Advances, Securities and Documentation: formula sheet

Key formulas

Principles of sound lending

Safety + Liquidity + Profitability + Purpose (plus diversification and compliance)

Write the four main principles with a line of explanation each. Mention extras only after them.

Discount on a bill

Discount = Bill amount × Rate ÷ 100 × Unexpired period (in years)

Proceeds = Bill amount − Discount. Use days ÷ 365 for the period unless the question states otherwise.

Interest on cash credit or overdraft

Interest = Amount outstanding × Rate ÷ 100 × Days ÷ 365

Interest is charged only on the amount actually drawn for the days it stays drawn, not on the full limit.

Undue influence (section 16, Indian Contract Act, 1872)

Position to dominate the will + use of that position to obtain an unfair advantage

Where the dominant party contracts and the transaction appears unconscionable, the burden of proving no undue influence lies on that dominant party.

Lien

Right to retain goods already in lawful possession until dues are paid

The Contract Act, 1872 gives a banker a general lien over goods bailed to it, unless there is a contract to the contrary. Lien gives a right to retain, not a right to sell.

Pledge

Bailment of goods as security for a debt or promise, with delivery of possession

Parties are pawnor (borrower) and pawnee (bank). Delivery may be actual or constructive. Sale needs reasonable notice to the pawnor.

Hypothecation

Charge on movable property, existing or future, without delivery of possession

As defined in the SARFAESI Act, 2002. It includes a floating charge and its crystallisation into a fixed charge on movable property.

Mortgage

Transfer of an interest in specific immovable property to secure a loan

Governed by the Transfer of Property Act, 1882. Applies to immovable property only.

Assignment

Transfer of a right or actionable claim to the lender as security

Used for life insurance policies, book debts and receivables. Notice to the debtor or insurer matters.

Test for choosing the mode

Type of property + who keeps possession

Movable and delivered: pledge. Movable and not delivered: hypothecation. Immovable: mortgage. Claim or receivable: assignment. Goods already held: lien.

Types of mortgage

Simple | Conditional sale | Usufructuary | English | Deposit of title-deeds | Anomalous

Six types. Be ready to define each in a line and say which a bank typically uses.

Section 81 – Marshalling securities

Owner mortgages properties A and B to X, then mortgages A to Y → Y can require X's debt to be met first from B, so far as B extends

Applies in the absence of a contract to the contrary. Cannot prejudice X or anyone who acquired an interest in any property for consideration.

Section 79 – Uncertain amount with maximum

Later mortgage (with notice) is postponed to the prior mortgage for all advances up to the stated maximum

Covers future advances, performance of an engagement, or balance of a running account. Applies even if later advances are made with notice of the subsequent mortgage.

Section 96 – Deposit of title-deeds

Simple mortgage provisions apply, so far as may be, to a mortgage by deposit of title-deeds

Use it to link the rules on enforcement and priority to equitable mortgages.

Contract of guarantee (s.126)

Guarantee = contract to perform the promise or discharge the liability of a third person in case of his default

Three parties: surety, principal debtor, creditor. May be oral or written.

Surety's right to securities (s.141)

Discharge = value of the security lost or parted with without the surety's consent

Applies to securities held at the time the suretyship contract is entered into, even if the surety does not know of them. Discharge is only to the extent of the value.

Surety's rights on payment (s.140)

On payment or performance of all he is liable for, surety gets all the creditor's rights against the principal debtor

Available when the guaranteed debt has become due or default has taken place.

Variance (s.133)

Variance in terms without surety's consent → surety discharged as to transactions after the variance

Applies to the contract between the principal debtor and the creditor.

Release of debtor (s.134)

Contract releasing the principal debtor, or act or omission of creditor that legally discharges him → surety discharged

Illustration: B's composition with creditors releasing him discharges A.

Composition, time, promise not to sue (s.135)

Contract between creditor and principal debtor to compound, give time or not to sue → surety discharged unless he assents

The contract must be with the principal debtor.

Third person gives time (s.136)

Contract to give time made with a third person, not the principal debtor → surety not discharged

Contrast with s.135.

Mere forbearance (s.137)

Mere forbearance to sue or enforce remedies does not discharge surety, absent a contrary provision in the guarantee

Silence or delay is not the same as a contract giving time.

Impairing surety's remedy (s.139)

Act inconsistent with surety's rights, or omission of a duty owed to surety, impairing his eventual remedy against the debtor → surety discharged

Illustration: prepaying instalments without the surety's knowledge.

Documents chain

Sanction → Loan agreement → Security documents → Guarantee → Stamping → Charge registration

Use this order as your answer skeleton for any documentation question.

Contract Act, Section 28 (restraint of legal proceedings)

Agreement absolutely restricting legal enforcement, or limiting the time to enforce, or extinguishing rights or discharging liability on expiry of a specified period so as to restrict enforcement, is void to the extent

Exception 1 saves an agreement to refer future disputes to arbitration, with only the awarded amount recoverable. Exception 2 saves a written agreement to refer a question that has already arisen.

Section 28, Exception 3 (bank guarantees)

Specified period for discharge of guarantor ≥ 1 year from the date of occurring or non-occurring of the specified event

Applies only to a bank or financial institution, in a written contract. A shorter period is not saved by the exception, so Section 28 applies to that clause.

Effect of non-registration of charge

Unregistered charge on company assets → not effective against liquidator or creditors; debt remains payable

Do not say the loan itself becomes void.

Banker's precautions

Authority + Title + Valuation + Stamping + Execution + Registration + Safe custody

A seven-point checklist for precaution questions.

Section 13(1): enforcement without court

Security interest enforced by secured creditor without intervention of court or tribunal

Applies notwithstanding sections 69 and 69A of the Transfer of Property Act, 1882.

Section 13(2): trigger and notice

Default + NPA classification → written notice → 60 days to pay in full

NPA classification is not required for a borrower that raised funds through debt securities.

Section 13(3): contents of notice

Notice = amount payable + secured assets to be enforced

Both details are mandatory in the notice.

Section 13(3A): objections

Creditor considers objection; if not tenable, gives reasons within 15 days of receipt

The reasons do not by themselves give a right to apply under section 17.

Section 13(4): measures after 60 days

(a) take possession; (b) take over management; (c) appoint manager; (d) notice to debtors of the borrower

Creditor may use one or more. Under (b), transfer by lease, assignment or sale only if a substantial part of the business is held as security.

Section 13(9): joint financing

Rights under 13(4) need agreement of creditors holding at least 60% in value of amount outstanding on the record date

Subject to the Insolvency and Bankruptcy Code, 2016. The decision binds all secured creditors.

Section 13(8): right of redemption

Full dues + costs tendered before publication of notice for auction, quotations or tender → no transfer

If steps were already taken, no further step may be taken.

Section 13(10) and (11): balance and guarantors

Shortfall → application to DRT or competent court; guarantors and pledged assets can be proceeded against without first using 13(4)

These are separate remedies for the creditor.

Section 26D: registration

No enforcement under Chapter III unless security interest is registered with the Central Registry

Inserted with effect from 24-1-2020.

Quick revision

• A sound lending decision looks at purpose, safety, repayment capacity and liquidity, not only the security offered.
• Lien is a right to retain goods until a debt is paid; it does not by itself give a power of sale.
• Pledge needs delivery of possession of movable goods; the bank holds the goods as security.
• Hypothecation leaves possession with the borrower; the bank has a charge but not possession.
• Mortgage is a transfer of an interest in specific immovable property to secure a loan.
• A guarantee involves three parties: creditor, principal debtor and surety.
• Under Section 141, the surety is entitled to every security the creditor holds against the debtor when the guarantee is given, whether or not the surety knows of it.
• If the creditor loses or parts with that security without the surety's consent, the surety is discharged to the extent of its value.
• In the Section 141 illustrations, a security obtained after the guarantee and later given up does not discharge the surety.
• A charge created by a company must be registered within the time allowed, or it may not be effective against other creditors.
• SARFAESI lets a secured creditor enforce security without court intervention, after notice, on a non-performing account.
• In case questions, state the rule, apply it to the facts, then give a clear conclusion.

Common mistakes

• Saying cash credit and overdraft are the same Fix: Remember cash credit is a separate account usually against stock and book debts for working capital. Overdraft is a facility on a current account, usually for temporary needs.
• Treating security as the main test of sound lending Fix: Explain that the first source of repayment is the borrower's income or cash flow. Security is only a back-up.
• Saying hypothecation needs delivery of goods to the bank. Fix: Remember that hypothecation is a charge without delivery of possession. If goods are delivered, it is a pledge.
• Saying a lien gives the bank a right to sell the goods. Fix: State that lien is a right to retain. A right to sell comes from a pledge, an agreement, or enforcement of security.
• Applying marshalling when the second mortgagee has no claim over any property the first lender does not already hold. Fix: Check that the owner mortgaged two or more properties to the first person and then mortgaged one or more of them to another person.
• Saying marshalling always applies. Fix: State that it applies in the absence of a contract to the contrary, and it cannot prejudice the prior mortgagee or a person who acquired an interest for consideration.
• Saying the surety is discharged completely whenever the bank releases a security. Fix: Write that the surety is discharged to the extent of the value of the security lost or parted with.
• Treating mere delay in suing as discharge of the surety. Fix: Cite section 137: mere forbearance to sue does not discharge the surety unless the guarantee says otherwise.
• Saying an unregistered charge makes the loan void. Fix: Say the debt is still payable, but the charge is not effective against the liquidator or creditors of the company.
• Ignoring stamping. Fix: State that an insufficiently stamped document may not be admitted in evidence until duty and penalty are paid.

Exam tips

• Start principle answers with the four main principles in order, then add extras.
• In comparison questions, use a point-wise list covering purpose, drawing, repayment, interest and security.
• In case questions, link each fact to a principle and end with a clear recommendation.
• Show interest and discount calculations in steps. Method marks matter in a written paper.
• Mention section 16 of the Indian Contract Act, 1872 only when facts suggest pressure or unfair terms.
• For 'distinguish between pledge and hypothecation', draw a two-column comparison on property, possession, ownership, right of sale and documents.
• Quote the source for each mode: Contract Act, 1872 for lien and pledge, Transfer of Property Act, 1882 for mortgage, SARFAESI Act, 2002 for the definition of hypothecation.
• In case questions, follow provision, facts, conclusion. State the test, apply it to the facts, then give one clear answer.