Charge has different meaning in the English vocabulary, and banking has a special meaning for the word charge. Here we are not describing the service charges debited by the banks on the account.
This article will explain the different type of charges lender creates over the asset provided by the borrower as a security.
If you do not understand it yet, do not worry. We have provided detailed information of charge and types of charges in the finance sector. Thus, read the article completely to understand the concept clearly.
What is Charge on Security?
Charge in the financial sector represents how much control the lender have over the property for/ against which they are lending.
As per Companies Act 2013, charge is defined in Sec. 2(16) of the act as “charge means an interest or lien created on the property or assets of the company or any of its undertakings or both as security and includes mortgage”.
Consider you are applying for a vehicle loan with bank for purchasing of 2 wheeler for personal use. The bank will create a charge on the security, in this case the Two-Wheeler. The Charge created over this vehicle is called Hypothecation.
Similarly, depending upon the security, the bank will create a different charge for a different asset.
There are several types of charges based on the specific asset as given below.
Types of Charge
There are seven common types of charges.
- Pledge
- Hypothecation
- Mortgage
- Assignment
- Lien
- Negative Lien
- Set Off
1. Pledge
As per Sec. 172- Indian Contract Act-1872 Pledge is defined as ‘bailment of goods to secure repayment of debt or performance of a promise’.
Pledge has the following features
- Pledge is applicable for the movable property.
- Possession & control of goods remain with bank and ownership remains with borrower.
- Upon repayment of the loan, the goods will be returned to the borrower.
2. Hypothecation
Hypothecation is defined as ‘mortgage of movable property and will be converted into pledge on non-payment of debt by taking the possession through SERFAESI Act 2002‘.
The Hypothecation Charge has the following features.
- In hypothecation, the possession and ownership remains with the borrower. But the bank has a charge over the property.
- The lender bank has an authority to take over the hypothecated stocks/ goods if the repayment of loan is not proper
3. Mortgage
Mortgage is defined as transfer of interest in specific immovable property for securing present debt, and future debt or for performance of an engagement which may give rise to a pecuniary obligation.
- A mortgage charge is created on the immovable property.
- Thus, with the mortgage the borrower binds himself personally to repay the amount, failing which bank has right to sell the property through court or file suit for recovery.
- For further details on mortgage and different types of mortgage, read article on What is Mortgage and Types of Mortgage in Bank Loan?
4. Assignment
Assignment is defined in Transfer of Property Act-1882 Sec 130 as ‘Actionable claims can be assigned. Actionable claim is a claim to any debt, not secured by mortgage, pledge, hypothecation or any beneficial interest in movable property not in possession of claimant, which the courts consider as affording grounds of relief.’
- Assignment is created on movable property not covered by Pledge, Hypothecation and Mortgage.
- The possession of property is with the borrower. But, the bank has the right to take over the asset in case of default.
- Example: LIC policy, Book debts, dues from Govt. dept., NSC/KVP etc.
5. Lien
Asp per Indian Contract Act 1872- Sec 170 & 171 ‘Lien is a right to retain securities that come to banker in the normal course of business, in respect of due by the customer. Lien are of – particular lien and general lien.‘
- The lien can only be exercised only on those securities, goods over which the person has expended some labor/ money etc.
- But, the General lien extends to all securities that pass through the hands in the normal course.
6. Negative Lien
Negative lien is a declaration from the borrower that he has not encumbered nor will encumber the assets in favor of third parties as long as he is indebted to the bank.
Hence, Banks will have a hold over the property under the negative lien. But, the asset banks can not directly realize the asset from the borrower.
7. Set Off
Set off is a right to appropriate a credit balance towards a debit balance of the same person in the same right and capacity.
Thus, banks can settle the loan if it is due with the credit balance from any other account of the same person.
For Example: If A is the borrower and having failed to repay the loan. Thus, the bank can appropriate balance from his operative savings account to the loan.
Set Off does not require consent from the borrower.
Charge for Different Securities
| Nature of security | Types of security | Kind of charge | Defined in Act |
| Immovable property | Land & Building | Mortgage | Transfer of property Act 1882 sec.58 |
| Actionable claims | Book Debts, FDR, NSC | Assignment | Transfer of property Act 1882 sec.130 |
| Movable property/goods | Plant & Machinery, Stocks, vehicle etc. | Pledge or hypothecation/ lien | Pledge – Indian contract Act 1872 sec.172 Hypothecation – SARFAESI Act 2002 Sec.2-n |
| Paper securities | Shares, Debentures, Bonds Mutual fund units. Etc | Lien | Indian contract Act Sec 170 & 171 |
| Personal guarantee | Promoters and 3rd party | Personal liability | Indian Contract Act. 1872 |
Conclusion
Thus, the Charge is an agreement between the bank and borrower on the control over the asset given as security or the asset created out of the financing.
Moreover, the Charge provides the bank a better control over the borrowers and makes the lending process easier for the borrower as well.