eMPTBS V

PLEDGE AND HYPOTHECATION

CHAPTER V

PLEDGE AND HYPOTHECATION

PLEDGE

Pledge is a bailment of personal property as security for some debt

or engagement. Pawn was synonymous with pledge at common law, but

modem usage tends to restrict these words to the bailment of tangible

chattels for money advanced, and has introduced the term "Collateral

Security", or simply "Collateral", to designate the subject matter of a pledge

given as security for an engagement other than a simple borrowing of

money, and particularly when the subject - matter consists of incorporeal

chattels such as stocks, bonds, or choses in action1.

Pledge is the transfer by one person to another of the possession of

certain goods to be held by the latter as security for the performance by the

former of some obligation to pay or perform, which being performed, the

pledge must be restored2.

Pledge is a delivery of goods, or the documents of title to goods, by a

debtor to his creditors as security for a debt, or for any other obligation. It

is understood that the subject of the pledge will be returned to the pledgor

when the debt has been paid or the obligation fulfilled3.

Bouvier’s Law Dictionary, 8th Edition, 1914, Vol III, p.2604

The Oxford Companion to Law by David M. Walker, 1980, p.963

Dictionary of Banking by F.E. Perry & G.Klein, 3rd Edn, 1988, p.240

147

A pledge or pawn is a delivery of chattels or choses in action by a

debtor to his creditor as security for his debt or any other obligation. Whilst

possession of the thing passes to the pledgee, the property in the thing (i.e.

the legal ownership) remains with the pledgor4.

The commonest case of pledge is the transaction with a pawn broker

by which some article is pledged as security for a loan of money and either

later redeemed or sold under statutory power provided under Section 176

of the Indian Contract Act, 1872. This section empowers the pledgee to sell

the thing pledged on giving reasonable notice to the pledgor if the pledgor

makes default in payment of the debt.

Possessory Security

Possession is the essence of the contract of pledge, but without

suitable written evidence the pledgee will be entitled only to hold the goods

until the pledgor defaults. For the sake of liquidity the banker normally

reserves the right of sale, with or without reasonable notice, and the

contract is evidenced by the execution of a document setting out the facts

and embodying, amongst other things, a power of sale. It is prudent to

ensure wherever possible that the pledge is completed before any document

is signed, thereby avoiding any suggestion of a contract of hypothecation

amounting to an agreement to create a pledge. "Get your goods first" is,

therefore, the prudent banking maxim.

4 Thomson’s Dictionary of Banking by F.R. Ryder & D.B. Jenkins, 12th Edn, 1974, p.462

148

A pledge is not a pledge if there be not either actual or token delivery

to the pledgee. Both mortgages and possessory securities (e.g. pledge)

partake to some extent of the conveyance type of security; under the

mortgage the mortgagor conveys, in point of form, the sum totality of

juristic rights possessed by him; under the possessory security he transfers

one right only, viz. possession. Logically therefore, the creditor, apart from

special agreement, should have one right only, viz. the negative right of

withholding possession from the debtor until the debt is paid. However the

pledge goes beyond this in giving the pledgee, even apart from agreement,

a power to sell on default, though not a power to foreclose.

The possessory security transfers the right of possession. It is,

however, the more striking characteristic that it must transfer factual

possession. The term "factual possession" is here used to include both or

either of the two concepts of physical or de facto possession on the one hand

and the legal possession on the other. Both are . distinct from a right to

possess or a right of possession, though in many cases, all three will

co - exist. Thus if the pledgor physically delivers the goods to the pledgee

in person, the latter will have physical possession, legal possession and a

right of possession.

The pledgee gets no absolute title at law. He gets what has been

called a "Special Property" in the goods, whilst the pledgor retains the

general ownership. The so - called special property, apart from the right of

possession, merely consists of the power to sell on default. There is no

transfer of legal ownership to the pledgee.

149

A pledge of goods is not complete unless and until there has been

actual or constructive delivery of goods. Constructive delivery is usually

described as the handing over of the key to the warehouse where the goods

are stored. In modern practice, constructive delivery will usually consist

either of delivery of a valid document of title which represents the goods,

such as a bill of lading, or of an acknowledgment (called an attornment) by

the warehouse - keeper that he holds the goods to the order or at the

disposition of the bank. The position is lucidly explained by Lord Wright in

Madras Official Assignee v Mercantile Bank of India Ltd5.

"At the common law a pledge could not be created except by delivery

of possession of the thing pledged, either actual or constructive. It involved

a bailment. If the pledgor had the actual goods in his physical possession,

he could effect the pledge by actual delivery; in other cases he could give

possession by some symbolic act, such as handing over the key of the store

in which they were. If, however, the goods were in the custody of a third

person, who held for the bailor so that in law his possession was that of the

bailor, the pledge could be effected by a change of the possession of the

third party, that is by an order to him from the pledgor to hold for the

pledgee, the change being perfected by the third party attorning to the

pledgee, that is acknowledging that he thereupon held for him; there was

thus a change of possession and a constructive delivery; the goods in the

hands of the third party became by this process in the possession

constructively of the pledgee".

5 [1935] AC 53

150

Trust Receipts

Customers who have obtained advances on the security of goods, or

of documents of title frequently cannot repay the amount borrowed until

they realise the goods. As possession of the documents of title is essential

to obtain the goods from the shipping company or warehouse - keeper,

bankers sometimes arrange to deliver the documents to the customer

against his signature to an instrument known as a Trust Receipt, by

which the customer undertakes to hold the documents or the goods, and any

proceeds therefrom, as a Trustee for the banker, in whose name the goods

are insured and warehoused. He further undertakes to keep the transaction

separate from others to prevent the prejudicing of the bank’s security by the

merging of the goods in his general stock; or he may undertake to store the

goods separately.

The rule that the pledgee loses his security if he loses possession

seriously limits the usefulness of pledge as security. Therefore, trust receipt

is obtained from a customer of a banker where goods have been pledged as

security for an advance. To pay the advance it is necessary for the customer

to get the goods and sell them, but the documents of title which would

enable the customer to get them, are in the possession of the bank. The

bank, therefore, releases the documents of title to the customer against

signature on a trust receipt, by the terms of which the customer undertakes

to deal with the goods as an agent for the banker for the purpose of getting

delivery of the goods and then selling or warehousing them. The customer

undertakes to effect any necessary insurance and to hold the proceeds of

sale on behalf of the banker until the loan is repaid. The trust receipt

151

protects the rights of the banker as pledgee, which would otherwise be lost

when the banker gave up the documents of title, and protects the banker

in the case of the customer’s bankruptcy, by taking the relative goods out

of the reputed ownership clause. The bank’s books must show that the

documents of title actually came into the hands of the bank before the trust

receipt relating to those same goods was signed. This shows that the pledge

was created by the deposit of the documents, and was extended by the

terms of the trust receipt. The point was made clear by the House of Lords

in North Western Bank Ltd v John Poynter, Son and Macdonalds6,

Lord Herschell LJ asserting :

"There can be no doubt that the pledgee might hand back to the

pledgor, as his agent for the purpose of sale, as was done in this case, the

goods he had pledged without in the slightest degree diminishing the full

force and effect of his security".

The law relating to pledge in India is traced to the English Law.

Sections 172 to 181 of the Indian Contract Act, 1872 relating to pledges are'

framed on the principles of English Law.

A pledge arises when movable property (goods) is delivered by one

person (pledgor) to another person (pledgee) to be held as security for the

payment of debt or for discharge of some other obligation, upon the express

or implied understanding that the subject matter of pledge is to be restored

to the pledgor as soon as the debt or other obligation is discharged. Where

a definite time is fixed for payment, pledgee has an implied power of sale

[1895] AC 56 at 67, 68

152

upon default, but if there is no stipulated time for payment, the pledgee

may demand payment and in default thereof, may exercise his power of sale

after giving notice to the pledgor of his intention to do so.

Section 172 of the Indian Contract Act, 1872 defines pledge as

follows:

The bailment of goods as security for payment of a debt or

performance of a promise is called ‘Pledge’. The bailor is in this case called

the "Pawnor". The bailee is called the "Pawnee".

Section 172 affirms the common law. There is no difference between

the common law of England and the law with regard to pledge as contained

in Sections 172 to 176 of the Indian Contract Act, 1872. Under the English

Common Law, a pawn or a pledge is a bailment of personal property as a

security for some debt or engagement.

The Supreme Court in Lallan Prasad v Rehmat All7 held that

there are two ingredients of a bond or a pledge namely 1) that it is essential

to contract of pawn that the property pledged should be actually or

constructively delivered to the pawnee and 2) that a pawnee has only a

special property in the pledge but the general property remains in the

pawnor and wholly reverts to him on discharge of the debt. The right to

property vests in the pledgee so far as is necessary to secure the debt.

7 AIR 1965 SC 1322

153

It is not necessary that there should be delivery of tangible property.

In the case of Morvi Mercantile Bank Ltd, by Official Liquidator v

Union of India*, the Supreme Court held that delivery of goods by one

person to another under a contract as security for payment of debt in

accordance with Sections 148 and 172 of the Indian Contract Act, 1872 is

a pledge and ordinarily delivery of tangible property is essential to a true

pledge; where, however, the law recognises that delivery of tangible symbol

involves a transfer of possession of the property symbolised such symbolic

possession takes the place of physical delivery. Since railway receipt is a

document of title and its transfer for consideration effects constructive

delivery of goods, these receipts can be pledged and the endorsee of the

railway receipt is held to be pledgee of goods and not only of document of

title.

While the owner has the right of possession coupled with right of

enjoyment and disposition, the pledgee has only the right of possession but

not the right of enjoyment. The pledgee’s right of disposition is governed by

the terms of the pledge and is limited to the recovery of the amount due to

him under that pledge.

Legally speaking, pledge does not warrant any written evidence. A

banker usually obtains a letter of pledge’ from the customer containing the

list of documents of title to goods and also clauses to the effect that

8AIR 1965 SC 1954

154

1. the bank is to have pledge upon all goods delivered by the

customer

2. the pledge be held as continuing security

3. right of sale to the banker on default by the pledgor

4. goods be insured by the customer

5. customer to pay rents and warehousing expenses

6. banker not responsible for default of any broker engaged for

selling the goods.

Pledgee as Secured Creditor

The Supreme Court laid down a very enlightening decision about the

pawnee’s status as secured creditor and his priority of charge. In Bank of

Bihar v The State of Bihar and others9, the facts were that the pledgor

availed cash credit facility from the bank against the pledge of sugar bags.

The key of the godowns containing the sugar bags was with the bank. The

Rationing Officer and the District Magistrate broke open the godown and

seized the sugar bags on account of arrears of sugar cess from the pledgor

under the Public Demands Recovery Act. The pledgee - bank filed a suit for

return of the sugar bags or recovery of the value.

9 AIR 1971 SC 1210

155

The point for determination by the Supreme Court was :

Whether the sugar seized by the Government was in possession of the

Bank as a pledgee at the time of the seizure and whether the rights of the

Bank as such pledgee have been determined by the seizure in question.

The Court, after referring to the Sections 172, 173 and 176 of the

Indian Contract Act, quoted the Halsbury’s Laws of England10 which

describe a pawn as a security where, by contract, a deposit of goods is made

a security for a debt and the right to property vests in the pledgee so far as

is necessary to secure the debt.

The Supreme Court held that the Bank as pawnee has special

property and a lien which is not of an ordinary nature on the goods. So long

as the bank’s claim is not satisfied no other creditor of the pawnor has any

right to take away the goods or its price. After the goods had been seized

by the Government it was bound to pay the amount due to the bank. The

balance could have been made available to satisfy the claim of other

creditors of the pawnor. By the mere act of the lawful seizure, the

Government could not deprive the pledgee - Bank of the amount which was

secured by the pledge of the goods. The government was bound to reimburse

the amount which the bank would have, in the ordinary course, realised by

sale of the pledged goods on default by pawnor in making payment of debt.

10 3rd Edition, Volume 29, p.211, 218, 219, 222

156

The Bank’s right as a pawnee could not be extinguished by the

seizure of goods in its possession. The pledge was intended to give the bank

a primary right to sell the goods in satisfaction of the liability of the

pawnor. The Cane Commissioner who was an unsecured creditor could not

have any higher rights than the pawnor and was entitled to only the

surplus money after satisfaction of the Bank’s dues.

The Supreme Court decision establishes that a bank’s right over

goods pledged to it cannot be defeated by a seizure thereof by government

authorities, however lawful the seizure may be, and by appropriation of the

sale proceeds towards the pledgor’s dues to the government. So long as the

bank’s claim is not satisfied, no other creditor has a right to seize and sell

the goods and take away the sale proceeds.

In Bank of Baroda v Collector of Indore and othersn, the

petitioner - bank advanced a cash credit loan to respondent No.5, the

dealers in soya bean, against the security of stocks of soya bean purchased

by respondent No.5 for the purpose of sale. The pledged stocks of soya bean

were kept in a godown under lock and key of the petitioner - bank in their

actual and exclusive physical possession, control and dominion. The stocks

of soya bean were redeemed by respondent No.5 and were released by the

petitioner - bank form pledge from time to time against payments by

respondent No.5. The Assistant Inspector, Food and Civil Supplies, visited

the office premises of respondent No.5, inspected the records maintained by

them and found that they had stocked 6400 quintals of soya bean which had

11 (1995) 82 Comp. Cas. 580

157

been pledged with the petitioner - bank stored in the petitioner - bank's

godown. The stocks of soya bean were confiscated by the Collector, Indore,

under Section 6A of Essential Commodities Act, 1955 (which regulates,

inter alia, stocking of essential commodities to ensure equitable distribution

at fair prices):

The petitioner - bank challenged the act of the Government in

confiscating the pledged stocks. The question before the Madhya Pradesh

High Court in the writ petition was whether the confiscation under Section

6A of the Essential commodities Act, 1955 as against the respondent No.5

would override the rights of the pledgee - bank.

The court, allowing the writ petition, held that the rights of the

pawnee who had parted with money in favour of the pawnor on the security

of goods cannot be defeated by the lawful seizure of the goods by the

Government. The petitioner bank was not bound by the confiscation order

passed against respondent No.5 as the petitioner bank held the stock in

question not on behalf of the dealer, but in exercise of its own right as a

pawnee to whom the goods have been duly pledged under the cash credit

agreement. In exercise of its right as pawnee, it had every authority to have

its debts discharged from out of the pledged goods before they could be

made available for any other purpose.

The High Court, in deciding the case, followed the judicial precedent

laid down by the Supreme Court in Bank of Bihar Ltd v State of Bihar

(supra).

158

Goods Charged to Two Banks

In Nadar Bank Ltd v Canara Bank Ltd12, the borrower pledged

its godowns to two banks, with the first bank the advance was termed as

"open cash credit" and the borrower was bound to submit periodical returns

of stock to the bank. When they did not do so the clerk of the bank went to

inspect the godown, and found the doors locked with the locks of another

bank, from whom the borrower took the advance under "Key loan" system.

The question arose as to the priority of the claim. The Madras High Court

held that the judicial relationship between the parties (first bank and the

borrower) is that of the pledgor and pledgee, though the system was

termed as "Open Cash Credit" in mercantile practice. The court observed

that in order to constitute a valid pledge it is essential that there must be

delivery of goods either actual or constructive. Constructive delivery will be

adequate to create a pledge and it applies to all cases where the pledgor

remains in possession of the goods under the specific authority of the

pledgee or for limited purposes. The condition that the prior consent of the

pledgee was necessary for the pledgor to deal with the goods ensures the

constructive possession as well as the character of the pledge. There can be

no hard and fast rule that the delivery of the keys of the warehouse is

essential to secure constructive possession. There cannot also be any rigid

delimitation of the purposes for which the pledgor is permitted to retain the

possession of the goods. The essential test is not the purpose but whether

the dominion over the goods pledged is retained and the physical possession

or handling of the goods by the pledgor is under the delegated authority of

12 AIR 1961 Madras 326

159

the pledgee or is independent. The court held that where the possession of

the pledgee is not lost and possession may be manual or constructive, a

subsequent pledgee even without notice cannot obtain any preference upon

a rule of estoppel.

The court had to decide which of the two innocent parties should

suffer the loss arising from the fraud of a third party. A reference was made

to Lickbarrow v Mason13 where Ashhurst, J. Stated:

"Wherever one of two innocent persons must suffer by the acts of a

third, he who has enabled such third person to occasion the loss must

sustain it".

The same goods were pledged by a borrower to two different banks

and it was held that the first pledgee - bank had priority over the second.

Pledge of Shares

It is not necessary that there should be the pledge duly filed in

transfer form. It has been held in Bengal Silks Mills Co. Ltd, In Reu

that a transferee in the case of a transfer of shares in blank has the right

to fill in the particulars, including his own name as transferee and the date

of the transfer, even after the death of original transferor. The transfer

so made will be a valid one and the transferee will be entitled to have his

name registered in the company’s register as the holder of the shares.

13 (1794) 5 Term Rep. 683

14(1942) 12 Comp. Cas. 206

160

The facts of the case before the Calcutta High Court were that one

Mt. Fatma Begum was the registered holder of six shares in the respondent

company. On 5th December 1922, she transferred them along with a blank

transfer deed bearing her signature to one A.S.A. Suhrawardy for Rs.2100/-.

She died in 1935. Suhrawardy transferred the shares along with the same

transfer deed to the petitioner for Rs.2400/- on 10th December 1940. When

in March 1941 the petitioner presented the share scrip and the transfer

deed to the company, the directors refused to register the transfer.

Thereupon the petitioner applied to the Calcutta High Court for an order

rectifying the register of members of the company and his petition was

allowed.

The Court provided the following illustraction to romp home its point

of decision.

"A gives authority to B to sell A’s land, and to pay himself, out of the

proceeds, the debts due to him from A. A cannot revoke his authority, nor

can it be terminated by his insanity or death" the authority for the

proposition being Gaussert v Martin15.

The said illustration forms part of Sec 202 of the Indian Contract Act,

1872 dealing with termination of agency where agent has an interest in the

subject - matter. This section of the Contract Act merely states in a codified

form the well - known principles of English Law regarding "authority

coupled with interest".

15 (1830) 10 B & C 731

161

The court also referred to Carter v White16 the head note of which

is as follows :

"A bill of exchange accepted for valuable consideration, with the

drawer’s name left blank, may be completed by the drawer’s name being

added after the death of the acceptor".

Bengal Silks Mills case (supra) is of interest to bankers since often

company shares together with blank transfers are lodged with banks as

security for advances. In such cases, according to this decision, the death of

the shareholder does not terminate the bank’s authority to complete the

blank transfer and get the share registered in its name in the company’s

books.

Following the authority laid down in Bengal Silk Mills case (supra),

it was held by the Calcutta High Court in Kanhaiya Lai Jhanwar v

Pandit Shirali and company17 that a transferee to whom share scrips

and transfer in blank are given has the authority of the transferor to fill up

the names of the transferee. It was also held that the deposit of share scrips

themselves is sufficient to create a pledge thereon. Blank transfers, if in

order, have the effect of transferring the title in the shares to the pledgees,

but a transfer of title is not necessary to create a pledge, simple delivery of

possession being enough.

16 (1884) 25 Ch. D. 666

(1953) 23 Comp. Cas. 39917

162

Right to Sell

Section 176 of the Indian Contract Act, 1872 provides as follows :

"If the pawnor makes default in payment of the debt, or performance,

at the stipulated time of the promise, in respect of which the goods were

pledged, the pawnee may bring a suit against the pawnor upon the debt or

promise, and retain the goods pledged as a collateral security; or he may

sell the thing pledged, on giving the pawnor reasonable notice of sale.

If the proceeds of such sale are less than the amount due in respect

of the debt or promise, the pawnor is still liable to pay the balance. If the

proceeds of the sale are greater than the amount so due, the pawnee shall

pay over the surplus to the pawnor".

The substance of this section is familiar and well settled English

Law.

It was held by Cotton L.J. in Re Morrit, ex p Official Receiver18

that a contract of pledge carries with it the implication that the security

may be made available to satisfy the obligation, and enables the pledgee in

possession (though he has not the general properly in the thing pledged, but

a special property only) to sell on default in payment and after notice to the

pledgor although the pledgor may redeem at any moment upto sale.

18 (1886) 18 QBD 222 at 232, CA

163

The Supreme Court in Lallan Prasad v Rehmat All19 held that

once the pawnee after reasonable notice to the pawnor of his intention to

sell the goods pawned, sells them under Section 176 of the Contract Act, the

pawnor’s right of re - delivery is extinguished but his right to redeem

continues upto sale, i.e. at any moment upto the time of exercise by the

pawnee of his power of sale by entering into a valid contract of sale. After

sale, it is the pawnee’s ordinary right to recover the balance of the loan

unsatisfied on the sale of the pledge.

Reasonable Notice of Sale

In Raja K.V.S. Sundara Narasayyamma Garu v Andhra Bank

Ltd?0, the Andhra Pradesh High Court held that before exercising the

power of sale the pawnee should give to the pledgor a reasonable notice of

sale. The provision of section 176 of the Indian Contract Act, 1872 is

mandatory and cannot be waived. The notice should be given

notwithstanding any contract to the contrary. Thus at the time of entering

into the contract of pledge, the pawnor cannot agree to waive notice as it

would be inconsistent with the provisions of Section 176.

19 AIR 1965 SC 132220 AIR 1960 AP 273

164

The Bombay High Court held in Official Assignee, Bombay v

Madholal Sindhu21 that a notice must be given in all cases of pledge

even when an instrument of pledge itself contains an unconditional power

of sale.

In Srinivasulu Naidu & others v Gajaraj Mehtra & Sons22, the

notice sent to the pawnor by the pawnee was not signed by the pawnee or

any other person authorised by him. The Madras High Court held that

nowhere it is stated that a notice of sale must be signed by the pawnee or

anybody on his behalf. Notice under Section 176 of the Indian Contract Act,

1872, is only an intimation of the intention to sell. The reasonable notice of

sale under Section 176 does not require specification or date, time and place

of sale. It is the moot question whether the pawnor has been given notice

of sale, whether signed or unsigned, by the pawnee.

The most frequent model of pledge with the bankers is the pledge of

jewels. The bankers on the reverse of the Jewel Loan Applications stipulate

that the bank will sell the jewels without notice in the event of default in

repayment by the pledgor. This clause violates the provisions of Section 176

of the Indian Contract Act, 1872 which clearly lays down that the pawnee

may sell the goods under pledge on giving reasonable notice of sale.

This clause is a nullity in the jewel loan applications since it is

unenforceable. In practice, the bankers issue advance notice to the pledgors

before auctioning the pledged jewels.

21 AIR 1947 Bombay 217

22 (1991) 1 All India Banking Law Judgments 195

165

Principle of "Nemo Dat Quod Non Habet"

There is a general rule of common law that a man cannot give a

better title to property than be himself possesses. This is often expressed

in the maxim "Nemo dat quod non habet". If, therefore, a customer steals

certain property and pledges it to his banker as security for a loan, the

banker although acting in perfect good faith without any knowledge of the

theft - will usually obtain no title thereto and will be obliged to return it to

the person from whom it was stolen.

Section 411 of the Indian Penal Code, 1860, provides that whoever

dishonestly receives or retains any stolen property, knowing or having

reason to believe the same to be stolen property, shall be punished with

imprisonment of either description for a term which may extend to three

years, or with fine, or with both. Dishonest intention is the sine qua non

of the offence under Section 411 of the Indian Penal Code. Unless and until

there is dishonest reception or retention of any stolen property the section

is not attracted.

Blackburn J stated in Cole v North Western Bank23 that at

common law, a person in possession of goods cannot confer on another,

either by sale or by pledge, any better title to the goods than he himself

had. There are few exceptions to this general principle. The most important

of them relates to negotiable instruments. A pledgee of such instruments is

entitled to the same favourable treatment as a transferee for value. Goods,

however, are not negotiable; neither are bills of lading or other documents

23 (1875) 44 LJCP 233

166

of title. Thus the pledgee of stolen goods will nearly always be forced to

restore them to the true owner, unless it can be proved that the goods have

been sold in "Market Overt" (recognised market throughout the country)

after having been stolen; or unless it can be shown that the true owner is

estopped from asserting his rights, as would be the case if he knowingly

stood by when the pledge was made.

Thus a valid pledge of goods or of documents can normally be created

only by or with the consent of the true owner.

HYPOTHECATION

Hypothecation is a right which a creditor has over a thing belonging

to another, and which consists in a power to cause it to be sold, in order to

be paid his claim out of the proceeds. There are two species of

hypothecation, one called pledge, pignus, and the other properly

denominated hypothecation. Pledge is that species of hypothcation which is

contracted by the delivery by the debtor to the creditor of the thing

hypothecated. Hypothecation, properly so called, is that which is contracted

without delivery of the thing.hypothecated24.

Hypothecation is a type of security where neither ownership nor

possession passes to the lender. In banking, it means an agreement to give

a charge over goods, or over the documents of title to goods, in

circumstances which make it impossible to give the banker possession. If

Bouvier’s Law Dictionary, 8th Edn, 1914, Vol 2, p.148024

167

this were possible the banker would take a pledge. In recognition of this

fact the agreement usually undertakes to give a pledge when the goods or

documents become available25.

Hypothecation is the pledging of something as security without

delivery of title or possession26.

Hypothecation is the act of pledging a thing as security for a debt or

demand without parting with the possession. In modem times attempts

have been made to introduce "hypothecation" from the Civil Law as a

general term equivalent to "charge" the proper English term. In this use of

the word, to hypothecate property is to charge it with the payment of a sum

of money or the performance of an obligation, giving the person in whose

favour it exists neither the right to the possession of the property, nor the

right to sell it, but merely the right of realisation by judicial proceedings in

case of default by the person who has made the hypothecation27.

H.L. Hart gives the following definition:

"Where property is charged with the amount of a debt, but neither

ownership nor possession is passed to the creditor, it is said to be

hypothecated28.

25 Dictionary of Banking by F.E.Perry & G.Klein, 3rd Edn, 1988, p.140 - 141

26 Black’s Law Dictionary, 7th Ed, 1999, p 747

27 Jowitt’s Dictionary of English Law, 2nd Edn, 1977, Vol 1, p.933

28 H.L. Hart, The Law of Banking, 4th Ed, 1931, Vol. 2, p 906

168

It is submitted that Hart’s definition is more accurate, in that it gives

the term a meaning of its own, not dependent on pledge or other forms of

security.

Salmond brings out the character of hypothecation when he states

that this security, which he calls a "hen", is of its own nature a security for

a debt and nothing more; it cannot survive the debt. "It is merely the

shadow, so to speak, cast by the debt upon the property of the debtor29.

If a customer is in possession (whether actual or constructive) of

goods, he will normally be able to pass that possession to his banker.

Accordingly, he will be able to create a valid pledge of goods. In some

instances, it is impossible for a banker to be given the actual or constructive

possession of goods, and in these cases that the possibility of hypothecating

them must be considered. For example, the goods may be in a part of the

customer’s own warehouse which cannot be sealed off in such a way as to

enable the banker to become a pledgee.

The risk of lending against hypothecation of goods is that since the

lender does not obtain actual or constructive possession of the goods, his

measure of control over them is very limited with the results that the

borrower will probably have ample opportunity of dealing with them

fraudulently. The fact that the borrower may thereafter find himself in

prison is but cold comfort to a lender who has lost money. An innocent

purchaser and a pledgee who obtain possession of the hypothecated goods

in good faith are unaffected by hypothecation.

29 Salmond, Jurisprudence, 11th Edn, p.469

169

Hypothecation implies that the possession and property in the goods

remain with the borrower and only an equitable charge is created in favour

of the banker. This is not a very satisfactory position for the banker as he

cannot have a preferential claim in the event of insolvency of the borrower

or in case of an attachment of goods by another creditor or if the goods are

pledged by the borrower to a third party who has no notice of hypothecation

to the banker.

The concept of hypothecation is not provided under the Indian

Contract Act, 1872. Hypothecation is neither governed by any statute nor

is there any law governing it directly or indirectly. It has been in mercantile

usage since time immemorial. Therefore courts have to consider the cases

involving hypothecation purely on general conditions of contract as per the

terms of hypothecation agreement.

The word "Hypothecation" is found under Section 3 of the Transfer

of Property Act, 1882 under "actionable claim". The interpretation clause of

Section 3 does not define the term "hypothecation".

Hypothecation - an Extended Pledge

In Bank of Maharashtra v Official Liquidator•30, the Mysore

(now Karnataka) High Court observed as follows :

"In the case of hypothecation or pledges of movable goods there is no

doubt about the creditor’s right to take possession, to retain possession and

to sell the goods directly without the intervention of court for the purpose

30 AIR 1969 Mysore 280

170

of recovering his dues. The position in the regular pledge completed by

possession is undoubted and set out in the relevant sections of the Contract

Act. Hypothecation is only extended idea of pledge, the creditor permitting

the debtor to retain possession either on behalf of or in trust for himself.

In Sewakram v State Bank of India51, the Madhya Badesh High

Court held that hypothecation is an extended idea of pledge. Therefore, if

the creditor has permitted the debtor to retain possession the debtor retains

that possession either on behalf of or in the trust for the creditor. The

hypothecatee is supposed to be in legal possession and custody of the

property though its physical possession is with the debtor.

The Madhya Pradesh High Court in M/s. Tara Rerolling Mills &

Five others v Punjab National Bank32 held that so far as hypothecation

is concerned, the possession remains with the hypothecator but the

hypothecatee has the right to get possession of the hypothecated property

and sell it for realisation of the debt secured by way of hypothecation. The

goods hypothecated to the Bank are covered by Section 176 of the Indian

Contract Act, 1872. There can be no distinction between "hypothecation"

and "pledge" for application of Section 176 of the Contract Act.

31 1990 (2) All India Banking Law Judgments 173

1998 (4) All India Banking Law Judgments 27532

171

Status of Lender under Hypothecation

In Union of India and another v Ct. Shenthilnathan and

another33, the Madras High Court held that hypothecation of goods is a

concept which is not expressly provided in the law of contracts, but is

accepted in the law merchant by long usage and practice. Hypothecation is

not a pledge and there is no transfer of interest or property in the goods by

the hypothecator to the hypothecatee. It only creates a notional and

equitable charge in favour of the hypothecatee and the right of the

hypothecatee is only to sue on the debt and proceed in execution against the

hypothecated goods, if they are available. The only right which the

hypothecatee got under hypothecation was a right to seek for the sale of

the hypothecated goods after a money decree on the debt. This Madras High

Court decision classifies the hypothecatee as unsecured creditor.

In Bank of India v State of Madhya Pradesh34, the R.T.O.

attached the bus (hypothecated to the Bank) for passenger tax and motor

vehicle tax under the Motor Vehicle Taxation Act. The Madhya Pradesh

High Court held that though the action taken by the RTO was legal, yet

because of special lien and hypothecation the Bank being a secured

creditor it has first charge and was entitled to sell the bus and appropriate

the sale proceeds towards its dues first.

33 (1977) 2 MU 499

1989 (2) BCLR 7834

172

Bank’s Right to Seize the Hypothecated Asset

In Lambersingh Mavasingh v Punjab National Bank35, the

appellant filed the appeal before the Gujarat High Court praying for time

for payment of the amount of the loan availed for purchase of the truck

from the bank. The High Court rejected the prayer. The borrower submitted

that the bank had no right to recover the possession without recourse to the

court. The question before the Court was whether the clause in the

hypothecation deed which enables the bank to recover possession of the

truck can be enforced or not. The High Court held that the loan is secured

by the hypothecation of truck and if such a clause for recapture of

possession is provided in the agreement, it is lawful. The High Court

observed that the real course the borrower should have adopted was to

approach the bank to accept a reasonable amount in the light of the adverse

circumstances which he had to suffer. Instead of doing that, the borrower

rushed to the court to pre - empt the bank from resorting to a remedy which

has been reserved to it under the agreement and dismissed the appeal.

Priority of Hypothecation Charge

In Union of India and another v Ct. Shenthilnathan and

another36, the facts were that the plaintiff was lending moneys to the

third defendant from time to time on the basis of a deed executed by the

latter in August 1960 hypothecating his camera and certain other articles.

35 Unreported Judgment - Appeal from order No. 165 of 1987 - Gujarat High Court

36 (1977) 2 MLJ 499

173

In February 1963, the camera was attached and taken possession of by the

District Revenue Authorities in the course of proceedings against the third

defendant for recovery of arrears of Income Tax for the assessment year

1958 - 59. The plaintiff filed a claim petition for release of the camera to

him to enable him to preserve it for the realisation of the dues under the

hypothecation bond. Upon rejection of the petition by the Sub - ordinate

Judge, Salem, the plaintiff filed a suit against the Government of India

(first defendant) and the Salem District Collector (Second defendant)

seeking a declaration that the camera was not liable to be attached by the

defendants in the tax recovery proceedings, in view of the plaintiffs prior

charge over it. The trial court gave judgment for the plaintiff and the

Government appealed. The appeal was allowed by the Madras High Court.

The Court held that the right of the hypothecatee is that of a bare money

creditor with the ancillary right to proceed against the hypothecated goods

after obtaining a decree in a court of law. Thus, a hypothecation is a

right in a creditor over a thing belonging to another and which consists in

the power in him to cause the goods to be sold in order that his debt might

be paid to him from the sale proceeds.

The best that can be claimed by the plaintiff is an equitable charge.

He could work out the equitable charge only after obtaining a decree on the

private debt. After obtaining the decree, he should seek execution as against

the goods under the hypothecation deed if available with the hypothecator

at or about the time when he seeks execution. The tax dues are public debt

and were not a debt which arose in the course of commercial dealings

between the citizen and the State. As between public debt payable to the

174

State and a private debt payable to a citizen, the former has priority. Under

the circumstances, the State Authorities are capable of attaching the

camera for recovery of Income - Tax arrears and they have a priority in the

sense that they are entitled to recover the tax dues from out of the sale

proceeds of the camera.

In State of Andhra Pradesh and another v Andhra Bank Ltd

and others37, a bank granted cash credit advance against hypothecation

of stock in the godown of the Sugar Mill under the open credit system. The

Tahsildar attached the sugar in the godown hypothecated to the bank for

recovery of dues towards sugar cane purchase tax to the State under the

provisions of the Andhra Pradesh Sugarcane (Regulation and Purchase) Act,

1961. The stocks were sold and the amount realised was deposited. The

Bank filed a suit claiming that the Bank is entitled to preferential first

charge and lien based on the hypothecation of the stocks to recover the suit

amount. The State, being simple money creditors (on account of tax

recovery) is entitled to any surplus that may be left. The Andhra Pradesh

High Court held that the concept of hypothecation is recognised in the civil

courts and it has become "law in force" in the country within the meaning

of Article 372 (1) of the Constitution of India as laid down by the Supreme

Court in Builders Supply Corporation v Union of India38. The rules

of common law relating to substantive rights have been recognised, adopted

and enforced by judicial decisions. That being so, to say that secured

creditor does not get any lien over the property hypothecated will amount

37 AIR 1988 AP 18

38AIR 1965 SC 1061

175

to negativing his right as a secured creditor. In view of these principles, the

doctrine of "Priority of Crown debts" is not applicable as against the secured

debt and therefore the bank’s (hypothecatee) claim has to be satisfied first.

In Canara Bank v Asst. Commissioner (Commercial Taxes),

Madras39, the Commercial Taxes Dept of Tamilnadu attached the

movables of the borrower on account of the Sales Tax dues. The movables

were already hypothecated to the Bank for certain credit facilities availed

by the borrower. The Bank filed a writ of mandamus before the Madras

High Court seeking a direction to the Taxation Authorities not to sell the

property as the bank has the first charge over the property by virtue of the

hypothecation in its favour. The High Court held that the hypothecation in

favour of the Bank is not a secured debt. Therefore the Bank’s charge as

hypothecatee could not be treated in preference to the government dues that

can be recovered as a prior charge if the goods hypothecated are available

for being proceeded against and attached for tax arrears.

Hypothecatee’s Right of Private Sale

The Nagpur Judicial Commissioner’s Court in Nanhuji v Chimnd40

held that a non - possessory hypothecation of movables is a valid contract

and should be recognised and enforced by the courts. The rights of the

hypothecatee are entirely regulated by the terms of the contract between

the parties. On default in payment of the debt, he can compel delivery of

property or obtain a decree for sale of the property, if so stipulated in the

39 1989 (1) All India Banking Law Judgments 258

(1911) 10 Indian Cases 86940

176

contract. If the property is simply hypothecated without any stipulation as

to the manner in which it is to be dealt with, the only remedy open to the

creditor is to obtain a money decree declaring his lien on the property and

his right to sell.

In Re S.Y.C. W & S. Mills41, the Mysore High Court (now

Karnataka High Court) held that in hypothecation or pledge of movables,

there is no doubt about the creditor’s right to take possession, to retain

possession and to sell the goods directly without the intervention of court

for the purpose of recovering his dues. Hypothecation is only extended idea

of pledge, the creditor permitting the debtor to retain possession either on

behalf of or in trust for himself (the creditor). Hence so far as movables

actually covered by the hypothecation deeds are concerned, there can be no

doubt that the bank is entitled to retain possession and also to exercise the

right of private sale.

In Syndicate Bank v Official Liquidator42, the Delhi High Court

held that hypothecation creates a special property in the goods in favour of

the hypothecatee. In the case of hypothecation, possession remains with the

hypothecator but the hypothecatee has the right to take possession of the

hypothecated property and to sell it for the realisation of the debt secured

by hypothecation. It is open to the bank to take possession of the

hypothecated property on its own or through the court. It is also open to the

bank to enforce the security by the suit.

41 AIR 1969 Mysore 280

42 AIR 1985 Delhi 256

177

In Union of India v Ct. Shenthilnathan43 the Madras High Court

held that hypotehcation creates only a notional and an equitable charge in

favour of the hypothecatee. The right of the hypothecates is only to sue on

the debt and proceed in execution against the hypothecated goods, if they

are available.

The Andhra Pradesh High Court in State Bank of India v S.B.

Shah Ali (Died) and others44 held that where there is a mere charge in

hypothecation agreement, the hypothecatee has to approach the court and

seek intervention of the court for obtaining money decree and for bringing

the hypothecated goods for sale through the court. When there is any

specific clause in the hypothecation agreement empowering the

hypothecatee to take possession of the goods and to sell the same, in the

event of default in payment, as per the said terms the hypothecatee can

proceed ahead without intervention of the court. It cannot be said that the

hypothecatee has to approach the court even though the deed provides for

taking possession in case of default of the hypothecator. If there is any

violation of the terms of the deed it will not bar the hypothecator to

approach the court and seek proper relief.

In Canara Bank v Official Assignee, Madras45 before the

Supreme Court the facts were that the appellant bank in an appeal before

the Madras High Court prayed that it should be permitted, as a secured

43 (1977) 2 MLJ 499

44 1994 (3) ALT 332 (D.B)

1997 I AD (SC)45

178

creditor in insolvency proceedings, to sell the hypothecated goods in the

possession of the insolvent for recovery of its dues, by virtue of the proviso

to Section 17 of the Presidency Towns Insolvency Act, 1909, read with

Section 52 (2) (a) of the Act. The High Court disallowed the claim. The bank

appealed to the Supreme Court contending that the insolvents of the goods

hypothecated to the appellant bank were in possession of such goods at the

commencement of the bankruptcy as its true owners, and had not been in

possession of the goods belonging to a third party by the consent of such

party, that the hypothecated goods were identifiable and therefore covered

by clause (a) of sub - section (2) of Section 52 of the Act and not by clause

(c) and that omission by the bank to give notice to the debtor did not

disentitle the bank to proceed against the hypothecated goods.

The Supreme Court held that in as much as the hypothecated goods

are clearly identifiable, the justice of the case required that the appellant

bank ought to be allowed to recover its dues by sale of the hypothecated

goods.

It is submitted that the judicial decisions about hypothecatee’s right

to sell the goods on default are variegated due to absence of a separate

legislation on hypothecation in India.

Illegal Use of Hypothecated Asset - Bank’s Status

A loan was advanced by the bank for purchase of a truck which was

hypothecated to the bank. On default in making repayment, the bank

brought a suit against the borrowers for recovery of the loan.

179

During the pendency of the suit, the said truck was seized by the

Range Forest Officer for violation of forest laws. An application was moved

by the bank for attachment before judgment of the truck. An order of

attachment before judgment was granted.

The Forest Department passed orders for confiscation of the vehicle.

Apprehending sale of the.vehicle by the Forest Department, the Bank again

applied for an order against sale or disposal of the truck. This application

was dismissed. Against that order, the Bank filed an appeal before the

Madhya Pradesh High Court. The High Court in the case titled "'Bank of

Baroda v Sitaram and others46 held that hypothecation of the truck

does not mean that the owner of the truck or the person responsible for its

running is absolved of the liabilities under any other law. If the truck is

utilised for transporting the contraband and is rendered liable for

confiscation, it is no defence that it was hypothecated to a

nationalised bank. The Forest Department officials had nothing to do

with the transaction the Bank had with the borrowers. If the truck is found

to be liable to be confiscated under law, the officers of the Forest

Department are within their rights to confiscate the same. In such a case,

the bank would lose its security but this cannot be helped.

46 (1995) 82 Comp. Cas. 435

180

Hypothecation and Writ Remedy

The Madras High Court decided a case titled "Sukra Shoe Fabric

v United Commercial Bank'*7 in respect of the hypothecator’s (borrower)

right to file a writ before the High Court questioning the hypotheeatee -

bank’s act in locking and sealing the factory premises containing the

hypothecated machinery.

The petitioner - firm was granted certain credit facilities by the

respondent bank against hypothecation of machinery. On default by the

borrower in making repayment within the stipulated time, the officers of

the bank along with an Inspector of Police entered the factory premises,

locked and sealed the premises after taking an inventory of the machinery.

A writ petition was filed by the petitioner - borrower for the issue of writ

of mandamus to direct the bank to remove the lock and seal applied to the

factory premises and deliver the possession of the same back to the

petitioner. The petitioner contended that the bank had no right either

in law or under the hypothecation agreement to enter the premises

and lock and seal the same.

The bank contended that it exercised the powers reserved under

clause 4 (j) of the Hypothecation Deed and seized the goods by means of

locking and sealing the premises. The Police Inspector, though present, did

not enter the premises. The bank raised a preliminary objection that writ

petition under Article 226 of the Constitution of India is not maintainable

since the rights of the parties are governed by a non - statutory contract

and the remedy of the borrower is Only to file a civil suit.

47 (1992) 73 Comp. Cas. 179

181

The High Court observed that the hypothecatee is a nationalised

bank and an authority under Article 12 of the Constitution of India. It owes

a public duty to its customers as well as to the borrowers. It has been held

by the Supreme Court in Shri Anadi Mukta Satguru Shree Muktajee

Vandasjiswami Suvama Jayanti Mahotsav Smarak Trust v V.R.

Rudani48 that mandamus can issue against any person provided that the

court is satisfied that such a person owes a duty to the public at large. The

bank falls within this category. The following passage of the said Supreme

Court Judgment is relevant here:

"Here again we may point out that mandamus cannot be denied on

the ground that the duty to be enforced is not imposed by the statute.

Commenting on the development of this law, Professor de Smith states : "To

be enforceable by mandamus a public duty does not necessarily have to be

one imposed by statute. It may be sufficient to have been imposed by

Charter, Common Law, Custom or even Contract"49. We share this view.

The judicial control over the fast expanding maze of bodies affecting the

rights of the people should not be put into water - tight compartments. It

should remain flexible to meet the requirements of variable circumstances.

Mandamus is a very wide remedy which must be easily available "to reach

injustice wherever it is found". Technicalities should not come in the way

of granting that relief under Article 226. We, therefore, reject the contention

urged for the appellants on the maintainability of the writ petition".

48 AIR 1989 SC 1607

49 de Smith, Judicial Review of Administrative Action, 4th Edn, p.540

182

The High Court rejected the first contention that the writ petition is

not maintainable. The only other question is whether the respondent - bank

has any authority of law to enter the premises, lock and seal the same.

Hypothecation agreement will not enable the creditor to enter the

premises, lock and seal the same without recourse to law.

The High Court further observed as follows on the bank’s act in

locking and sealing the factory premises :

"When the factory was actually working, the officers of the

respondent - bank along with the police have gate - crashed into the factory

and purported to lock and seal the premises. If a nationalised bank can take

the law into its own hands, how can the courts criticise and find fault with

others?. The rights given to a creditor under a hypothecation agreement can

be exercised only by approaching the court of law, and not by taking the law

into its own hands. If we recognise such a power in a nationalised bank,

then every other State Financial Corporation and Government Company

will be emboldened to follow the same procedure. It will tantamount to

bidding good - bye to the rule of law. There are sufficient remedies available

to the creditor - bank. Even in case there is an imminent danger of the

debtor secreting the properties or depleting the securities, it is not

uncommon for civil courts to issue temporary orders of attachment as well

as appointment of commissioners to safeguard the interests of the deserving

creditors.

183

Under what provision of law the police accompanied the bank officials

when they purported to enforce a term of the hypothecation deed? More

often than not, the public complain that the police do not lend their support

in urgent cases where there is a threat to life, liberty and property of a

citizen. While so, it is rather strange that the police should have

accompanied the officers of the respondent - bank when they are allegedly

enforcing a term of the hypothecation deed. The said action of the

respondent bank is totally unauthorised and arbitrary".

The Madras High Court allowing the writ petition, directed the

respondent bank to remove the lock and seal applied to the petitioner’s

factory and to deliver the possession of the factory premises along with the

goods and articles to the petitioner.

Hypothecation and Criminal Breach of Trust

The Supreme Court in Central Bureau of Investigation v Duncan

Agro Industries Ltd50 held that when the debtor hypothecates his goods

to the bank by way of security, there is no entrustment of the goods by the

debtor to the banker. If there is any contravention of the terms of the

contract it will be a mere breach of contract making the debtor liable for

damages under the civil law. There will be no occasion for committing any

offence of criminal breach of trust by the borrower in the case of

hypothecation.

50 (1996) 87 Comp. Cas. 849

184

The observations of the Supreme Court are as follows :

"The expression" entrusted with property" "or with any dominion over

the property" has been used in a wide sense in section 405 of the Indian

Penal Code, 1860. Such expression includes all cases in which goods are

entrusted, that is, voluntarily handed over for a specific purpose and

dishonestly disposed of in violation of law. The expression "entrusted"

appearing in section 405 of the Indian Penal Code, 1860, is not necessarily

a term of law. It has wide and different implications in different contexts.

It is, however, necessary that the ownership or beneficial interest in the

ownership of the property entrusted in respect of which offence is alleged

to have been committed must be in some person other than the accused and

the latter must hold it on account of some person or in some ways for his

benefit. The expression "trust" in section 405 of the Indian Panel Code,

1860, is a comprehensive expression and has been used to denote various

kinds of relationship like that of the trustee and beneficiary, bailor and

bailee, master and servant, pledgor and pledgee. When some goods are

hypothecated by a person to another person, the ownership of the goods still

remains with the person who has hypothecated such goods. The property in

respect of which criminal breach of trust can be committed must necessarily

be the property of some person other than the accused or the beneficial

interest or ownership of it must be in other person and the offender must

hold the property in trust for such other person or for his benefit. In a case

of pledge, the pledged article belongs to some other person but the same is

kept in trust by the pledgee. In the instant case, a floating charge was made

on the goods by way of security to cover up credit facility. In such case for

disposing of the goods covering the security against credit facility the

offence of criminal breach of trust is not committed".

185

In Punjab National Bank v Anand Kumar51, the facts were that

the respondents have opened an account with the petitioner - bank. Cash

credit facility was given to them. The respondents have hypothecated goods

with petitioner - bank. On 26.9.1983 manager of the petitioner - bank

inspected the factory premises of the respondents and the bank godown

situated therein and found that goods hypothecated with the bank had been

removed by the respondents to the extent of 3760 quintals and the goods

placed there were found short to a large extent. The petitioner’s Manager,

therefore, made a complaint to the S.H.O. Hissar for registration of a case.

The case was registered against the respondents. After investigation, the

police concluded that there was no evidence that the respondents have

committed any offence with regard to the pledged goods. However, the

police found the respondents to be guilty of the offences punishable under

sections 420 (cheating and dishonestly inducing delivery of property) and

406 (punishment for criminal breach of trust) of the Indian Panel Code and

the police put up a challan against them. Learned Chief Judicial Magistrate

found that offence under sections 420 / 406 of the Indian Penal Code was

not made out.

It was observed by the learned Chief Judicial Magistrate that for

misappropriation of hypothecated goods, the entrustment of goods by one

person to another is an essential ingredient and the ownership of goods

remains with the original owner and only the possession changes hands and

it was held that no entrustment was made in the present case.

51 2000 ISJ (Banking) 385

186

The Punjab and Haryana High Court held that whether the

entrustment was there or not is a matter of evidence. The goods were

pledged by the respondents with the petitioner - bank though the possession

was kept in their godown. So prima facie it cannot be said that there was

no entrustment. Moreover, the learned Chief Judicial Magistrate could have

also considered whether the case falls under section 379 (punishment for

theft) of the Indian Penal Code. The allegation of the petitioner is that the

goods were hypothecated and the possession was kept in the godown with

the respondents. When this is the position, the view taken by the learned

Chief Judicial Magistrate cannot be accepted.

The High Court allowed the Criminal Revision setting aside the order

of discharge of the respondents. The case was remanded to the learned

Chief Judicial Magistrate for proceeding with the case in accordance with

law.

It is submitted that this case points to change injudicial thinking as

far as illegal removal of hypothecated goods is concerned. Criminal breach

of trust was thought of hitherto. The turn to the offence of theft in case of

illegal removal of hypothecated goods is welcomed in banking circles as it

will signal a warning note to the offenders.

Hypothecation and Natural Justice

In Sri Rama Machinery Corpn. Ltd v Standard Chartered

Bank, Madras52 before the Madras High Court, the facts were that there

was a contract between the bank and customer for advancement of loan for

52AIR 1999 Madras 137

187

purchase of vehicle. The borrower defaulted in repayment. The bank seized

the vehicle as per the terms of the contract between the parties. The issue

before the High Court was whether prior notice before seizure is necessary

to be given to the borrower by the bank under the Principles of Natural

Justice. The High Court held that if prior notice is issued before seizure of

the vehicle, naturally the vehicle will be taken away from the jurisdiction

of the State and the very purpose of exercising the power of seizure will be

taken away.

The observations of the Madras High Court in the case are as follows:

"In Penumbra of Natural Justice by Tapash Gan Choudhaiy, at page

58, the circumstances under which principles of natural justice could be

excluded are also stated, which read thus,

"It is well established both in England and in India that where a

right to a prior notice and an opportunity to be heard before an order is

passed would obstruct the taking of prompt action, such a right can be

excluded. Thus, the rule may be discarded in an emergent situation where

immediate action brooks no delay to prevent some imminent danger or

injury or hazard to paramount public interests".

In the case between Union of India v Tulsiram Patel53, it is held

thus,

53 1985 (3) SCG 398 in para 101; AIR 1985 SC 1416

188

"Not only, therefore, can the principles of natural justice be modified

but in exceptional cases, they can even be excluded. There are well - defined

exceptions to the "nemo judex in causa sua" rule as also to the "audi

alterum partem" rule. The "nemo judex in cause sua" rule is subject to the

doctrine of necessity. So far as the "audi alterum partem" rule is concerned

both in England and in India, it is well established that where a right to a

prior notice and an opportunity to be heard before an order is passed would

obstruct the taking of prompt action, such a right can be excluded. This

right can also be excluded where the nature of the action to be taken, its

object and purpose and the scheme of the relevant statutory provisions

warrant its exclusion; nor can the "audi alterum partem" rule be invoked

if importing it would have the effect of paralysing the administrative

process or where the need for promptitude or the urgency of taking action

so demands, as pointed out in Menaka Gandhi Case54’.

The Madras High court further observed that it is clear that there is

no necessity to issue notice even in the case of certain administrative action.

If this is the position even in the case of administrative orders, in the case

of contracts it can be said that there is no need for prior notice. If prior

notice is issued before seizure of the vehicle, naturally the vehicle will be

taken away from the jurisdiction of the State and the very purpose of

exercising the power of seizure will be taken away.

54 Menaka Gandhi v Union of India AIR 1978 SC 597 at p.681