[Submitted by Ms. Vijaya Agarwala,
B. Com (H), Pursuing CS,
Kolkata, West Bengal]

June 7, 2014

Introduction

Hypothecation is a method of creation of security of movable property. However, the goods so hypothecated continue to be in the possession of the owner, that is the borrower. Hence, it is a way of creating security without delivery of title or possession and as in the literal sense of term, the lender is ‘hypothetically’ in control of the property.

The only point of distinction between pledge and hypothecation is that in case of pledge, the beneficial possession of goods is transferred to the lender whereas in hypothecation, possession remains with the owner. Hypothecation is merely an extended form of pledge which allows the lender to retain possession in trust for himself. Though there is no doubt that the creditor’s right to take possession or sell the goods directly for the purpose of recovering his dues continues to remain in either case.

The law then and now

The erstwhile definition of charge under Act, 1956 defined charge as “for the purpose of this Section charge includes mortgage ”

With the dawn of Act, 2013, the definition of charge now stands amended as “charge means an interest or lien created on the property or assets of a company or any of its undertakings or both as security and includes a mortgage”

Section 125 of the Act, 1956 dealing with registration of charges, clearly and explicitly listed out charges that are required to be filed with the Registrar of Companies (‘RoC’) for the purpose of safeguarding the interest of the lender and to prevent the Company from creating several charges against a property. Section 125(4) of Companies Act, 1956 rendered -

“This section applies to the following charges:
(a) a charge for the purpose of securing any issue of debentures ;
(b) a charge on uncalled share capital of the company ;
(c) a charge on any immovable property, wherever situate, or any interest therein ;
(d) a charge on any book debts of the company ;
(e) a charge, not being a pledge, on any movable property of the company ;
(f) a floating charge on the undertaking or any property of the company including stock-in-trade ;
(g) a charge on calls made but not paid ;
(h) a charge on a ship or any share in a ship ;
(i) a charge on goodwill, on a patent or a licence under a patent, on a trade mark, or on a copyright or a licence under a copyright.

Corresponding Section 77 of chapter VI of Companies Act 2013, reads as -

“ It shall be the duty of every company creating a charge within or outside India, on its property or assets or any of its undertakings, whether tangible or otherwise, and situated in or outside India, to register the particulars of the charge signed by the company and the charge-holder together with the instruments, if any, creating such charge in such form, on payment of such fees and in such manner as may be prescribed(in Form CHG 1 ), with the Registrar within thirty days of its creation.”

With the notification of Section 77 Companies Act, 2013, section 125 of the 1956, Act, however, now stands repealed. Section 77(1) of the Act has simply done away with the list provided in the principal Act, and requires registration of each and every charge created on the assets of the Company whether tangible or intangible.

Also, e-Form CHG. 1 contains an option of registering hypothecation of motor vehicle in Field 11(a). The principal Act, was though silent on registration of hypothecation, however, in the matter of Sree Meenakshi Mills Ltd. And Anr. vs Registrar Of Companies, Madras it was held by the RoC that the non registration of charge did not render it void against the liquidator as the hypothecation of the hire purchase agreements created a charge on the book debts of the company, and that it was immaterial that the hypothecation bond was intended to secure to the defendants other rights besides the book debts.

Several rulings in the past seem to have consensus on hypothecation being an extended form of pledge and creates a charge on the property/ assets of the borrower. Below we, discuss the inference drawn from such rulings:

Case 1:

Madras High Court

Rehaboth Traders By Partner R. vs Canara Bank And Ors. on 22 August, 1997

The appellant Rehaboth Traders, a partnership firm, having failed to discharge its liability, was adjudged as insolvent. The respondent Canara Bank had advanced loan to the appellant against hypothecation of goods.

The Hon’ble High Court stated that It is true that the word 'hypothecation' has not been expressly defined in the law of contracts. But, the scope of the word 'hypothecation' has been explained in catena of judgments of the Hon’ble Apex Court, as well as various High Courts in the country. It is also true that there is no transfer of interest of property in the goods by the hypothecator to the hypothecatee.

It was held by the apex court that, in case of hypothecation of goods, the Bank shall be treated as a secured creditor and shall have preferential right of recovery in relation to other creditors and that hypothecation is an extended form of pledge.

Case 2:

Delhi High Court

Ideal Bank Ltd. (In Liquidation) vs Pride Of India Pictures Ltd. on 25 January, 1983

The company borrowed large sums of money from one Adarsh Films Ltd., respondent No. 2, for short "the creditor", against the mortgage of its assets, including apparently some of the assets which had already been pledged with the bank. The arrangement visualised that the creditor would run two cinemas of the company and would get possession of the cinemas, and other assets for a period of four years from the date of the mortgage or for such longer period as may be necessary to recover the outstandings.

It was held by the Hon’ble Court that mortgage of movable property is a recognized form of hypothecation and confers a good title upon the persons in whose favour it is made. It is recognized that such transaction is not only valid but is customary throughout the country and even resorted to by banks with a view to enable the pledges to carry on business with the pledged property. Hence, the property of the company was charged/ pledged or hypothecated.

What can be derived looking at precedents in this regard is that although it is a settled understanding that hypothecation and pledge are not synonyms and mean two different concepts, yet the general practice is to treat hypothecation as a subset of pledge and thereby companies have feigned the importance of also registering hypothecation. The Act, 2013 however seem to indicate otherwise.

Conclusion:

Hence, this development in the area of corporate governance is sure to vex the corporate world, burdening them with too many filing requirements, failing which needless to say, the Act has dreadful penal provisions inlaid for the officers in default. The law as it stands now actually requires registration of every charge. So companies will have to register the hypothecation of any movable property be it any motor vehicle or car for the business use of its officers.