The risk is inherent in lending and the reduction of risk to an acceptable level is the function of security. While lending money, bankers secure the loans and advances in one way or other but the security is not available to the banker unless it is properly charged in his favor. Even a good security, unless properly charged, will be of no avail. Let’s know about various methods for creating charge over securities.
What is charge
Charge means the right of payment out of a certain property. In a charge, there is no transfer of interest or property. It is a right over some tangible asset of the borrower.
It is a legal transaction as a result of which the lender acquires certain rights over the property and the borrower refrains from dealing with them. In a charge there must be a notice to the subsequent transferees, otherwise, the charge is not effective as to the subsequent transferees.
Lord Justice Atkinson aptly explained charge as: “I think there can be no doubt that where in a transaction for value both parties evince an intention that property existing or further shall be made available as security for payment of a debt and that the creditors shall have a present right to have it made available, there is a charge even though the present legal right which is contemplated can only be enforced at some future date, and though the creditor gets no legal rights of property, either absolute or special or any legal right tot possession but only gets the right to have the security make available by an order of the court.”
Methods for creating charge over securities
A charge may be classified as:
1) a fixed charge, 2) a floating charge.
- Fixed charge: A charge is said to be fixed if it is made specifically to cover definite and ascertained assets of a permanent nature or assets capable of being ascertained and defined, e.g., a charge on land and building or heavy machinery. It prevents the loan from dealing with the property charge without a consent of the charge holder.
- Floating charge: It is a charge on property which is constantly changing, e.g., stock. A company can deal with such property in the normal course of its business until it becomes fixed on the happening of an event. Thus, it is a charge on the assets of a company in general.
Pari Passu Charge
The term is usually used in case of consortium lending. In a case of such lending, a number of banks or financial institutions join together to lend to banks or financial institutions join together to lend to a single borrower in an agreed ratio against some common securities.
The securities are a charge to all the bankers/financial institutions without any reference like first charge or second charge etc. The term that institutions will have a “pari passu charge” over the assets of the borrower means that the lenders are entitled to have equal rights over the assets as per the agreed share.
In other words, in the absence of sufficient assets to pay each lender, they will lose rotatably without any preferences to anyone or more.
A creditor holding a second charge by way of mortgage is entitled to the proceeds after the first charge is met.
He must inform the prior mortgagee of his charge because the first mortgagee cannot part with the proceeds or title of the property if he has notice of the second charge.
Charging over securities
Charging a security means making it available as a cover for an advance. A banker, in the course of his business, has different kinds of securities submitted to him as cover for advances by his customers. Some securities are, in certain cases, movable while others are immovable.
In certain cases possession of goods is handed over by the borrowers to the bank while, in other cases, it may not be possible or practicable to do so. It is not enough that the security is good but the method by which it is offered as security to the banker must be legal and perfect.
It is, therefore, important that the charge must be complete and all necessary formalities comply with so that in case of default by a borrower. The security will be available to the banker.
It should, however, be noted that whatever form the charge may take, the banker does not become the absolute or exclusive owner of the property; he has only certain defined rights in it until the debt due to him is repaid.
The manner by which some articles or commodities or properties are made available to a baker as security is known as charging of securities.
There are a number of methods by which banker can obtain a charge over the debtor’s property. The method used depends on upon.
- The type of property to be charged
- The nature of the advance
- The degree of control over the debtor’s property required by the banker. The common method of charging securities are:
Lien is the right of one person to retain goods and securities in his possession belonging to another until certain legal debts due to the person retaining the goods are satisfied.
In other words, it is the right of the creditor to retain the goods and securities in his possession, belonging to a debtor, until the debt due is paid. Lien does not give a power of sale but only to retain the property.
Lien differs from other forms of charge in the respect that it does not arise out of an implied or express agreement. But the right of lien arises out of the dealings between the parties. There are three essential conditions for exercising the right of lien which is as follows:
- The goods over which this right is to be exercised must be possession of the creditor who will exercise it.
- There must be a lawful debt due to the person in possession of the foods by the owner of the goods.
- There must not be any contract to the contrary, e.g., safe custody etc.
There are three kinds of lien classified hereunder:
- Possessory lien
- Equitable lien.
- Maritime lien
A possessory lien can only be exercised by the person in possession of the goods. It is lost by
- Loss of possession
- When money due is paid
- Substitution of security
- When a right of lien is waived.
The pre-requisites of a possessory lien are that the possession should be rightful, continuous and not for any special purpose. The possessory lien may be further divided into two kinds.
- Particular lien
- General lien.
Particular lien: Particular lien is that lien which confers the right to retain that particular commodity in respect of which the particular debt arose. Such debts usually arise from service rendered or laborer or money spent on the goods on which the right it’s to be exercise. For example, a radio repairer has a particular lien on the radio repaired. A laundry owner has this right on the clothes washed by him for realization of washing charges. a particular lien is given by law to bailers, agents, pledges, carriers, railways, shipowners, port trust authorities, and unpaid sellers etc.
General lien: A general lien confers a right to retain goods and securities not only in respect of a particular debt incurred in connection with them but in respect of the general balance due by the owner of the goods and securities, to the person in possession of them.
General lien may be conferred upon by an agreement to that effect or by custom and usage or by the provisions of any statute. The right of general lien is specially given by law to a) bankers b) solicitors c) brokers d) wharfingers e) warehouse-keepers.
There is a principle that a particular lien defeats a general lien, and therefore, where a banker has a particular lien, he cannot also claim a general lien.
A banker has a general lien on cash, cheque, bill of exchange and securities deposited with him in his character of a banker for any money due to him as a banker.
Banker’s lien: As a general rule, the right of lien does not give the person exercising the right, any power or right to sell or dispose of the securities retained. But in case of a bank, it is otherwise. A Banker’s lien is more than a general lien.
It is an implied pledge and the banker has a right to sell the property after reasonable notice, provide the property comes into his hands in the ordinary course of his business.
The question in regard to what is a reasonable notice will depend upon the circumstances of each case. This special position has been recognized in Brandao us Barnett (1846). Lord Campbell stated that
“Bankers have a general lien in all securities deposited with them as bankers by a customer unless there be an express contractor circumstances that show an implied contract, inconsistent with lien.”
Section 171 of the contract act lays down that a banker’s lien can be applied if:
- The property is in the hands of the banker in the capacity of his customer’s bankers;
- the instruments of the money or goods with the banker are not for a specific purpose inconsistent with the lien;
- the possession of the instruments has been obtained lawfully as a banker;
- there exists no implied or expressed agreement contrary to the lien.
The banker has a general lien over the goods pledged and is entitled to combine several accounts of customers into one realization account and in absence of any special agreement to the contrary banker has a right to exercise lien on the goods pledged in one account for a balance due on another account.
The banker only acquires a lien over pledged goods for the recovery of his dues and has a right, after notice to the debtor, to sell those goods to reimburse himself.
It is only where such a sale is actually held that the debtor can claim an adjustment of the sale proceeds of the goods against the amount claimed by the bank.
The banker’s general lien will not extend to securities deposited with him for a specific purpose inconsistent with the lien. Hence, the following situations are not covered by banker’s lien.
- It does not extend to securities which do not belong to the customer if the banker is aware of it.
- Articles or goods deposited by the owner for safe custody.
- Securities or valuables lying in safe deposit locker.
- Securities deposited for sale, collection of interest, dividend etc. Though he will not be able to exercise his right of lien on Government promissory Notes and shares, but he is entitled to do so for any interest earned and the dividend collected.
- A banker has no lien on its fully paid-up shares but on partly-paid shares.
- A banker has no lien on insurance policy pledged as a security for a loan as soon as the debt is repaid.
- Where a banker discounts a bill, he has no lien on the current account balance of the said account of his customer.
- Conveyance of land is not subject to this lien but title deeds left without a memorandum of deposit is subject to such lien.
- Fixed deposit deposited for collection of interest from another bank. In the case, interest collected will fall under his right of lien.
- Securities deposited upon a particular trust.
- Any security left in the banker’s hands to cover a proposed advance which is subsequently declined.
- A banker cannot forfeit share in satisfaction of debt due by a shareholder.
- A bank does not have lien over the credit balance lying in a customer’s account. The banker’s right in such case is a right of “set-off”.
A banker gets the right of lien by virtue of law. As a measure of caution, a bank sometimes requires a customer to give a letter of lien enabling him to regard as security for an advance, present or future, granted to the customer.
This letter also authorizes the bank to sell the securities are given for a special purpose. Usually, bankers take a combined letter of lien and set-off for exercising both the rights.
At the time the advance is made, the banker sometimes asks a borrower to execute a letter declaring that his assets are free from any sort of charge or encumbrance.
The borrower also undertakes that the assets stated in the said declaration shall not be encumbered or disposed of without a bank’s permission in writing so long as the advance continues.
This undertaking is known as a Negative lien. Usually, the arrangement is drafted in the form of an agreement.
The banker cannot directly realize his debts from such assets. However, on account of the above restrictions, the interests of the banker are to a certain extent protected.
An equitable lien is an equitable right conferred by law to a charge upon the movable or immovable property of another until certain specific claims are satisfied.
An equitable lien is created by operation of law. The instances of the equitable lien are:
- Where the banker releases the pledged goods to the borrower under a trust receipt that sale proceeds of the goods will be duly deposited in the loan account. The goods are under lien to the bank.
- An unpaid vendor of immovable property has an equitable lien on the property for the whole or part of the purchase money until actual payment.
- A partner who pays partnership debts on dissolution has an equitable lien on the property of the partnership.
A maritime lien is a right especially binding a ship, her furniture, machinery, cargo and freight for the payment of claim based upon the maritime law. It is given by law to
- the Master of the ship for seamen’s wages.
- Bottomry Bondholder who has advanced money to the master of the ship in distress.
- the salvors on the salvaged property.
- To the persons who have suffered losses as a result of collision due to ships negligence. It can be enforced by a legal process by arresting the ship or by proceeding against it in the admiralty Court. The lien subsists even if the ship has been sold for valuable consideration to a third party.
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