Money can be borrowed from a bank or financial institution in the form of loans, by keeping some asset as security, to provide assurance of repayment. The value of the security offered as collateral is either equivalent to or greater than the loan amount. The two most frequently confused terms in this regard are pledge and hypothecation. The reason for their distinction is that in pledge the possession of the asset passes to the lender with the movement of the asset, Conversely, there is no transfer of possession in case of hypothecation. Go through with this article once, to know the difference between pledge and hypothecation.
Content: Pledge Vs Hypothecation
|Basis for Comparison||Pledge||Hypothecation|
|Meaning||Bailment of goods as security against the debt for the performance of the obligation or the payment thereon, is known as the pledge.||Hypothecation is the pledging of goods, against the debt without delivering them to the lender.|
|Defined in||Section172 of Indian Contract Act, 1872||Section 2 of Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002|
|Possession of property||Remains with the creditor||Remains with the debtor|
|Parties||Pawnor and Pawnee||Hypothecator and Hypothecatee|
|Rights of lender in exceptional circumstances||To sale out the goods in his possession to adjust the debt.||To take to possession of the asset first, then it out to recover the debt.|
Definition of Pledge
A kind of bailment in which the goods are kept with the lender as security for the payment of a debt or fulfillment of the contract. There are two parties involved in the contract of pledge, i.e. pawnor, the one who pledges the asset and Pawnee, the one who grants a loan against collateral.
The Title of goods remains with the Pawnor, but the possession of goods passes to the Pawnee. Deposit of goods with the lender is the precondition for the pledge. There can be actual or constructive possession of goods. It is the duty of the Pawnee, not to make unauthorized use of the pawnor’s goods and take reasonable care of the goods pledged.
In the case of the failure of payment by the borrower, the lender has the right to sell the asset held as collateral to recover the amount of the debt.
Definition of Hypothecation
Hypothecation refers to a financial arrangement where the borrower borrows money by against the security of goods. Here goods mean movable property. In business parlance, hypothecation is defined as the charge created over the asset (usually inventories, debtors, etc.) for the repayment of debt of suppliers, creditors, and other parties.
In this arrangement, the asset is not delivered to the lender but kept by the borrower until he defaults in payment of debt. So the possession of asset belongs to the debtor only. There are two parties to hypothecation, where hypothecator is the borrower while hypothecatee is the lender. The right of the two parties depends on the agreement signed between them.
If the hypothecator fails to pay the amount, then firstly, the hypothecatee has to take the possession of the goods hypothecated. Thereafter, he can sell them off to adjust the amount of his loan.
Key Differences Between Pledge and Hypothecation
The significant differences between pledge and hypothecation are specified below:
- The pledge is defined as the form of bailment in which goods are held as security for the payment of the debt or the performance of an obligation. Hypothecation is slightly different from the pledge, in which the collateral asset is not delivered to the lender.
- The pledge is defined in section 172 of the Indian Contract Act, 1872. On the other hand, Hypothecation is defined in Section 2 of Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002.
- In the pledge, the possession of the asset is transferred, but in the case of hypothecation, possession lies with the debtor only.
- Parties to the contract of the pledge are pawnor (borrower) and Pawnee (lender) whereas in hypothecation the parties are hypothecator (borrower) and hypothecatee (lender).
- In the pledge, when the borrower default in payment, the lender can exercise his right to sell the asset to recover the debt amount. Conversely, in hypothecation, the lender does not have the possession of goods so he can file a suit to realize his dues to take the possession first and then disposing off them.
One of the simplest examples of pledge and hypothecation is Pledge – Many people take a loan from the moneylender by pledging their gold jewelry, against the debt. Hypothecation – Many people take loans from banks or financial institutions to purchase a car where the debt and the car ( the subject matter of the contract between lender and borrower) both remain with the borrower only.
The common of the two terms is that the subject matter is a movable asset. Similarly, the two ways are used in borrowing funds from the bank or financial institution. Collateral security act as an assurance to the lender that the borrower will repay the debt or, if the borrower fails to pay the outstanding dues the lender can forfeit the goods and dispose it off.