Sometimes a customer of a bank may seek bank loan against book debts which have either become due or will accrue due in the near future. The customer may have to receive the money from them for a goods contractor will form a third party.
The debt which the customer has to realize form debtors is assigned to the banker. The established principle is that once the debt is assigned and the third party (i.e., the debtor) is given notice of the assignment, he is under a duty to pay the debt to the bank and not to the customer.
Section 130 of the Transfer of Property Act 1882 permits the assignment of an actionable claim to anyone except to a judge, a legal practitioner or an officer of the Court of Justice.
According to section 3 of the said Act, “actionable claim” means a claim to any debt or any beneficial interest in movable property not in the possession of the claimant which the Civil Courts recognize as affording grounds for relief, whether such debt or beneficial interest be existent, accruing, conditional or contingent.”
A debt secured by mortgage of immovable property or by hypothecation or, the pledge of movable property, is not included in the actionable claim. The person who assigns an actionable claim is called the assignor and the person to whom it is assigned is called the assignee. Assignment of debt may be with or without consideration.
Disadvantages of bank loan against book debts
- Advances against book debt are not looked with favor by the banker. Because, this is, after all, unsecured in nature and a clean advance, for its repayments entirely depends on the creditworthiness of the client. If the debtor refuses to pay, the bank will seek the legal remedy for its recovery. The value of debts as a security is mainly dependent upon the creditworthiness of the debtors of the customer.
- The realization of book debts is not an easy job and is risky.
- In the case of book debts, the banker is placed in the position of a debt collector.
- If the book debts are subject to a prior charge or a counter-claim of the debtor, the banker will not be able to get the full benefits of the book debts.
Books debts are, therefore, not accepted as main security but are taken as collateral security along with the principal security.
Only where the debtors are solvent or, where the dues form the government on contracts or, in the case of debenture of a good company having a charge on the property or, where the assignment is of money payable form a special fund, book debts are worthwhile for acceptance by the bankers as security for advances.
Precautions and Checks
Book debts are furnished as security by assigning them to the bank. When the debtors are given notice of such assignment, they become duty-bound to pay the money to the bank. When the debtors are given notice of such assignment, they become duty-bound to pay the money to the bank.
Even if the customer goes bankrupt, his trustees cannot deprive the bank of his right of claiming the amount form the third party debtors. The banker should take the following precautions while advancing on the security of a book debt.
- The banker must enquire into the solvency of the debtor who owes money to the customer. The bank should also check the validity of the debt.
- Legal Assignment: The assignment of book debt must be effected by execution of an instrument in writing signed by the transferor or his duly authorized agent, clearly expressing his intention to transfer his interest in the debt to the assignee. He may pass an order to his debtor to pay the assigned debt to the banker. If the debt is in the form of a promissory note, the assignment must be made on the note itself.
- Notice in Writing: The banker should give notice of assignment to the debtor. Notice of assignment must contain particulars, such as the name of assignor, the name of the assignee and the debt assigned. This is necessary to prevent the debtor from making payment of debt to the customer. Non-service of notice does not render the assignment ineffective or invalid but it is essential so as to make debtor liable to make payment to the assignee.
- To acknowledge the notice: The debtor should be requested to acknowledge receipt of the notice and to confirm the debt. They should also be requested to furnish details of the earlier assignment, if any, and the right of set-off which they might have against the debt.
- Notice of joint debtors: In order to bind all the debtors, it is necessary that notice should be given to all joint debtors or point trustees and, if the debtor is dead, to all his executors or administrators.
- The borrower must authorize the bank to receive the debt of the party by executing a power of Attorney in his behalf. An undertaking should also be obtained from the borrower that money if received by him from the debtor in respect of the assigned debt, will be paid to the banker.
- The assignment should be of the whole debt and not of a part of it.
- Execution by limited company: Where the assignment is executed by a limited company, it must be registered with the Registrar of Joint Stock Company. Failure to get such registration renders the charge void against the liquidator and any creditor of the company.
- After the assignment of debt, all rights and remedies of the transferor, whether by way of damage or otherwise, shall vest in the transferee, and the latter may sue or institute proceedings for the same in his own name against the debtor without obtaining the transferor’s consent and without making him a party to the suit.
- The assignment, however, does not entitle the assignee (i.e., the banker) better rights than what the assignor had against the debtor. For example, if the debtor has a counter-claim against the assignor, he continues to have the power to set-off such claim against the amount due to the assignee.
- The transferee of an actionable claim shall take it subject to all the liabilities and equities to which transferor was subject in this respect at the date of transfer. (Section 132 of transfer of Property Act, 1882).
- Future Debt: Future debts may not be accepted as security. In a contract of sale of goods by installments or some construction contracts where the amounts are to be paid according to the progress of the work, it is likely that the customer may not strictly carry out the terms of the contract and thus nothing becomes payable by the third party. Even if the work has been properly carried out its quality may be disputed by the debtor.
Modes of Credit Facility
The facility of granting advance to the customer against book debts can be given in two ways:
- The customer sends the invoices and the sale documents to the bank. The bank examines the documents and credits the account of the customer with the value of acceptable invoices less margin. It returns the rest of invoices to the customers. The bank also keeps the account of the debtors and on collecting money from them credits their account. The borrower’s account is also credited with the balance of money collected by the bank which was not credited originally on account of margin.
- The borrower may send a list of eligible debtors to the bank. The bank after going through the list and satisfying itself regarding the validity of debts and solvency of debtors determines the amount of advance to be given after keeping sufficient margin.
- Demand Promissory Note
- Letter of continuity (in case of overdraft account)
- Legal assignment of debt
- Power of attorney executed by the borrower in favor of bank to receive debt of the borrower.
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