Goods as a Security for the Loan/Advance :
Though, earlier, bankers were not forthcoming to advance against goods or documents of title to goods, now more and more secured advances of the scheduled banks in India are against goods.
Merits of this Security
(i) Goods have a ready market and as such can be easily sold unlike other kinds of security.
(ii) Valuation of the goods can be easily done.
(iii) The banker gets a tangible form of security compared to unsecured advances, which in case of default by the borrower, can be realized by sale of pledged goods.
(iv) Advances against goods are normally given for short periods and therefore the risk of the banker is considerably reduced.
(v) Barring a few states where the stamp duty is heavy, creating a charge on the security is less costly and involves minimum formalities.
(vi) Banker acquires a good title to the goods when dealing with customers of repute and standing. Demerits of this Security
(i) Certain goods are liable to perish or deteriorate in quality over a period of time, thus resulting in reduction of the value of the banker’s security.
(ii) There are possible risks of fraud or dishonesty on the part of the borrower. For example, when 10,000 tins of cashew nuts are shown in the godown as security for an advance, it is not possible for the banker to verify the quality and quantity in every tin. It is not even possible to verify whether all the 10,000 tins contain cashew nuts. A fraudulent borrower may not store the full stocks as declared in the godown.
(iii) The value of the security in certain cases more particularly electronic consumer goods are subject to wide fluctuations. Therefore, the valuation of such goods is difficult. Even in the case of necessaries, there being several varieties, unless the banker has expert knowledge, the valuation may be misleading. Disposing of large quantities of goods within a short time may be difficult and may not fetch the expected/ declared price.
(iv) The banker may find it difficult to store the goods.
(v) Transporting the goods from the borrower’s premises to the banker’s premises and thereafter to the market in case of sale is a considerably costly and time-consuming affair.
(vi) When the banker releases goods for sale on the execution of trust receipts, the money realized by the sale of such goods may not be deposited with the banker, and the borrowers may default to the bankers.
(vii) If the goods are warehoused, the warehouse keeper enjoys a lien over the goods for any unpaid charges.
The banker therefore, has to ensure periodically that all charges are duly paid.
Valuation of Goods
(i) Advances are given based on the stocks and their value declared in monthly stock/statements. The stock/ goods are to be inspected at regular intervals and prices verified and tallied with purchase invoices.
(ii) By visiting factory/godown by officials and valuers like cost accountants
(iii) Follow up of account ensuring payment to creditors for stock and collection of debtors thus avoiding diversion/misuse of funds.
Precautions to be taken
(i) Advances against goods should be restricted to genuine traders and not to speculators.
(ii) Loans must be given for short periods, since the quality and thereby the value of the security is likely to diminish.
(iii) The banker must have a working knowledge and gather information of the different types of goods regarding their character, price movements, storage value, etc.
(iv) The banker should confirm the state of goods.
(v) The goods should be insured against loss by theft or fire.
(vi) The banker should verify and confirm the title of the borrower to the goods by inspecting the invoices or cash memos.
(vii) The banker as a Pawnee is liable, if reasonable care is not taken of the goods pledged. He should therefore, take proper care for their storage and also take reasonable steps to protect them from damage and pilferage.
(viii) The price of the goods must be accurately ascertained.
(ix) Necessary margin must be taken by the banker to protect him against fluctuations in the price of goods.
(x) The banker must obtain absolute or constructive possession of the goods.
(xi) In the case of hypothecated goods, the bank should obtain from the borrower a written undertaking that the goods are not charged to any bank or creditor and will not be so charged as long as the borrower is indebted to the bank. The banker should obtain at regular periods certificates regarding the quantity and valuation of the goods, which should be physically verified by the banker.
Documents of Title to Goods
What are Documents of Title to Goods?
As per the Section 2(4) of the Sale of Goods Act, 1930, a document of title to goods is ‘a document used in the ordinary course of business as a proof of possession or control of goods authorizing or purporting to authorize either, by endorsement or delivery, the possessor of the documents, to transfer or receive the goods thereby represented.’ Thus, the essential requisites of a document of title to goods are:
(i) The mere possession of the documents creates a right either by virtue of law or trade usage, to possess the goods represented by the documents.
(ii) Goods represented by the documents can be transferred by endorsement and/or delivery of the documents.
(iii) The transferee of the documents can take delivery of the goods in his own right.
(iv) Although they appear to be negotiable instruments, documents of title to goods are not negotiable instruments. The title of bona fide transferee for value can be affected by defects in the title of transferor.
They may be called quasi-negotiable instruments.
Examples of documents of title to goods are bills of lading, dock warrant, warehouse-keeper’s certificate, railway receipts, delivery orders, etc. Documents of title to goods must be distinguished from other documents like the warehouse-keeper’s non-transferable receipts, which are mere acknowledgement of the goods. Documents of title to goods are preferred by bankers because under Section 52(2)(e) of the Presidency Towns Insolvency Act, 1909, and Section 28(3) of the Provincial Insolvency Act, 1920, possession of goods represented by such instruments duly endorsed in his favour are taken out of the order and disposition of the insolvent. The significance of this is that in case the borrower becomes insolvent, the Official Receiver or Official Assignee as the case may be, cannot include such goods in the assets of the insolvent.
Merits of this Security
(i) By mere pledge of the instruments the goods are pledged and serve as a good security.
(ii) The person in possession of the document can transfer the goods by endorsement and/or delivery. The transferee thereafter is entitled to take delivery of the goods in his own right.
(iii) The documents are easily transferable, and the formalities involved are less compared to mortgage or assignment.
Demerits of this Security
(i) Possibility for fraud and dishonesty
Since the bill of lading or a railway receipt or a warehouse-keeper’s certificate does not certify or guarantee the correctness of the contents of the bags or packages, the banker will have no remedy against the carrier or warehousekeeper, if they turn out to be containing worthless goods.
(ii) Forged and altered documents
The documents might be forged ones, or even if genuine, the quantity may be altered.
(iii) Not Negotiable documents
The document being “Not Negotiable”, the transferee of such documents will not get a better title than that of the transferor. Therefore, if the person who pledged the documents has a defective title, the banker will not acquire a better title.
(iv) Unpaid vendor’s right of stoppage in transit:
Under the Sale of Goods Act, 1930, an unpaid vendor has the ‘right of stoppage in transit’ and he is entitled to direct the carrier that the goods need not be delivered, if not already done. If this right is exercised by the unpaid vendor, the banker cannot obtain the goods and his security is of no value.
(v) In the case of lost documents, delivery of the goods is allowed on the execution of an indemnity bond, this option may be misused by the borrower by selling the goods to some other customer who may take delivery of the goods declaring that he had lost/misplace the document and indemnifying the carrier. To avoid such a contingency, the banker can give notice to the carrier regarding his interest and the pledge.
Precautions to be taken by the banker
(i) The documents must be examined thoroughly to ensure that they are genuine and of recent origin. In the case of bills of lading, they are prepared generally in triplicate and as such all the copies must be obtained by the banker. Otherwise, the carrier is released from his obligation by delivering the goods on the presentation of any one copy containing ostensibly regular endorsements.
(ii) The banker should ensure that the documents do not contain any onerous clauses or prejudicial remarks about the condition of goods received.
(iii) Banker should ensure that the goods are adequately covered by insurance for full value against risks of theft, fire, damage in transit, etc., and in the case of goods shipped by sea, all the marine risks should be covered.
(iv) Banker should ensure to get consignee copy and banks name being entered as consignee, so that endorsement/transfer of title is specific.
Trust Receipt
Whenever the bank releases documents of title to goods to the borrower without payment being made, then a ‘Letter of Trust’ should be taken. So also in the case of goods hypothecated to the bank. The reasons are as follows:
(i) The borrower on sale of the goods has to hold proceeds in trust for the banker.
(ii) The goods taken under such trust receipts or the sale proceeds thereof, are not available to the official receiver in case the borrower becomes insolvent.
A Trust letter incorporates the following clauses
(i) Borrower’s recognition, of bank’s rights in the goods as security and in case of sale, the proceeds, thereof.
(ii) Borrower’s, undertaking to hold the goods or sale proceeds thereof, in trust for the banker. (iii) Borrower’s undertaking, to ensure proper storage and insurance, at his cost.
(iv) Borrower’s undertaking to direct the buyer to pay the monies directly to the banker, if so required by the banker.
(v) Borrower’s undertaking to return unsold goods on banker’s request or dispose of the same as directed by the banker.