Cash credit in its truest sense is against the pledge of goods. Cash credit is sometimes allowed against the hypothecation of goods. In a manufacturing company, whose stocks of raw materials and manufactured goods constantly fluctuate, it is difficult for the bank to control such changes; so hypothecation facilities are required by them and banks also allow this facility. Let’s know more about cash credit against hypothecation of goods.
Because the bank’s staff are unable to control such change, the system of pledge letters and delivery orders is, therefore, not suitable in such cases. The same is true of the small traders and small industrialists who cannot offer their stocks as a pledge but can only offer hypothecation of the stocks in their shops/ godowns etc.
Cash credit against hypothecation of goods
In the case of Cash credit (hypothecation) the ownership and possession of the goods remain with the borrower. By virtue of the hypothecation agreement the bank and take possession of the goods hypothecated, if the borrower defaults. Bankers are, in that case, entitled to take legal action against the debtor not only for the debt but also for breach of trust. The letter of hypothecation creates an equitable, and not a legal charge, on the stocks.
The goods remain in the of the borrower but by displaying the bank’s signboard on the factory premises and on the godowns the banker is able to give notice to the third parties of his interest in the stocks. This equitable charge can be defeated easily by the borrower either by selling the goods to a bonafide purchaser for value and the pledge gets priority over the bank’s claim.
Prior hypothecation of the same goods gives the prior hypothecate a prior charge. the assignee in insolvency or execution creditor has priority over the bank’s claim under the reputed Ownership clause under the Insolvency Act.
Banks prefer to sanction hypothecation advances to limited companies to individuals and firms because the charge by way of hypothecation in the case of a limited company is compulsorily required to be registered with the Registrar of Joint Stock Companies and it is constructive notice to the public. There is no such protection available to a banker in the case of individuals or firms.
The real security in such advance is a mortgage of immovable property belonging to the borrower or a guarantee of a third person acceptable to the bank as collateral security. It is, therefore, essential that the guarantor should be kept alive of his liability. The documents got executed by the guarantor should provide a continuing guarantee.
Under Section 130 of the Contract Act, a continuing guarantee can be terminated by the surety as to future transactions by notice. Hence, if a guarantor serves the bank with a notice to revoke the guarantee, operation in the account should be stopped and no further debt should be fresh loans not covered by guarantee and credits will go to reduce the guarantor’s liability.
The following are the characteristics of hypothecation:
- Only movable assets and book debts can be hypothecated.
- The charge is floating, present, or future. It is not crystallized until it becomes a pledge.
- The Stocks are constantly changing, as buying and selling go on regularly.
- The lender has no effective control over the securities, as they are not in his possession, either actual or constructive.
Practice and procedure
The advance should be allowed only to parties of good reputation, undoubted standing, and credit.
Before allowing any advance against the hypothecation of goods, a banker must ascertain by inquiry and inspection that the stock has not been pledged or hypothecated to any other bank or creditor.
A written undertaking from the borrower should be obtained in this respect. In the case of Limited Companies, searches are to be made to see that no prior charge over the securities offered exists.
The banker should obtain a periodical statement of stock, duly signed by an authorized person with valuation as per invoices. The stock statements usually contain a declaration by the borrower regarding his clear title to the goods and the correctness of the quality, quantity, and valuation thereof.
The stocks are entered and valued, as in this case of the pledge, in the stock register; and after allowing the stipulated margin, drawing power is worked out.
The inspection of stocks is carried out at least once a month by the Manager at an irregular interval to detect any fraud. At the time of the inspection of the stock, the Manager must give special attention to the incoming and outgoing of each item of goods.
If any particular item remains in the stock for a long time, an inquiry is to be made as to its reason.
Bank’s signboard or nameplate is to be displayed prominently outside and also inside the shops/godowns.
The stocks must be insured against all risks. i.e., fire, theft, burglary, riot, flood, civil commotion, war, etc for the full value in joint names of the borrower and the bank.
The policies should be kept alive/duly renewed in time debating the premium etc. to the borrower’s account.
Where the volume of business warrants, it is useful to post a bank’s chowkidar wearing a uniform with the bank’s name inscribed thereon.
If the sanctioned limit is large; the godown keeper should also be posted in the godown to keep the regular account of the incoming and outgoing stock.
Sometimes, customers may request an advance against goods in transit. In transit. In such cases, transit insurances of the goods must be obtained at the borrower’s cost.
Such advance is allowed only if the borrowers are of unquestionable standing and the amount involved is not too large in proportion to the total advance.
Hypothecation advance is allowed by banks to the borrower only for their working capital and not for any capital investment against mortgage of immovable property or guarantee of the third person acceptable to the bank.
In the case of an advance to a Limited Company, this charge is to be filed for registration with the Registrar of Joint-stock companies within 21 days after the date of creation of the charge by the execution of documents.
This will protect the bank against a liquidator in a case of insolvency of the borrower. This also serves as notice to subsequent encumbrances. Besides, it is usual to obtain the personal guarantee of some well-to-do directors.
After the complete liquidation of the advance allowed to a Limited Company, the bank is to inform the Registrar of Joint Stock Companies in the prescribed form with a requisite fee so that the charges registered with them may be treated as canceled.
Documents
- Demand Promissory Note
- Letter of continuity
- Deed of Hypothecation
- Letter of guarantee of director, managing agent; etc (in case of a limited company)
- certificated for registration of charge (in the case of companies)
- Mortgage of property, if any, as collateral security
- Latest stock statement duly signed by the authorized person
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