellaneous/ General or “Boilerplate” clauses such as Notices, Amendment, language of communications, eteProvisions Relating to Amount & Flow of Cash Basic commercial terms + Loan Amount ~ this would simply state the total loan amount the Lender has agreed to provide to the Borrower, + Tenure (life of loan) — this simply means the pre-agreed time period that the borrower has to repay the principal and pay the interest & any other dues in full, + Disbursement (drawdown) mechanism — this is the pre-agreed manner in which the borrower receives each instalment of the loan and would be set out in simple terms, e.g.: such a provision may state that the borrower is required to inform the Lender at least 10 days before it requires the next instalment of the loan and each instalment should be for not less than X rupees, and that a receipt for such amount should be provided to the lender in not less than 5 days.Interest Rate May be Fixed or Floating Fixed rate is usually expressed as a certain percentage applicable per annum, e.g.: 10% p.a. Floating rate is expressed as the cumulative or sum of two values, one of which varies or changes from time to time and one of which is fixed. Y The variable component of Floating Interest Rate is called “Base Rate” or “Benchmark Rate and the fixed part is commonly referred to “Spread” or “Margin” or other similar terms Thus, a Floating Interest rate would be expressed as: ¥ Interest Rate = Base Rate (or “Benchmark Rate”) + SpreadSome examples of floating rate could be the following interest rates: Example 1 of Floating Rate: Interest Rate = EURIBOR + 2.5% So, for example: if EURIBOR on a given day is 5%, then on that day the interest rate for this Joan will be 7.5%. Note: Such interest is often expressed in terms of “bps” or “basis points” where 100 bps reflects 1%. So, in our example above, the interest could have been written as Interest Rate = 250 bps over EURIBOR Note further that: a 6-monthly average (or other periodic average) of the base rate is commonly :d to avoid daily ups & downs in such benchmark rates, NB: EURIBOR stands for European Inter-Bank Offered Rate, and is a rate that is used by various European banks to lend to one another in the European interbank market for short-term loans ~ it is accordingly variable and changes to reflect market trends. Note further that while LIBOR was the most commonly used rate for such purposes, it is no longer to be used — see Module 2 Notes for a discussion of the issues relating to LIBOR and why it is being discontinued)+ Example 2 of Floating Rate: Interest Rate = MCLR + 5% + (So, for example, if MCLR on a given day is 2%, then on that day the interest rate for this loan will be 7% - note that MCLR stands for Marginal Cost of Lending Rate, which RBI notified in 2016 as being the benchmark rate to be followed for floating interest for loans by Indian banks, except in a few specific cases. The RBI's Master Direction - Reserve Bank of India (Interest Rate on Advances) of March, 3, 2016, which was updated on June 10, 2021, sets out the relevant details of MCLR) * Interest Date and Interest Period: Borrower cannot make interest payments as and when it may suit the borrower, but must follow a pre-agreed schedule, Each Interest Date would fall on the last day of an Interest Period, Interest Periods usually vary between 1, 3 or 6 months but can sometimes even be of 9 or 12 months each,Fees/Charges and Reimbursements: The Lender will set out certain fees for all the activities and services that it must undertake in order to provide the loan. Additionally, if the bank has to undertake any expenses (¢.g.: appoint a lawyer to advise on the load, undertake due diligence etc.), it may require the Borrower to provide such amounts as well + Some examples of standard fees in term loans include + Facility or front-end fee, which is a fee paid to a lender for setting up a transaction. It is usually calculated as a percentage of the total value of the loan and is payable before or shortly after funds are drawn + Commitment fee, which a fee charged by a lender to a borrower to compensate the lender for its commitment to lend* Loan restructuring fee, which a fee charged by a lender if, due to borrower’s inability to pay or a change in borrower’s circumstances, the lender agrees to change certain terms of the loan + Prepayment Fee, which a fee charged by the lender if the borrower decides to pay off such a bilateral term loan before the loan tenure is over Standard reimbursement of Lender’s expenses include: + Legal fees incurred by lender + Increase in lender’s cost (e.g.: due to any change in law)Repayment (of P1 al + There is generally a pre-agreed repayment schedule + Forms of repayment schedule + Amortization —a schedule whereby the loan will be repaid in equal instalments, spaced out at equal intervals of time + Balloon — borrower starts of by making very small payments which gradually balloon into bigger instalment + Bullet — the entire amount of loan is repaid at one go at the end of the tenure of the loan.Tax Gross-Up * Clause that reflects a practice whereby the liability for payment of taxes on the interest is transferred to the Borrower. + On Borrower to ensure that Lender receives all payments without any deduction for taxes + If the Borrower must deduct taxes, will pay Lender an increased amount such that, after deduction, Lender receives the full amount it would have received without deduction of such taxes.RISK MITIGATION PROVISIONS + Such Clauses Include iii. iv. v. vi. the Use of Proceeds obligation... Representations Clause & Reliance Clause. Positive & Negative Covenants, Financial Covenants, Information / Reporting Covenants, and Consequence Clauses (CoD and EoD clauses)* * Apart from the contractual remedies provided by CoD and EoD (and indemnity, if required by lender), Lenders also have the option of statutory remedies such as under Section 19 (providing penalty for misrepresentation & fraud), Section 73 & 74 (damages for breach of contract) under the Indian Contract Act, 1872.SUPPORTING FRAMEWORK PROVISIONS Definitions & Interpretation Clauses + They enable clear and consistent application of provisions in the loan agreement, + Provides a specific and fixed meaning to the key words and terminology used in the agreement so that the parties do not have differing ideas of the meaning and scope of various words or terminology. + The interpretation clause provides guiding principles for construction of the legal provisions in the loan agreement. Governing law &dispute resolution * provide a route to resolve differences among the lender and borrower when contractual remedies fail. + Beyond courts and such forums, means of dispute resolution also includes arbitration and other alternative dispute resolution mechanisms.Boiler Plate Clauses + Guides the parties in the manner that their relationship will be conducted. It includes * Notices clause — provides the coordinates at which each can reach out to the other + Amendment clause — enables the modification of the terms of the loan if so desired by the parties and clarifies the process to be followed + Language clause: sets out the common language that both parties would understand and makes it obligatory for the parties to use that language in their communications with each other. All these clauses ensure the proper application of the transactional clauses and regulate the conduct of the lender and borrower with each other during the lifecycle of the loan transaction.SECURITY ARRANGEMENTS Security * A contractual protection provided by the borrower to a lender by way of creation of an interest in certain assets of the borrower * This isto ensure that upon any default by the borrower (on the terms of the loan agreement & related documents), the lender has recourse to certain assets of the borrower, which it has the right to take possession off dispose by sale and apply the proceeds of such sale to its dues. * Note; An important component of the security process isthe “perfection” ic. REGISTRATION of the charge’ security post creation. While creation for most types of security occurs through the due execution of the relevant documents (with some exceptions: e.g. mortgage through deposit of title ded), perfection js done by completion ofthe prescribed process for registration under the applicable statutes (CA 2013, SARFAESI Act, 2002, IBC, 2016). + The form of security depends on the type of assets being created: Immovable Property - Mortgage + A mortgage has been defined at Section 58(a) of the Transfer of Property Act, 1882 as ”...the transfer of an interest in a specific immovable property for the purposes of securing the pabmen of money advanced of ty be advanced by way"of foun, existing or future debt or the performance of engagement which may give rise to a pecuniary liability..."+ Transfer of Property Act, 1882 provides for following types of mortgages (Simple mortgage Section 58 (b): Where, without delivering possession of the mortgaged property, the mortgagor binds himself personally to pay the mortgage-money, and agrees, expressly or impliedly, that, in the event of his failing to pay according to his contract, the mortgagee shall have a right to cause the mortgaged property to be sold and the proceeds of sale to be applied, so far as may be necessary, in payment of the mortgage-money, the transaction is called a simple mortgage and the mortgagee a mortgagee. (i) Mortgage by conditional sale. Section 58 (c) — Where the mortgagor ostensibly sells the mortgaged property— on condition that on default of payment of the mortgage-money on a certain date the sale shall become absolute, or on condition that on such payment being made the sale shall become void, or on condition that on such payment being made the buyer shall transfer the property to the seller, the transaction is called a mortgage by conditional sale and the mortgagee a mortgagee by conditional sale: Provided that no such transaction shall be deemed to be a mortgage, unless the condition is embodied in the document which effects or purports to effect the sale.(iii) Usufructuary mortgage Section 58 (d) —Where the mortgagor delivers possession or expressly or by implication binds himself to deliver possession of the mortgaged property to the mortgagee, and authorizes him to retain such possession until payment of the mortgage-money, and to receive the rents and profits accruing from the property or any part of such rents and profits and to appropriate the same in lieu of interest, or in payment of the mortgage-money, or partly in lieu of interest or partly in payment of the mortgage-money, the transaction is called an usufructuary mortgage and the mortgagee an usufructuary mortgagee. (iv) English mortgage. Section 58 (e) —Where the mortgagor binds himself to repay the mortgage-money on a certain date, and transfers the mortgaged property absolutely to the mortgagee, but subject to a proviso that he will re-transfer it to the mortgagor upon payment of the mortgage-money as agreed, the transaction is called an English mortgage.(¥) Mortgage by deposit of title deeds Section 58 (f) —Where a person in any of the following towns, namely, the towns of Calcutta, Madras [and Bombay], and in any other town which the [State Government concerned] may, by notification in the Official Gazette, specify in this behalf, delivers to a creditor or his agent documents of title to immoveable property, with intent to create a security thereon, the transaction is called a mortgage by deposit of title-deeds (vi) Anomalous mortgage — Section 58 (g) A mortgage which is not a simple mortgage, a mortgage by conditional sale, an usufructuary mortgage, an English mortgage or a mortgage by deposit of title-deeds within the meaning of this section is called an anomalous mortgage.The commonly used types of mortgage for commercial loans in India include: (1) Mortgage by Deposit of Title Deeds: Title deeds are delivered to a property to the lender, with the express intention of creating a security over the property to which they relate, gives rise to an equitable mortgage. + Note that there is no written document required — however, a memorandum of entry will typically be executed, confirming the deposit of title deeds with the lender + The borrower may provide a declaration to the lender of the fact that the borrower deposited title deeds with the lender, with the express intention of creating a security over the property + The Transfer of Property Act, 1882 lays down certain territorial restrictions on the creation of a mortgage by the deposit of title deeds, and as such can only be done in the commercial centers specified therein.(2) Simple Mortgage: + A mortgage whereby without delivery of possession of the mortgaged property, whereby the mortgagor binds himself? herself that in the event that mortgagee fails to repay the loan amount, the mortgagee shall have the right to cause the sale of the mortgaged property and apply proceeds of such sale towards repayment of the loan amount, + The document executed in order to create the mortgage will be a mortgage deed.MOVABLE PROPERTY: + Charge is created over movable property (including movable and current assets) primarily by way of: 1. Hypothecation + The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI) defined hypothec "a charge in or upon any movable property, existing or future, created by a borrower in favour of a secured creditor without delivery of possession of the movable property to such creditor, as @ security for financial assistance and includes floating charge and crystallisation of such charge into fixed charge on movable property”. + Assets typically over which charge is created by hypothecation include: all kinds of movables such as movable plant, equipment and machinery, as well as Book debts, stock in trade, cash at hand, cash at bank etc. ion as+ the Documentation for creation of hypothecation is a: Deed of hypothecation’ Memorandum of Hypothecation, 2. Pledge: + The Indian Contract Act, 1872 defines pledge at Section 172 as “the bailment of goods as security for payment of a debt or performance of a promise ix called ‘pledge”. + Bailment is defined at Section 148, Indian Contract Act, 1872 as + "the delivery of goods by one person to another for some purpose, upon a contract that they shall, when the purpose is accomplished, be returned or otherwise disposed of according to the directions of the person delivering them". + Examples of assets typically over which charge is created by pledge: Shares, savings certificates, ete. + Documentation for creation of charge: Deed of Pledge3. Security over certain types of IP rights + Through assignment — document for such purpose would be a written agreement between the assignor and assignee. + Depending upon the IPR on which the charge is created, the charge-holder may be required to register its title with the relevant registrar.PROCEDURAL REQUIREMENTS + Stamp Duty would be applicable on the written instruments for creation of security + Instruments of mortgage creation are compulsorily registrable under the Indian Registration Act, 1908, + Perfection of security: Achieved by filing of certain statutory forms with the concerned Registrar of Companies as per Companies Act, 2013. + Further, a statutory filing has been prescribed under the SARFAESI Act, 2002 with the Central Registry of Securitisation Asset Reconstruction and Security Interest of India (“CERSAP’). Filing is also required to be done with the Information Utilities under the Insolvency and Bankruptey Code, 2016 (“IBC”),4. Guarantee + Section 126 of the Indian Contract Act, 1872, provides: A ‘contract of guarantee’ is a contract to perform the promise, or discharge the liability, of a third person in case of his default. The person who gives the guarantee is called the ‘surety’; the person in respect of whose default the guarantee is given is called the ‘principal debtor’, and the person to whom the guarantee is given is called the ‘creditor’. A guarantee may be either oral or written. + Guarantee Arrangement — Guarantor takes on the liability for paying the debts and any pending payments owed to the lender if the borrower fails to make such payments. + A tripartite arrangement between principal debtor, creditor and the guarantor as surety. Guarantee can be personal (i.c., given by an individual / natural person) or corporate (given by a juristic person, i.c., a corporate entity). Guarantee can be limited (ie., for a capped amount or for a specified portion of the amounts that may become due to the lender) or unlimited (i.e, the guarantor takes on the liability to make all payments that become due under the loan agreement without limiting such obligation to pay).END OF MODULE 3 CLASS NOTES NB: All persons referring to the contents of these Class Notes (‘notes’) (comprising 70 slides of this PPT) are advised to independently verify the same and to further check the legal position for any updates and/or amendments to law / practice: the contents of these notes are indicative and for purposes of initiating a discussion only, and are to be used as a preliminary, reference point for independent study by the students with whom it has been shared. The contents of these notes are not to be deemed as legal advice under any circumstances. In these notes, provisions of the legal framework have been referred to / summarised / described — these are set out to provide an indicative idea only for purposes of reference & revision. It is required to refer to the bare act of the relevant statute / law for the actual text and content of the statutes & laws referred to herein. ‘These notes may be used purely for purposes of assisting students to organize and systematize their independent study and research on banking & finance law. These notes is not to be circulated beyond the student group to whom it has been provided without the permission of the course instructor (Prof. Shuchi Sinha).