Need to dispel confusion on types of security

LEGAL EYE

The emergence of improved capital availability, easier financing arrangements and funding products have revolutionised the Indian financial sector "� providing options unthinkable a few years back. Unfortunately, the legal framework in India regulating securitisation has not kept pace with these developments. Indian securitisation law is derived from a mixed bag of the general law of contract, common law rules and ad-hoc legislation. To an extent, the SARFAESI, by defining "security interest," has partially dispelled the confusion prevailing over commonly used terms such as pledge, charge, hypothecation, lien, their various forms and sub-sets. But considerable confusion still persists on the types of security and their implications.

Securities can be categorised in various ways: possessory and non-possessory, personal, real and intangible, the nature of the security device, the status and relationship of the debtor and creditor. None of the existing Indian laws address this holistically, and some are concerned only with limited aspects such as the Registration Act.

The Transfer of Property Act (TPA) is probably the most comprehensive law, dealing mainly with immoveable property, particularly mortgages, defined as a transfer of interest in specific immoveable property for securing a debt or any performance in monetary terms. Mortgages can be possessory and non-possessory, with the latter most commonly effected by deposit of title deeds with the mortgagee.

Tangible moveable assets such as securities, goods, equipment, and crops can be subjected to both possessory and non-possessory securitisation. A pledge is created by delivery of secured goods to the creditor, dealt with in Section 172 of the Indian Contract Act, 1872. A pledge is therefore a possessory security, which entitles the pledgee to retain, and in default dispose of, the pledged goods. Pledge is interchangeable with the term Lien, otherwise a term with wide connotations, as the right of a creditor in possession of his security. However, Section 170 of the Contract Act refers to a banker's lien on any goods "bailed" to them, virtually an implied pledge, which in a mercantile system involving the provisions of the Negotiable Instruments Act actually create a right of hypothecation.

Moveable property may be secured by hypothecation as well, a traditional and widely used form of securitisation. Hypothecation is referred to in the TPA, to distinguish it from an actionable claim, but remained statutorily undefined till SARFAESI recognised it as being a charge without delivery of possession. It is interesting how the interchangeability of the security descriptions persist. European countries which follow civil law recognise the concept of enterprise mortgage for all moveable assets of a business, including liquid assets. The distinction between pledge and hypothecation is also becoming increasingly blurred, as delivery is no longer a prerequisite for pledge, with the concept of constructive delivery, i.e. pledger's possession under pledgee's authority, becoming prevalent.

Is hypothecation then a charge? Charge in its common law connotation, as a lender's non-possessory security interest in property, is not very different from hypothecation "� SARFAESI defines it accordingly. However, the Companies Act has earmarked a charge as being specific to debts owed by limited companies and includes mortgages. Charges have to be entered in the company's statutory register, and recorded with the Registrar of Companies. Charge does not include pledge of shares, and therefore is not a lien "� though it may be possessory or non-possessory.

But lien in a different context, in Section 45 of the Sale of Goods Act, provides for the non-possessory right of an unpaid seller on sold goods in transit, after expiry of credit period, even on insolvency of buyer, irrespective of possession. This is the earliest statutory recognition of the technique of retention of title, a funding option used extensively in trade practices.

The only other form of title retention contracts are those of hire purchase and moveable leases. The still-born Hire Purchase Act, 1972, was repealed in 2005, being irrelevant in the present economic scenario, when credit is freely available with no justification for the exorbitant statutory interest.

And, finally "SARFAESI," the triumph of India's banking reforms, entitling the creditor to an absolute right of foreclosure of its security interest. However, the non-applicability of the Act to various classes of security, including pledge and various liens under the Indian Contract Act and Sale of Goods Act, have been decried as devaluing the purpose of SARFAESI, effectively. And SARFAESI protects only the charmed circle of financial institutions, while security interests in trade, involving intermediary manufacturing and sub-buyers remain unaddressed. We need to evolve a harmonised law, consistent with cross-border practices.

Kumkum Sen is a partner in Rajinder Narain & Co

kumkumsen@rnclegal.com