Lender’s right when the borrower owns and possesses the hypothecated assets

The lender’s right to the term “Hypothecation of assets” was not defined anywhere in the statute till the SARFAESI ordinance 2002. Some courts have even compared   ‘hypothecation to a mortgage of movables’.

Hypothecation occurs when an asset is offered by the borrower to the lender as prime or collateral to secure a loan/credit limit without giving up title, possession, or ownership rights. The asset hypothecated remains under the possession of the borrower and he is free to deal with it. The charge under hypothecation and terms and conditions thereby is created by an agreement commonly known as a “Letter of Hypothecation” or hypothecation deed. As the hypothecation deed was not uniformly drafted and varies from bank to bank, the courts while considering the rights of banks as hypothecatee have relied upon the deed executed and therefore given conflicting decisions.

However, SARFAESI ordinance 2002 states the Hypothecation of assets as under:

“a charge in or upon any movable property, existing or future, created by a borrower in favour of a secured creditor without delivery of possession of the movable property to such creditor, as a security for financial assistance and includes floating charge and crystallization such charge into fixed charge on movable property”.

Thus, in Hypothecation, the Bank (hypothecatee) is treated to be a secured creditor and has a right to seize the asset and sell the hypothecated goods without court intervention, to recover the outstanding dues.

The securities commonly covered under hypothecation deed are goods, book debts, machinery, vehicles, furniture, and crops [crops though fixed to earth (immovable) cannot be “mortgaged” as they can be easily detached and sold]. Banks create their charge on inventories for working capital finance extended by them by way of hypothecation of stock which remains in the possession of the borrower. In the same way, the charge will be created on book debts (receivables) for working capital facilities extended by the banks by way of hypothecation of book debts. Whenever a bank extends a term loan for the purchase of machinery and furniture, the charge will be created on that specific machinery and furniture by way of hypothecation. Many a time, the borrower offers hypothecation of his machinery and furniture as collateral security to the bank. The collateral security is offered to the lender when the lender asks for additional security.

Related Post: