Pledge: Overview under the Indian Contract Act

Introduction:

In law, the concept of pledge is laid down under Section 172 of the Indian Contract Act (ICA). Pledge is a bailment of personal possession as security for some debt or engagement.

Pawn was synonymous with a pledge at common law but the term “Collateral Security” was introduced to designate the subject matter in the pledge given as reliability for an engagement in spite of an easy word for the borrowing of money, and especially when the subject matter comprises of incorporeal belongings such as stocks, bonds, etc.

The concept of pledge includes two persons mainly known as Pawnor and Pawnee.

In a pledge, a Pawnor is the one who transfers possession, but not ownership to another party. While a Pawnee is known as the rightful owner of that particular possession.

So, in the words of Pawnor and Pawnee, In the concept of pledge, the Pawnor bails his goods to the Pawnee as security against the amount he takes from him. So, now the Pawnor commits to pay the amount to the Pawnee and as a result, the Pawnee has a duty to return the goods after Pawnor pays the amount. The Pawnee will be liable to pay compensation to the Pawnee if he makes unauthorized use of the bailed goods.

There are three categories in which securities are provided, namely – lien, mortgage, and pledge.[1] Under a contract of pledge, any good or the title of the good is pledged by one party to the other as collateral for the money advanced by the latter party. Thus making of pledge is a condition precedent for advancing money.

Pledge may also be defined as delivery of goods by the debtor to the creditor for the debt or for any other contractual obligation and the object herein delivered shall be returned to the pledgor when the debt money has been repaid or the obligation has been performed.[2]

Illustration

Aisha borrowed Rs.1000 from Pratik and gave her bicycle as a reliability for paying back the amount, in the condition that if Aisha pays back to Pratik she will get his bicycle back. This contract between them will be termed as pledge. Also, Pratik can make no unauthorized use of the bicycle and if he does will be liable to pay compensation to Aisha.

Essential Requirements of Pledge

1. A contract should exist between the parties for the pledge and delivery of goods.
2. There should be an exceptional reason and purpose for the delivery of the goods.
3. The subject matter should always be good that is something in possession.
4. For the pledge to take place there should be a delivery of goods from the pledger to the pledgee.
5. In pledge, the transfer of ownership does not take place.

Rights of Pawnor and Pawnee

Rights of Pawnee

1. Right of Retainer: The Pawnee is allowed to hold on to the goods pledged until his/her dues are paid. He may hold on to them until he gets the payment of the debt or the performance of the promise is done and also for interest due on the loaned funds and all required outstandings incurred by him in relating to the possession of the goods pledged.
2. Right to Extraordinary Expenses: The Pawnee is bound to receive the costs which are incurred by him for taking care of the pledged goods by the Pawnee.
3. Right to Sell: The Pawnee has a right to sell the goods and reimburse his amount if the Pawnor fails to pay the amount back to the Pawnee.
4. Right to get Compensation: Pawnor will become liable to Pawnee when he will suffer from the goods of the Pawnor.

Rights of the Pawnor

1. Right to take back the Goods: The Pawnor will be entitled to get back the goods pledged on the performance of promise or repayment of loan and interest if any.
2. Right to ask for Damages or Compensation: Pawnor has the authorization to get the compensation if the Pawnee makes any unauthorized use of the goods or fails to keep the goods safe.
3. Preservation of the Goods: The Pawnor is entitled to see and check whether the Pawnee has preserved the goods pledged and has properly maintained them or not. 

Duties of Pawnor and Pawnee

Duties of Pawnee

1. Duty to ensure Reasonable Care: It is Pawnee’s responsibility to take as much care of the goods pledged to him as an ordinary man would, under similar circumstances of his own goods. The burden of proof is on the Pawnee that there has been no negligence when he fails to give back the goods or returns them in a damaged condition.
2. Duty to lend back the goods once the loan is repaid: Once the Pawnor has paid back the loan it becomes the duty of the Pawnee to give back the pledged goods to him. He cannot keep it with him on any grounds.
3. Duty not to make any unauthorized utilization of the goods: If the Pawnee used the pledged goods in a manner which is not consistent with the conditions of the contract, he shall be liable for any loss notwithstanding whether he is not at fault for negligence and even if the damage is the result of an accident as per Section 154.
4. Duty not to misarrange the goods: The Pawnee must not at any cost mix up the goods lend by the Pawnor with his own goods but must keep them separate from goods owned by him.

Duties of Pawnor

1. Obligation to disclose any known faults: It is the first and foremost responsibility of the person to disclose the known faults of the goods by the Pawnor. He’ll be liable to pay for the damages if he is not able to make the disclosure of such known faults.
2. Duty to pay back the loan: It is the responsibility of the Pawnor to pay the loan in order to get his goods back.
3. Duty to bear extraordinary expenses of the pledge: It is an obligation on the part of the pawnor to reward the Pawnee with the exceptional costs incurred by keeping the goods safely.
4. Duty to indemnify Pawnee: The pawnor is legally responsible to pay the compensation or damages to the Pawnee if he suffers from any type of legal damages due to Pawnor’s goods.

Pledge by Non-Owners

It is the common rule that only the owner has the right to make a valid pledge. But in few cases as follows even a non-owner can create one:

1. Pledge created by a mercantile agent: Pledge created by the mercantile agent is valid when he creates it with the consent of the owner, in ownership of goods or the documents of title to goods. It will be valid only if the Pawnee acts in good faith and has not at the time of the pledge notice that the Pawnor has not the authority to do the pledge. 
2. Pledge made by a vendor or purchaser in possession after sale: Pledge made by a vendor left in the security of goods after the sale and a purchaser who obtains temporary ownership of goods before the sale is valid when they take the consent of the seller before the sale provided the Pawnee acts in good faith and has no notice of the previous sale of goods to the buyer or of the lien[2] of the seller over the goods.
3. Pledge where Pawnor has a restricted interest: The pledge between a Pawnor having restricted interest and Pawnee can only be legally correct if during the pledge the Pawnee did not act in bad faith and does not know about the subject of the goods. A person having alien over the goods or a finder of goods may pledge them to the extent of the interest.
4. Pledge by the other owner in possession: The pledge by the co-owners in possession can be valid only if they have the consent or assent of the other co-owners in possession.
5. Pledge by the one to possession under a voidable contract: Where a person has obtained the possession of the goods under a voidable contract. The pledge thus created might be valid provided the contract has not be revoked before the contract of pledge and the Pawnee acts in good faith and without the notice of the Pawnor’s defect of the title.

Important Differences

Pledge vs Mortgage

Serial No.	Basics	Pledge	Mortgage
1)	Definition	It is the bailment of some personal possession as security for some engagement.	A legal contract by a bank or a building society, etc lends money in return for taking title of debtor’s property.
2)	Kind of Security	Movable	Immovable
3)	Possession of the goods/security	The possession remains with the pledgee.	The possession usually remains with the borrower.

Pledge vs Lien

Serial No.	Basics	Pledge	Lien
1)	Definition	Something held as security on a contract, a promise in order to discharge a debt is known as Pledge.	Lien is a form of security interest granted over an item of property to secure the payment of the debt.
2)	Contract	For a pledge to exist there should be a contract between the parties.	No contract as such is required in Lien.
3)	Sale of asset	In pledge, the parties have the right to sell.	But a lien holder can only hold goods till payment. He has no right to sell the asset.
4)	Sue	The parties in a pledge has the right to sue each other.	In the case of lien, neither of the parties can approach the court.

Pledge vs Bailment

Serial No.	Basics	Pledge	Bailment
1)	Definition	It is the delivery of an asset or goods as security for the payment of debt.	It is the delivery of goods for a special purpose.
2)	Section involved	It is defined under Section 172 of the ICA, 1972.	It is defined under Section 148 of the ICA,1972.
3)	People involved	There is a pawnor, the one who delivers the pledged goods, and a pawnee who receives the delivery of such goods.	There is a bailor who delivers the bailed goods and a bailee is the person who receives them
4)	Remedy on default	If there’s a default on the payment then the pawnee may sell the goods.	On default, the bailee may either retain the goods or sell them.
5)	Consideration	There should be a consideration in the pledge.	There may or may not be any consideration.

Case Laws

State Bank of Saurastra v. Chitranjan Rangnath Raja and Anr.[3]

In this case, the bank was the Pawnee. The Pawnor who was the defendant
had bailed his 5000 tins of groundnut oil as security against the amount of Rs. 75000. But then, the defendant died following the bailed goods of the defendant were lost from the possession of the bank. “Later, after the given time limit, the bank filed a case against the defendant for the repayment of the amount. The bank had then stated that, as the bank is the Pawnee, they have the right to get their money back, but because they lost the goods of the plaintiff whose market value is Rs. 75000, that makes their liability zero towards the defendant. Thus the petition got dismissed.”

Lallan Prasad vs Rehmat Ali [4]

The judgment by the Supreme Court was that ‘’there are two ingredients of a bond or a pledge. Firstly, the property which is pledged should be constructively delivered to the Pawnee. Secondly, that a Pawnee has to have only an extraordinary property in the pledge as long as the main possession remains in the name of the Pawnor and also that it completely returns to him on absolve of the debt. The right to property lies in the pledgee so far as is considered to secure the debt. ‘’

Raja K.V.S. Sundara Narasayyamma Garu vAndhra Bank Ltd [5]

Andhra Pradesh High Court had held that “pawnee should give to the pledgor a reasonable notice of sale before exercising the power of sale. It was also held that Section 176 of the Indian Contract Act, 1872 is obligatory and can’t be relinquished. The notice is mandatory. Also at the similar time of getting into the contract of pledge, the Pawnor does have the right to waive notice as it would not be parallel with the provisions of Section 176.”

Srinivasulu Naidu & others v Gajaraj Mehtra & Sons[6]

The notice which was served to the Pawnor by the Pawnee was not signed by the Pawnee or any other person authorized by him. The Madras High Court had held “that It is not compulsory for the Pawnee to sign the notice or authorize any other person to do it. Notice under Section 176 of the Indian Contract Act, 1872, is only a copy of the intention to sell hence the reasonable notice of sale is not required to have specification or date, time and place of sale.”

Conclusion

Hence pledge in the Indian Contract Act means there’s a Pawnee who transfers/pledges his own possession to the other person, known as Pawnor, as security against said the amount. They both have their own rights and duties towards each other for example, the Pawnor has an obligation to pay the agreed amount to the Pawnee while the Pawnee has a duty to act in good faith and take due and reasonable care of the goods and return them to the Pawnor. The duties of the Pawnor and Pawnee are the same as that of Bailor and Bailee one of the differences being  Bailment is for a purpose of any kind whereas Pledge is for the accomplishment of a set promise. , ie. Either the repayment of the debt or performance of that promise.

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References:

[1] H.KSaharay, Dutt on Contract, p.873(11^th ed 2013), http://www.legalserviceindia.com

[2] F.E Perry & G. Klien, Dictionary of Banking, p.240 (3^rd ed 1988), http://www.legalserviceindia.com

[3] State Bank of Saurastra v. Chitranjan Rangnath Raja and Anr. 1980 AIR 1528

[4] Lallan Prasad vs Rehmat Ali AIR 1965 SC 1322

[5] Raja K.V.S. Sundara Narasayyamma Garu vAndhra Bank Ltd AIR 1960 AP 273

[6] Srinivasulu Naidu & others v Gajaraj Mehtra & Sons (1991) 1 All India Banking Law Judgments 195