by

Rajesh Goyal 

I received recently an email requesting to explain the difference between above terms as the sender has been put this question in his interview.   With my 30 years experience in banking, it looked very simple, but I realised that when I was studying my law, I too had to put lot of effort to make the same clear.    Moreover, a large number of  bankers even get confused between these terms.  Thus, in the following paragraphs I will try to explain these in simple language so that even most of non-bankers or even students can understand the same.    Some  bankers too may find it interesting and helpful in their internal exams / interviews.

In What Context Are  Terms Pledge, Hypothecation and Mortgage Used :

These terms are used for creating a charge on the assets which is given by the borrower to the lender as a security for any loan.  Thus, one of these terms will be normally used whenever an individual or a business firm avails any loan and the bank keeps some assets as a security, so that it will be able to sell the same in case that individual or the firm defaults in repayments.

Define  Pledge, Hypothecation  and Mortgage.  

(1) Pledge is used when the lender (pledgee) takes actual possession of assets (i.e. certificates, goods ).  Such securities or goods  are movable securities.  In this case the pledgee retains the possession of the goods until the pledgor (i.e. borrower) repays the entire debt amount.   In case there is default by the borrower, the pledgee has a right to sell the goods in his possession and adjust its proceeds towards the amount due (i.e. principal and interest amount).  Some examples of pledge are Gold /Jewellery Loans, Advance against goods,/stock,  Advances against National Saving Certificates etc.

(2) Hypothecation is used for creating charge against the security of movable assets, but here the possession of the security remains with the borrower itself.   Thus, in case of default by the borrower, the lender (i.e. to whom the goods / security has been hypothecated) will have to first take possession of the security and then sell the same.   The best example of this type of arrangement are Car Loans.   In this case Car / Vehicle remains with the borrower but the same is hypothecated to the bank / financer.   In case the borrower, defaults, banks take possession of the vehicle after giving notice and then sell the same and credit the proceeds to the loan account.  Other examples of these hypothecation are loans against stock and debtors.  [Sometimes, borrowers cheat the banker by partly selling goods hypothecated to bank and not keeping the desired amount of stock of goods.   In such cases, if bank feels that borrower is trying to cheat, then it can convert hypothecation to pledge i.e. it takes over possession of the goods and keeps the same under lock and key of the bank].

(3) Mortgage :  is used for creating charge against immovable property which includes land, buildings or anything that is attached to the earth or permanently fastened to anything attached to the earth (However, it does not include growing crops or grass as they can be easily detached from the earth).  The best example when mortage is created is when someone takes a Housing Loan / Home Loan.  In this case house is mortgaged in favour of the bank / financer but remains in possession of the borrower, which he uses for himself or even may give on rent. 

Difference Between Pledge, Hypothecation and Mortgage at a Glance:

Pledge, Hypothecation and Mortgage Under Indian Law

Pledge : Section 172 of the Indian Contract Act defines pledge as "The bailment of goods as a security for the payment of a debt or performance of a promise"   The bailor in this case is called a Pawnor and the bailee is called Pawnee

To create a valid pledge in the eyes of Law, the three important points needs to be noted : (a) Delivery of Possession :  As in bailment, in pledge too delivery of possession is required.  For exmaple, in Revenue Authority vs Sundarsanam Pictures, AIR 1968, it was held NOT to be pledge because the film producer borrowed a sum of money from a financier and agreed to deliver the final prints of the film when ready.  Thus, there was no delivery of the goods at the time of agreement;  (b) Delivery is in return of a loan or promise to perform something.    Therefore, if your friend gives you his Motor-cycle to go to college, it is not pledge but can be called simple bailment;  (c) It should be in pursuance of a contract :  The delivery must be done under a contract (oral or written).   However, it is not necessary that delivery and loan take place at the same time.  Delivery can be made even after the loan is received.

Hypothecation:   was not defined under Indian Law for long time and was used more on the basis of practice.   However, now under the Secruitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, hypothecation is defined as "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 crystallization into fixed charge on movable property".  .

Mortgage :  is defined in Section 58 of the "Transfer of Property Act 1882".  It is the transfer of an interest in specific immovable property for the purpose of securing payment of money advanced by way of loan.

What is an Assignment ?  

There is another term  (i.e. Assignment) which is sometimes confused with above terms.  An assignment constitutes an action taken with a contract.  Assignment occurs when the owner of a contract, known as the assignor, gives a contract to another party, known as the assignee.   The assignee assumes all responsibilities and benefits of the contract.  When it comes to loans, assignment can relate to life insurance policies and mortgage contract from one party to another.    Mortgages and other contracts sometimes contain provisions limiting or stipulating conditions for assignment.

One example of assignment is 'transfer by the holder of a life insurance policy (the assignor) of the benefits or proceeds of the policy to a lender (the assignee), as a collateral for a loan'.    In such case in the event of the death of the assignor, the assignee is paid first and the balance (if any) is paid to the policy's beneficiary.      However,  insurance policies other than life insurance,  may not be used for this purpose.