PLEDGE

Meaning of Contract of Pledge

A pledge contract is an agreement between two or more parties

outlining the specific actions that each party will take in order to achieve
a common objective. Contract terms are typically decided upon by the
parties concerned and may be revised or updated as needed.

PARTIES

● The person who delivers the goods is known as a pawnor or

pledgor.
● The person who accepts the goods, for the time being, is known
as a pawnee or pledgee.

Essential Features of Pledge

1. Valid contract: All the basic features of a valid contract should be

fulfilled; For example, offer, acceptance, consideration, capacity to
contract, wilful consent, etc. If basic features are not fulfilled, the contract
would be void and unenforceable.

2. Delivery of possession: Possession of goods should be transferred

from the pawnor/pledgor to the pawnee/pledgee. It can either be actual
or constructive. Actual delivery is where goods are transferred in real
whereas constructive delivery is where the goods are transferred
indirectly. Example:

● The key to the warehouse is handed over to Mr A, where the

goods are kept – is a constructive delivery.
 ● On the other hand, if the actual goods had been handed over to Mr
A, that would be actual delivery.

3. Ownership cannot be transferred: Pawnee/pledgee only possesses

the goods for the time being, as per the duration of the contract.
Pawnor/pledgor still remains the actual owner of the goods.

4. Security against debt: Goods must be pledged against the debt of

the pawnor.

5. Return of goods on repayment: Once the motive of the contract

gets performed, the pledged goods should be returned to the
pawnor/pledgor, who is the real owner of the goods, in the duly
prescribed manner.

Rights of the Pledgor

1. Right to redeem goods: If the pledgor from his end fails to fulfil the
contract or does any default, then according to section 177 of the Indian
Contract Act, the pledgor can redeem his pledged goods before the
pledgee sells them. But the pledgor has to compensate the pledgee for
the expenses or damages incurred to him.

2. Right over the increased value of goods: If the value of the pledged
goods increases, it is the right of the pledgor to claim those values along
with the return of the goods.

Rights of the Pledgee

1. Right to retain goods: As per section 173 of the Indian Contract Act,
the pledgee has the right to retain the goods unless the amount
owed by the pledgor is paid, the promise is fulfilled, or the interest
accrued during the preservation of the goods is paid.

2. Right over extraordinary expenses: As per section 175 of the

Indian Contract Act, the pledgee is entitled to receive compensation
for the extraordinary expenses he incurred while preserving the
goods.

3. Right to sell goods: On the same grounds where the pledgee was
entitled to retain goods, the pledgee can also sell them under section
176 of the Indian Contract Act by giving reasonable notice of sale to the
pledgor.

Note: If the amount received after the selling is still lesser than the
amount due, the pledgor still would be liable to pay the balance amount,
and if the amount received is in surplus, then the pledgee is bound to
return the surplus to the pledgor.

Other rights of Pawnee or Pledgee

● Right of Lien- Section 173 entitles the pawnee with a right to

retain goods until he is paid
● Money due under the pledge
● Interest to be paid on debt
● Necessary expenses for preservation of goods.
● Right of retainer for subsequent advances- Section 174
provides for a presumption that if there are any subsequent
advances made by pawnee to pawnor, it will be included in the
 original debt only. Therefore, the pawnee has the right to retain the
goods until subsequent advances are paid.

Duties of the Pledgor

1. Duty of compensation: For the care taken by the pledgee of the

pledged goods, the pledgor is entitled to compensate for all ordinary
and extraordinary expenses incurred by the pledgee.

2. Duty to pay interest in addition to principal amount: Pledgor is

bound to repay the entire principal amount back to the pledgee by
adding the interest upon it if it arises during the contractual period.

3. Duty to disclose all facts: Pledgor is liable to reveal all the facts
about the goods he is pledging to the pledgee before coming into the
contract. If the pledgee experiences any loss because of the
non-disclosure of the fact, the pledgor will be held liable.

Duties of Pawnor

Pawnor has the following duties

● The pawnor is liable to pay the debt or perform the specified
promise.
● To compensate the pawnee for any expenses incurred by him for
preserving the goods pledged.
● To disclose the defaults that may put the pawnee under
extraordinary risks.
 ● The pawnor must compensate the pawnee, if loss is caused to him
due to defect in pawnor’s title of goods.

Duties of the Pledgee

1. Duty to take reasonable care: Care taken by the pledgee should be

just, fair, and reasonable. It should be in such a way as if the pledgee is
taking care of his own goods. If goods get damaged due to the pledgee’s
negligence, the pledgee would be liable to compensate the pledgor.

2. Duty of not using the pledged goods: Pledgee is not supposed to

use the goods pledged to him by the pledgor unless and until the
pledgee is authorised to do so.

3. Duty to return goods: Once the motive of the contract is fulfilled, the
pledgee is liable to return the goods back to the pledgor.

4. Duty to return the benefit: If the pledgee gets any benefit arising
from the pledged goods during the contract, the pledgee is supposed to
repay the benefit enjoyed by him to the pledgor.

5. Duty to keep goods separate: Pledgee is supposed to keep his

goods separate from the pledgor’s goods, and if he mixes it, only he has
to bear expenses to separate, and if it is not possible, he shall pay for
the damages incurred to the pledgor.

Duties of Pawnee

Pawnee has to fulfil the below mentioned duties:

● Duty to take reasonable care of the goods pledged.
 ● Duty to return the goods upon payment of debt or performance of
promise.
● Duty to not mix his own goods with the pledged goods.
● Duty not to act in anyway which is inconsistent with the contract of
pledge.
● Duty to not make unauthorized use of goods.
● Duty to return accretion of goods if any.

Pledge by Non-owners

Ordinarily, only the owner of the goods, or anyone authorized by him in

that position, can pledge the goods or services. Nonetheless, in order to
simplify commercial transactions, the law has recognized some
exceptions. These exceptions apply to legitimate pledges made by
people who are not the actual owners of the goods but have been left in
their control

Non-owners can make a valid pledge in the following circumstances −

Mercantile agent (Sec 178)

A mercantile agent is an agent who has the authority to acquire and sell
goods on behalf of his principal and can consign items for sale or raise
money on the security of goods. A valid pledge can be made by such an
agent with the consent of the principal.

A person in possession under a voidable contract (Sec. 178 A)

A person in possession under a voidable contract can form a valid
contract of pledge of goods, as long as the contract was not cancelled
at the time of the pledge and the pledger acted in good faith and without
knowledge of the pledger's defective title.
For example, if A purchases a watch from B under coercion and pawns
it with C before B cancels the deal, the pledge is valid. C will get the
initial title to the watch, and B can only claim A for damages.

Pledger having limited interest (Sec. 179)

When a person pledges goods in which he has a limited interest, the
pledge is only valid to the extent of his interest. As a result, a person
with a lien on goods can pledge them up to the extent of his interest.

For example, A goes to B (a tailor) to have his cloth stitched for a fee of
Rs. 2,000; When the suit was ready, B needed cash urgently and
pledged it to C for Rs. 3000. The pledge is valid up to the amount of B's
interest, which is 1500. Here, A may recover his suit from C by giving
him Rs.1500.

Pledge by a co-owner in possession

If the goods are owned by many persons and are left in the possession
of one of the co-owners with the consent of the other owners, a valid
pledge of the goods in his possession may be made by such a
co-owner.

Pledge by seller or buyer in possession

A seller who has left the goods in his possession after sale or a buyer
who obtains possession of the goods before sale with the seller's
consent can make a valid pledge, provided the pawnee acts in good
faith and has no knowledge of the pawnor's defect in title.

For example, A buys a bicycle from B. Even so, the cycle is with the
seller. B then pledges the cycle with C, who is unaware of B's sale and
acted in good faith. This is a valid commitment.

Key differences between Pledge and Hypothecation

● Purpose: A pledge is used as collateral for a loan, while
hypothecation is used to secure a debt or obligation.
● Ownership: In a pledge, the pledged asset remains in the
possession of the borrower, while in hypothecation, the asset is
transferred to the lender or creditor.
● Risk: In a pledge, the risk of loss is borne by the borrower, while in
hypothecation, the risk of loss is borne by the lender or creditor.
● Possession: The borrower retains possession of the pledged
asset in a pledge, while the lender or creditor takes possession of
the hypothecated asset.
● Registration: Pledge is a registrable charge, hypothecation is not.
● Sale: Pledged assets cannot be sold without the consent of the
lender, while hypothecated assets can be sold by the lender to
recover the debt.
● Priority: In case of liquidation, pledge has priority over
hypothecation.
● Type of assets: Pledging is commonly used for tangible assets
such as inventory or equipment, while hypothecation is often used
for intangible assets such as accounts receivable or intellectual
property.
● Condition: Pledge is created by delivering the assets to the
creditor, hypothecation is created by contract.