Banking and Insurance - Laws and Practice · Advances, Securities and Documentation

Modes of Creating Security: Lien, Pledge and Hypothecation

Updated 11 October 2026 · Fact-checked

Security is created by lien, pledge, hypothecation, assignment or mortgage. Lien is a right to retain goods until dues are paid. Pledge is a bailment of goods as security, with possession delivered. Hypothecation is a charge on movable property without delivery of possession. Mortgage is a transfer of an interest in immovable property. The deciding test is possession and the type of property.

Understand Modes of Creating Security: Lien, Pledge, Hypothecation

A bank lends money. It wants a right over some asset so that, if the borrower defaults, it can recover from that asset. This right is called security. The law gives several ways to create it. They differ on two points: who holds the asset, and whether the asset is movable or immovable.

Lien is the simplest. It is a right to retain goods or securities that already lawfully lie with you until your dues are paid. It does not need a separate agreement. A general lien is a right to retain goods against the general balance owed to you. Under the Indian Contract Act, 1872, bankers, factors, wharfingers, attorneys of a High Court and policy brokers may retain goods bailed to them as security for a general balance of account, unless there is a contract to the contrary. So a bank has a general lien over securities and goods deposited with it by a customer in the ordinary course of banking. A lien gives a right to retain only. It does not by itself give a right to sell. A bank usually takes a letter of set-off or a lien-and-set-off clause in its documents to cover this.

Pledge is a bailment of goods as security for payment of a debt or performance of a promise. The goods are delivered to the bank. The borrower is the pawnor and the bank is the pawnee. Delivery can be actual, or constructive, such as handing over the key of the godown or the document of title. If the borrower defaults, the pawnee may, after giving the pawnor reasonable notice, sell the goods. The pawnee can also sue on the debt and keep the goods as collateral. If the sale proceeds fall short, the pawnor remains liable for the balance. Any surplus goes to the pawnor.

Hypothecation is a charge on movable property, existing or future, created by a borrower in favour of a secured creditor without delivery of possession. The SARFAESI Act, 2002 defines it in this way and says it includes a floating charge and its crystallisation into a fixed charge. The goods stay with the borrower, who uses them in business. A common use is stock and book debts in a cash credit account. Because the bank has no possession, it needs a hypothecation agreement and usually monitors stock statements. If the borrower defaults, the bank can take possession under the agreement or use the SARFAESI route.

Assignment transfers a right or actionable claim, such as a life policy, book debts or a receivable, to the bank as security. Mortgage is the transfer of an interest in specific immovable property to secure a loan. It is covered in a separate topic. A simple memory aid: lien retains, pledge delivers, hypothecation leaves goods with the borrower, mortgage deals with immovable property.

Key rules to remember

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.

How to solve Modes of Creating Security: Lien, Pledge, Hypothecation questions

Exam questions give you facts about an asset and a loan and ask which security applies, or ask you to distinguish two modes. Use the same order each time.

1Identify the asset. Is it goods, securities, a receivable, a policy or immovable property?
2Check possession. Has the asset been delivered to the bank, or does the borrower keep it?
3Pick the mode using the test: delivered movables are pledge, retained movables are hypothecation, immovable property is mortgage, claims are assignment, goods already held by the bank give lien.
4State the rule in plain words with its source, such as the Contract Act, 1872, the Transfer of Property Act, 1882 or the SARFAESI Act, 2002 definition.
5Apply the facts. Say who is pawnor or pawnee, whether delivery was made, and what the bank may do on default.
6State the bank's remedy: retain only for lien, sell after reasonable notice for pledge, take possession or use SARFAESI for hypothecation.
7Conclude clearly in one line and add the practical documentation point, such as a pledge or hypothecation agreement.

Quickest way: Possession and property test

When to use it: Use it for short-answer or distinction questions where time is tight.

Write the two questions: what property, and who holds it.
Match to the mode in one line each.
For a distinction, compare on five heads: nature of property, possession, ownership, right to sell, and documents.
Close with the remedy on default.

Common mistakes in Modes of Creating Security: Lien, Pledge, Hypothecation

Saying hypothecation needs delivery of goods to the bank.
Students confuse it with pledge because both concern movables.
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.
Students treat lien as full security.
Fix: State that lien is a right to retain. A right to sell comes from a pledge, an agreement, or enforcement of security.
Using pledge for immovable property or mortgage for goods.
Students ignore the type of property.
Fix: Check the property first. Pledge and hypothecation deal with movables. Mortgage deals with immovable property.
Forgetting that a general lien can be excluded by contract.
Students learn the banker's right as absolute.
Fix: Add the words 'unless there is a contract to the contrary'.
Selling pledged goods without notice to the pawnor.
Students focus on the bank's right and skip the condition.
Fix: State that the pawnee must give the pawnor reasonable notice of sale. Any surplus goes to the pawnor and any shortfall stays recoverable from the pawnor.
Treating constructive delivery as no delivery.
Students think physical handover is the only delivery.
Fix: Note that handing over the key of the godown or the document of title can be valid delivery for a pledge.

Worked examples

Example 1

Sunrise Traders Pvt. Ltd. obtains a cash credit limit from a bank. The stock of rice stays in its own godown and the company sells it in the regular course. The bank takes a charge on the stock and book debts. Identify the mode of security and state the bank's position.

Show the solution

The asset is stock and book debts, which are movable property.
Possession stays with the company. There is no delivery to the bank.
Movable property without delivery of possession gives hypothecation. The SARFAESI Act, 2002 defines it as a charge on movable property, existing or future, without delivery of possession, and includes a floating charge.
Because the stock keeps changing, the charge is floating and crystallises into a fixed charge on default.
On default the bank can enforce under the hypothecation agreement and, if the account is a non-performing asset, under the SARFAESI Act. The bank needs proper documents and should monitor stock statements.

Answer: The security is hypothecation of movable property, not a pledge, because possession stays with the borrower. The charge is floating and fixes on default.

Example 2

Ravi deposits gold ornaments with a bank as security for a loan. He defaults. Explain the mode of security and the bank's rights and duties on sale.

Show the solution

The ornaments are movable goods and are delivered to the bank. This is a pledge under the Contract Act, 1872.
Ravi is the pawnor and the bank is the pawnee.
On default, the bank can sue on the debt and retain the goods as collateral, or sell the goods.
Before selling, the bank must give Ravi reasonable notice of the sale.
If the sale proceeds exceed the dues, the surplus goes to Ravi. If they fall short, Ravi remains liable for the balance.

Answer: It is a pledge. The bank may sell after giving Ravi reasonable notice, must pay over any surplus, and may recover any shortfall from him.

Exam tips

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.
Mention the practical point at the end, such as the agreement to be executed and stock statements to be obtained.

Practice questions from Advances, Securities and Documentation

Modes of Creating Security: Lien, Pledge, Hypothecation in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

NISM CertificationsPledge, Hypothecation, Freeze and Statements

Modes of Creating Security: Lien, Pledge, Hypothecation: frequently asked questions

What is the main difference between pledge and hypothecation?

In a pledge, the goods are delivered to the bank. In hypothecation, the borrower keeps the goods and the bank only has a charge on them. Both apply to movable property.

What is a banker's general lien?

It is the right of a banker to retain goods or securities bailed to it against the general balance of the customer's account. The Contract Act, 1872 gives this right unless there is a contract to the contrary. It is a right to retain, not to sell.

Can a bank sell pledged goods on default?

Yes, after giving the pawnor reasonable notice of the sale. Any surplus goes to the pawnor. If the sale falls short, the pawnor stays liable for the balance.

How does a bank create a charge on movable property?

It takes a pledge if the goods are delivered to it, or a hypothecation if the borrower keeps them. It may also take an assignment for claims and receivables. In each case the right documents should be signed.