Pledge, Pledgee and Pledgor in Business Law

What is Pledge?

The pledge is one of the varieties of bailment only. In this case, bailment of goods has been made as a security for payment for the debts or the performances of the promise. The person who bails is known as the pledger or pawnor and the person who receives the goods is known as the pawnee.

Characteristics of Pledge

Characterises of the pledge is as follows:

  • There must be a debt that is payable or a promise that has to be performed.
  • Goods must be the subject matter for the contract of the pledge.
  • The goods must be sent to the pawnee by physical delivery
  • Only possession is transferred in this case.

Pledge as a Special Kind of Bailment

According to Section 172, “a pledge is the bailment of goods as security for payment of a debt or performance of a promise. The person, who delivers the goods as security, is called the ‘pledgor’ and the person to whom the goods are so delivered is called the ‘pledgee’.”

The ownership remains with the pledgor. It is only a qualified property that passes to the pledgee. He acquires a special property and lien which is not of ordinary nature and so long as his loan is not repaid, no other creditor or ‘authority’ can take away the goods or their price. Thus, in Bank of Bihar v. State of Bihar and Ors. (1971)

Company Cases 591, where sugar pledged with the Bank was seized by the Government of Bihar, the Court ordered the State Government of Bihar to reimburse the bank for such amount as the Bank in the ordinary course would have realized by the sale of sugar seized.

Delivery Essential

A pledge is created only when the goods are delivered by the borrower to the lender or to someone on his behalf with the intention of their being treated as a security against the advance. Delivery of goods may, however, be actual or constructive.

It is constructive delivery where the key of a godown (in which the goods are kept) or documents of title to the goods are delivered. The owner of the goods can create a valid pledge by transferring to the creditor the documents of title relating to the goods.

Example: A businessman pledged a railway receipt to a bank, duly endorsed. Later he was declared bankrupt. The official assignee contended that the pledge of the railway receipt was not valid. Held, that the railway receipts in India are title to goods and that the pledge of the railway receipt to the bank, duly endorsed, constituted a valid pledge of the goods.

Similarly, where the goods continue to remain in the borrower’s possession but are agreed to be held as a ‘bailee’ on behalf of the pledgee and subject to the pledgee’s order, it amounts to constructive delivery and is a valid pledge.

Advantages of Pledge

To a creditor, the pledge is perhaps the most satisfactory mode of creating a charge on goods. It offers the following advantages:

  • The goods are in the possession of the creditor and therefore, in case the borrower makes a default in payment, they can be disposed of after reasonable notice.

  • Stocks cannot be manipulated as they are under the lender’s possession and control.

  • In the case of insolvency of the borrower, the lender can sell the goods and prove the balance of the debt, if any

  • There is hardly any possibility of the same goods being charged with some other party if actual possession of the goods is taken by the lender.

Pledge by Non-owners

The general rule is that it is the owner of the goods who can ordinarily create a valid pledge.

However, in the following cases, even a pledge by non-owners shall be valid in the following cases:

Pledge by a Mercantile Agent

Where a mercantile agent is, with the consent of the owner, in possession of goods or the documents of title to goods, any pledge made by him, when acting in the ordinary course of business of a mercantile agent, shall be as valid as if he were expressly authorized by the owner of the goods to make the same.

Such a pledge shall, however, be valid only if the pawnee acts in good faith and has not at the time of the pledge notice that the pawnor has no authority to pledge (Section178)

A ‘mercantile agent’ as per Section 2(9) of the Sale of Goods Act, 1930, means a mercantile agent having, in the customary course of business as such agent, authority either to sell goods or to consign goods for the purpose of sale or to buy goods or to raise money on the security of goods.

For a pledge by a mercantile agent to be valid the following conditions must be satisfied:

  • Good faith: The pledgee must have acted in good faith and must not have at the time of the pledge noticed that the pawnor had no authority to pledge the goods. The onus of proving both these facts rests upon the person disputing the validity of the pledge.

  • Acting in the ordinary course of business: The mercantile agent must have acted in the ordinary course of his business. Therefore, if he does the business outside his business premises or out of business hours, such a transaction would fall outside this section.

Pledge by Seller or Buyer in Possession After Sale

Pledge by seller or buyer in possession after sale Under Section 30 of the Sale of Goods Act, a seller left in possession of goods after the sale, and a buyer, who obtains possession of goods with the consent of the seller, before the sale, can create a valid pledge.

Once again, for the pledge to be valid the pledgee should have acted in good faith and without notice of the previous sale of goods to the buyer or of the lien of the seller over the goods.

Pledge by a Person in Possession Under a Voidable Contract (Section 178-a)

Where a person obtains possession of goods under a voidable contract the pledge created by him is valid provided: (a) the contract has not been rescinded before the contract of pledge and (b) the pawnee acts in good faith and without notice of the pawnor’s defect of title.

Pledge by Co-owner in Possession

One of several joint owners of goods in sole possession thereof with the consent of the rest may make a valid pledge of the goods.

Pledge by a Person Having Limited Interest (Section 179)

Where a person pledges goods in which he has only a limited interest, the pledge is valid to the extent of the interest. Thus, a pledgee may further pledge goods to the extent of the amount advanced thereon.

What is Pledgee?

According to Section 176 in case the pledgor fails to pay his debt or complete the performance of obligation at the stipulated time, the pledgee can exercise any of the following rights:

  • Bring a suit against the pledgor upon the default in the redemption of the debt or performance of promise and retain possession of goods pledged as collateral security; or

  • Sell the goods pledged on giving the pledgor a reasonable notice of sale. In case the goods pledged when sold do not fully meet the amount of the debt, the pledgee can proceed for the balance. If, on the other hand, there is any surplus, that has to be accounted for by the pledgor. Before the sale can be executed, reasonable notice must be given to the pledgor so that:

    • The pledgor may meet his obligation as a last chance;
    • He can supervise the sale to see that it fetches the right price.

Example: A trader pledged certain goods in favor of a bank. On default to return the loan, the bank sold the goods without giving a notice of sale to the trader as the loan agreement specifically excluded it.

Held, that such an exclusion clause is inconsistent with the provisions of the Act and as such void and unenforceable.

However, the sale made by the pledgee without giving reasonable notice to the pledgor is not void, i.e., cannot be set aside. The pledgee will be liable to the pledgor for the damages.

Pledgee Rights

In addition to the rights mentioned in Section 176, a pledgee has the following rights:

  • It is the duty of the pledgor to disclose any defects or faults in the goods pledged which are within his knowledge. Similarly, if the goods are of an abnormal character say, explosives, or fragile, the pledgee must be informed.

    In case the pledgor fails to inform such faults or abnormal character of the goods pledged, any damage as a result of non-disclosure shall have to be compensated by the pledgor.

  • The pledgee has a right to claim any damages suffered because of the defective title of the pledgor

  • A pledgee’s rights are not limited to his interests in the pledged goods. In case of injury to the goods or their deprivation by a third party, he would have all such remedies that the owner of the goods would have against them.

    In Morvi Mercantile Bank Ltd v. Union of India, the Supreme Court held that the bank (pledgee) was entitled to recover not only ₹20,000 – the amount due to it but the full value of the consignment, i.e., ₹35,000. However, the amount over and above his interest is to be held by him in trust for the pledgor.

  • Pawnee’s right of retainer [Section.173]: The Pawnee may retain the goods pledged, not only for payment of the debt or the performance of the promise but for the interest of the debt and all necessary expenses incurred by him in respect of the possession or for the preservation of the goods pledged.

    However, Section 174 provides that the Pawnee shall not, in the absence of a contract to that effect, retain the goods pledged for any debt or promise other than the debt or promise for which they are pledged; but a such contract, in the absence of anything to the contrary, shall be presumed in regard to subsequent advances made by the Pawnee.

  • A pledgee has a right to recover any extraordinary expenditure incurred for the preservation of the goods pledged ( Section 175).

Duties of Pledgee

The duties of the pledgee are as follows:

  • The pledgee is required to take as much care of the goods pledged to him as a person of ordinary prudence would, under similar circumstances, take off his own goods, of a similar nature.

  • The pledgee must not put the goods to unauthorized use.

  • The pledgee is bound to return the goods on payment of the debt.

  • Any accruals to the goods pledged to belong to the pledgor and should be delivered accordingly. Thus, if the security consists of equity shares and the company issues bonus shares to the equity
    shareholders, the bonus shares are the property of the pledgor and not the pledgee.

Duties of Pledgor

There are a number of duties of a pledgor. These are:

  • He must disclose to the pledgee any material faults or extraordinary risks in the goods to which the pledgee may be exposed.

  • He is responsible to meet any extraordinary expenditure incurred by the pledgee for the preservation of the goods.

  • Where the pledgee has exercised his right of sale of goods, any shortfall has to be made good by the pledgor.

  • He is liable for any loss caused to the pledgee because of defects in his (pledgor’s) title to the goods.

There are a number of rights of a pledgor. These are:

  • The pledgor has a right to claim back the security pledged on repayment of the debt with interest and other charges.

  • He has a right to receive a reasonable notice in case the pledgee intends to sell the goods, and in case he does not receive the notice he has a right to claim any damages that may result.

  • In case of a sale, the pledgor is entitled to receive from the pledgee any surplus that may remain with him after the debt is completely paid off.

  • The pledgor has a right to claim any accruals to the goods pledged.

  • If any loss is caused to the goods because of the mishandling or negligence on the part of the pledgee, the pledgor has a right to claim the same

Finder of Lost Goods

The finding is not owning. A finder of lost goods is treated as the bailee of the goods found as such and is charged with the responsibilities of a bailee, besides the responsibility of exercising reasonable efforts in finding the real owner.

However, he enjoys certain rights also. His rights are summed up here under.

Right to Retain the Goods

A finder of lost goods may retain the goods until he receives the compensation for money spent in preserving the goods and/or amount spent in finding the true owner. A finder, however, cannot sue for such compensation.

But where a specific reward has been offered by the owner for the return of the goods lost, the finder may sue for such reward and may retain the goods until he receives it.

Right to Sell

When a thing which is commonly the subject of sale is lost, if the owner cannot with reasonable diligence be found or if he refuses, upon demand, to pay the lawful charges of the finder, the finder may sell it,

  • when the thing is in danger of perishing or of losing the greater part of its value;
  • when the lawful charges of the finder in respect of the thing found, amount to two-thirds of its value
  • Clarkson, K., Miller, R., Jentz, G., & Cross, F. (2014). Business Law: Text and Cases (11th ed.).

  • Keenan, D., & Riches, S. (2007). Business law. Harlow: Pearson Longman.

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