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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].
Pledged- The lender will have legal possession of the pledged asset, and the lender has the right to sell the asset in the event that the borrower is unable to meet his loan obligations.
In hypothecation, the asset remains in the possession of the borrower. In the event that the borrower is unable to make due payments on his loan obligations, the lender first has to take action to possess the said asset before they can be sold off to recover losses.
Difference Between Hypothecation and Pledge
Hypothecation is a way of creating a charge against the security of movable assets, which is much similar to pledge. However, pledge is a charge, which is defined by law whereas it is not so in the case of hypothecation. Under Section172 of the Indian Contract Act,1872: “Pledge is a contract where, by way of deposit of goods a security for a debt is created and the right to property vests in the pawnee so far as it is necessary to secure the debt.”
In case of pledge, the assets are in the custody of the lender, real or constructive, whereas in the case of hypothecation the assets are in the custody of the borrower.
Hypothecation is to be registered under Section 125 of the Indian Companies Act, 1956 when the hypothecator is a company, whereas no such provision exists in case of charges by way of pledge.
In hypothecation, goods are not kept under the lock and key of the banker. The borrower, however, will have to submit a stock statement at prescribed intervals as per terms of sanction to the bank. In addition to the fact that the bank does not have the physical possession of the goods under hypothecation, the fact remains that no statutory status is given to a hypothecation transaction. In this regard, it is, however, to be noted that hypothecation has a close link to floating charge. It must be noted that without the consent of the Bank, no person can utilize the hypothecated goods for his own benefit or sale by the borrower or any person connected thereto.
AGREE WITH Mr. Ayoub ANSWER
In Pledge, the assets are required to be legally mortgage in the name of financial institution while in hypothecation, the assets in shape of inventory is always required to be maintained and in equall or higher amount insurance is also required to be assigned.
I agree with Mr. Vinod answers colleagues and Mr. Ayoub
