This Article is written by Hia Sharma student of Himachal Pradesh National Law University Shimla.
What is contract of pledge?
Section 148 of The Indian Contract Act, 1872, hereinafter referred to as the ‘Act’, defines bailment as the ‘delivery of goods by one person to another person to serve for some purpose’. There is a contract that is formed between the two parties and that when the purpose for which the goods were bailed is fulfilled, the goods are returned or disposed off according to the contract terms and requirements. The person who delivers the goods is called the ‘bailor’. The person to whom the goods are delivered is called, the ‘bailee’.
Section 172 of the act defines ‘Pledge’, ‘pawnor’ and ‘pawnee’. Pledge is defined as the bailment of goods as a security for the payment of a debt or for the performance of a promise. The bailor is in this case called the ‘pawnor’. The bailee is called the ‘pawnee’
The elements are largely similarly to that of contract of bailment.
- There must be delivery of possession of goods by one person to the other.
- The good must be delivered with some purpose to serve as a security against loan.
- The goods are returned, altered or modified as per the terms and conditions of the contract.
Firstly, there should be bailment of goods, that is, delivery of possession of goods from one party to the other party. The delivery can be physical delivery in which the goods are transferred physically form one party to the other party, delivery could be symbolic in which the possession is seemed to be transferred overtly by the parties. The delivery can be constructive in which the possession is already with the other party and the same is applied as security for a loan taken.
Delivery of pledged goods can also be made by the way of attornment which means that the goods of the pledger or the pawnee are lying with some third party who is holding the goods in his possession on the behalf of the owner, the pawnor here. Thus, here the third party will hold the goods on the behalf of the pledgee.
The delivery of the title of the good to be pledged instead of actual physical goods constitutes an actual delivery for the purpose of pledge to the pledgee. This was laid down by the Supreme Court, in Morvi Mercantile Bank Ltd. v Union of India. It was held that the delivery of title of goods implied a valid contract of pledge between the two parties, the bank and the company here. According to the Section 180 of the Act, the pledgee can sue the wrongdoer if it deprives the pledgee of the possession of the pledged goods, thus the bank can sue and recover the required amount from the railways.
Secondly, the purpose for the bailment of goods is to make the bailed goods serve as a security for the payment of the debt or loan or performance of a promise.
Who can pledge the goods?
Owner of the goods – The goods can be pledged as a security for the loan taken by anyone who is the owner of the goods or by any authorised person, authorised by the owner of the goods to enter into the contract of pledge.
Mercantile agent – According to the Section 178 of the Act, a mercantile agent can also pledge the goods if he has the consent of the owner, he is in the possession of the goods or has the document of title to the goods and he is acting in the ordinary course of the business. But the Pawnee must act in a good faith and must not have the knowledge that the pledger is acting outside his authority. If the mercantile agent has not been authorised to pledge the goods of his owner and he still pledges the goods provided that the pledgee has no knowledge that whether the agent is authorised or not authorised to the act and Pawnee acted in a good faith, the rights of Pawnee are taken to be supreme. This means that the owner of the goods cannot ask the Pawnee to return the goods as the agent was unauthorized but he can claim compensation from the agent for going beyond his authority.
Pledge by a person in possession under voidable contract- Section 178A of The Indian Contract Act, 1872 provides for the provision of contract of pledge by a party who has the possession of goods under some voidable contract. The contract can thus be vitiated or cancelled by the party whose consent was not free within a reasonable period of time making the contract void.
In a case Phillips v. Brooks Ltd., the facts were that a man acting to be a man of credit induced a man to give him with a valuable ring in return of his cheque which proved to be valueless. Before the fraud exposed, the ring was pledged with the pledgee, the defendants. The pledge here was held to be valid, though the possession was under a voidable contract. The person has acted in good faith and has pledged the goods before the contract could be rescinded.
Pledge where pawnor has only a limited interest- Section 179 of The Indian Contract Act, 1872 states that the contract of pledge by a party who has only a limited interest in the good can enter into a contract of pledge but it will be valid only up to that extent to which the pledger or the pawnor has the right in the goods pledged. But if the party had only a limited interest and he went beyond his rights, the rights of the pledgee will be protected, provided that the pledgee acted in a good faith and has no knowledge about the fact that the party has only a limited interest in the goods pledged.
Pledge by a seller or buyer in possession after the sale- If the buyer has taken the possession of the goods and has not paid for the same yet and pledges the goods the rights of the pledgee will be protected. The seller can only claim compensation. Similarly, if the buyer has bought the goods but the possession is with the seller only and the same goods are pledged, again the rights of the pledgee will be protected.
Rights of a pledgee or pawnee
Right to retain the goods pledged – The Section 173 of the Act states that the pledgee has a right to retain the goods pledged with him as a security for a loan advances by the pawnee to the pawnor. The pledgee can keep the goods till the time the pledger has not returned the amount of the loan taken. The right to retain the goods can also be exercised if the interest amount on that particular loan has not been paid by the pledger. The right further extends till the necessary expenditure that has been incurred by pledgee with regard to the possession of the goods pledged.
Section 174 of the Act provides that the Pawnee cannot retain the goods pledged by the pawnor for any other loan advanced to him except for the loan for which the goods were pledged if there is a contract to the contrary specifying so.
Right to recover extra ordinary expenses – The Section 175 of the Act provides the right of the pledgee to be reimbursed with any extra expenditure that he incurred during the course of the possession of the goods. The pledger cannot retake his goods back from the pledgee until he reimburses the pledgee with the necessary expenses.
Right to file suit – The Section 176 of the Act provides that the Pawnee has a right to bring a suit against the pawnor in case he makes a default. If the pawnor fails to pay back the loan amount or the interest on that loan amount or the necessary expenses bore by the pawnee to keep the goods safe in the stipulated period of time, the pawnee has a right to sue him in the court of law for getting reimbursed for the amount and also retain the goods pledged as a collateral security.
Right to sell the goods pledged – The Section 176 of the Act provides for the provision of right given to the pledgee to sell the goods in case the pledger fails to pay back the loan amount, interest on the loan amount or the necessary expenses, provided the pledgee gives a reasonable notice of sale to the pledger.
It was held in the case Sunderlal Saraf v. Subhas Chand Jain, that it is not mandatory for the pledgee to specify the date and the place of the sale in the notice as specified above for the sale of the pledged goods. The only requirement is to send a reasonable notice before the sale of goods.
It was laid down in the State Bank of India v. Smt. Neela Ashok Naik, that the right to sale the goods, in case the pawnor makes a default is solely the discretion of the Pawnee. He can file suit to recover the debt amount instead of selling the goods and consequently retain the pledged goods as collateral security.
The Section 177 of the Act provides for the right of a pawnor. The party who takes the loan and pledges goods as security for the loan amount has a right to redeem the goods back or take the goods back as soon as he returns the loan amount, the interest of that loan amount and all the required necessary expenses.
In case the reasonable notice of sale of goods has been given to the pawnor in case of default of payment in the stipulated period of time, the pawnor still has a right to redeem the goods pledged by making the necessary payments till the actual sale of the goods pledged. This is guided by the Limitation Act, 1963. But the pawnor has to pay, in addition, any extra expenditure incurred by the Pawnee due to the default of the pawnor.
In this article, we discussed the contract of pledge, as delivering the possession of movable goods to a pledgee by a pledger as a security for a loan taken from the pledgee for a certain obligation to be fulfilled. The essential features to validate a contract of pledge were explained along with certain case laws. Then we discussed about the parties that can enter into contract of pledge. Then there was a discussion about the rights of a pledgee or pawnee and that of the pledger or pawnor.
1. Avtar Singh, Contract and Specific Relief Act, Twelfth Edition
2. Bank of Bihar v State of Bihar 1971 AIR 1210
3. Morvi Mercantile Bank Ltd. v Union of India 1965 AIR 1954, 1965 SCR (3) 254
4. Phillips v Brooks Ltd (1919) 2 KB 243
5. State Bank of India v Smt. Neela Ashok Naik, AIR 2000 Bom 151
6. Sunderlal Saraf v Subhas Chand Jain, AIR 2006 MP 35
7. The Indian Contract Act, 1872