Hypothecation over Securities :

What is ‘Hypothecation”?:

The term “Hypothecation’ means a charge created on any movable asset/property, for a loan borrowed by the owner of goods/movable assets (existing or future) without transferring, either the property or the possession to the lender.

The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act,2002 (SARFAESI Act) defines hypothecation thus :

“hypothecation means 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 crystallisation of such charge into fixed charge on movable property”

Hypothecation – important features:

1. The charge hypothecation is applicable to movable assets.

2. The ownership and possession are held by the borrower of the assets (security).

3. The document (hypothecation agreement) provides for a covenant, whereby the borrower agrees to give possession of the goods (movable assets) when called upon to do so by the creditor. Upon taking over the possession of goods, the charge is treated as pledge.

Other important aspects of Hypothecation:

Banks should exercise precautions while handling lending against hypothecation for the following reasons:

(a) The possession of the goods/assets are held by the borrower, hence, it is always difficult for the creditor (lender) to have control over such goods.

(b) The borrower may sell the hypothecated stocks, and pay other creditors.

(c) The possibility of raising double finance against the same stock cannot be ruled out. For example the borrower may hypothecate the same stocks to another bank, the goods may be latter pledged to another creditor.

(d) In case of default, the realization of assets may be difficult and costly.

Hypothecation – Precautions required:

In view of the above difficulties, banks are required to take certain precautions in respect of goods and assets hypothecated, to protect the interest of the banks.

1. Banks should ensure that the borrower enjoys hypothecation facility with only one bank and not with multiple banks. An undertaking to this effect in writing should be taken by the bank to avoid any risk.

2. Banks should display boards in the show room, shops where hypothecated goods are displayed/stored, indicating that such goods are hypothecated to bank.

3. Banks should ensure that

(i) periodical stock statements are submitted by the borrower.

(ii) stock statements should contain relevant, and correct details as regards to quantity, quality and price.

(iii) Regular inspections are carried out to verify the facts mentioned in the stock statements

(v) In case of any discrepancy, depreciation in the value of stock, appropriate action should be taken by the bank immediately by calling for additional securities and increase in the margin.

4. If the borrower is a limited company, the hypothecation charge must be registered with the Registrar of Companies (ROC) within a period of 30 days of its creation. This is very important, otherwise, the charge will be void against the liquidator and/or any creditor of the company.