7 difference between Pledge and Hypothecation

Running a business  is no easy job. Entrepreneurs may face many sorts of problems. Moreover, we can face a cash crunch anytime. During economic slowdowns we often witness job losses. Reduced income can be quite challenging.A loan can be obtained in such cases of financial difficulty.  Loans are a very good way to manage our expenses in times of emergency. Financial institutions provide various types of loans. Generally, many financial institutions ask for collateral while approving loans. Collateral works as a security deposit. Firms use collateral to recover debt in cases of default. At times, borrowers also need to mortgage their assets to avail a loan. Any valuable entity, such as gold or real estate property can be mortgaged. 

One can also open trading account and use the securities owned through trading to get loans. Pledge and hypothecation are two of those. However, there are certain differences between the two.

What is Pledge

Section 172 of the Indian Contract Act  adopted in 1872 contains the definition of a pledge. It states that a pledge is a form of a contract where a pledger uses goods as security when they take out  a loan. A person or firm that pledges the goods is known as a “Pledger”, and the lender is called the “Pledgee”. The pledger can use the goods for repayment of the debt or for fulfilling a specific contract. In other words, pledges are a unique type of bailment  that entails keeping assets as promissory notes.

       A noteworthy point here is that the pledger delivers the concerned securities to the pledgee. Further, as per the Supreme Court’s direction, we can consider any kind of movable property owned by a borrower as  a pledge. For instance, investors can get securities if they open a trading account and start trading. These securities can be easily pledged to obtain a loan.

Hypothecation

Hypothecation is also a financial contract wherein a borrower receives money against the security of goods. However, the goods pledged by the borrower remain in the debtor’s  custody r or  even after the lender provides the loan amount. Here, we consider that the delivery of security is already complete. But in reality, the borrowers still possess the concerned securities. For instance, an individual opens a trading account and gets shares in a particular company. He can pledge the securities he has and get a loan, let’s say, for house renovation. Yet, the securities will remain in his possession only, and he can open a trading account to trade them at his will. 

       Failing the hypothecator to make the payments can lead to the transfer of possession to the lender. By selling these assets, the lender can adjust the debt. In addition, here, the rights of the two parties are as per the terms of the agreement mentioned in the contract. 

Key points of difference between Pledge and Hypothecation

Now that you must have understood the basic principles of pledge and hypothecation, let’s take a  glance at how they differ from one another. The working of both borrowing mechanisms outlines the differences, as discussed in earlier sections. Other points worth mentioning are as follows:

1. To begin, anyone considering taking out loans with valuables should be aware that the pledge and hypothecation are two distinct methods of borrowing money. However, these ways to take loans from financial institutions are  covered by  separate acts. Section 172 of the Indian Contract Act codifies the Pledge. On the other hand, the definition of Hypothecation is present in Section 2 of the SARFAESI act.

2. In a pledge, borrowers use  movable properties to provide their actual possession to the lenders. However, in hypothecation, firms grant loans without taking over the securities. So, if one opens a trading account and gets shares, he can use them to take a loan and trade them too.

3. The rights of a lender in hypothecation and pledge differ too. In the case of a pledge, a lender already has possession of securities or goods. So, he can sell them to adjust the loan amount if a borrower defaults. However, in hypothecation, the lender must first take possession of the property if the  loan defaults. 

3.In a pledge, possession of the property is with the lender or creditor. Whereas, in hypothecation, the borrower or debtor retains  possession of the property.

4. Pledge gives a lender the right to sell the property if a borrower defaults. However, in hypothecation, the lender will have to seize the property first.  Transactions can take place only after those funds have been recovered. 

5. A pledge’s legal document is known as a Deed of Pledge.A hypothecation agreement is required to use the facility.

6. The two parties in a  pledge are technically referred to as a pawnee and a pawnor.

7.The best  known example of a pledge is a gold loan. You might be already aware, gold loans are quite popular in India. On the contrary, loans such as a car loan come under the category of hypothecation. 

Conclusion

A pledge is a bailment in which a party or pledger keeps movable assets, such as securities, with the other party. Whereas hypothecation is a practise of banks or other financial institutions in which they create a charge on the borrowers’ properties.. There is no delivery of assets to lenders, and the borrower can continue to use them as usual. Borrowers are free to own the assets until they default on their debt repayment. Despite this stark contrast, both borrowing facilities accept movable properties, including financial securities like shares. 

 Individuals can open trading accounts with well-known firms such as Share India to buy securities, which they can use to take out  loans. It provides trading assistance so you can own good securities, which you can trade or use to take out  loans whenever required