Documentation against loan and advances

Document is a written statement of facts and a proof or evidence of existence of a particular transaction between parties involved thereto, to be answerable/liable on placement before a Court of Law for satisfaction of the charges created therein.

Importance of Documentation: Completion of required documentation formalities as per approved sanction letter before disbursement of a loan is necessary to protect the interest of the bank from any distress situation and also necessary for acknowledgement of the debt by the borrower. Correct documentation enables the banker to take legal recourse against the defaulting borrowers. The bankers deal with other peoples money which are repayable on demand. Naturally, the banker’s  prime consideration is the safety and liquidity of their depositor’s money. In case of  the borrower’s inability to repay the loan the banker must have some alternative tangible assets of the borrower to fall back upon to recover the loan. The banker, therefore, tries to create some sort of a charge on any other assets of the borrower in his favour. Such charge makes the asset charged available to the banker when needed in satisfaction of the advances made to him. Herein lies the role and importance played by different types of securities in loans and advances of a Bank.

TYPES OF DOCUMENTS:

Documents related to securing loans and advances are classified into the following two categories (a)  Charge Documents, and (b) Legal Documents:

a)           Charge documents are pre-formatted and printed forms provided by the Bank to the client for execution to create charge on the securities against loans and advances.

b)         Legal Documents are legal papers provided by the client certifying the legal status of the borrower, borrowing power, title to goods and property, legal deeds and power of attorney related to creation of charge on securities.

PARTS OF DOCUMENTATION:

Apparently there are three parts in documentation, namely :

☻        Obtaining instruments/Documents.

☻        Stamping.

☻        Execution and Registration.

EXECUTION OF DOCUMENTS:

Documents to be executed (signed) by the parties concerned competent to do so either in official capacity or in personal capacity as the case may be. In some cases such documents are required to be executed in presence of witness.

The following precautions are to be taken at the time of execution of documents:

a)         Documents to be filled in and are executed in the presence of the Manager or an authorised officer of the Bank. He must put his initial in pencil so that in future it can be ascertained in whose presence the documents were executed. He may have to depose in a Court in future.

b)         The client should sign in accordance with the specimen signature recorded with the Bank.

c)         If documents consist of more than one page, all the pages are to be signed by the executants at the end of the form and also at the end of the schedule of securities.

d)        Mention of date and place of execution in a document is mandatory.

e)         All documents must be duly filled-in before execution. Documents should not be kept blank except one extra set of Promissory Note and Letter of Continuity.            

f)          There should not be any cutting, overwriting, insertion, cancellation, or alteration in any document. If any such thing happens, it is to be authenticated by all the executants under their recorded signatures.

g)         After execution / Registration of documents, these should be entered into the Register (Safe custody Register for Loan Documents) duly scrutinized and initialed by an authorized officer of the Bank.

h)         Loan Disbursement of Credit facility should not be allowed before completion of documentation formalities.

Release of Securities:

No securities are to be returned to the borrower without approval of two authorised signatories one of which must be either Manager or Manager (Operations).

 BANKER’S RIGHT OF GENERAL LIEN:

Lien is the right of a creditor to retain goods/securities belonging to the debtor, till the debt is paid. Lien holder is in possession of the goods or securities but it does not give him the power of sale unless such a right is expressly conferred by the statute. This is possessory lien.

Possessory lien is of two kings: a) Particular Lien & (b) General Lien.

a)           Particular Lien: A particular lien is attached to some specific goods. It is a right to retain possession over particular goods in connection with which the debt arose.

b)           General Lien: General Lien means the right to retain all the goods of another in the possession of the person until all the claims of the possessor are satisfied. It entitles a person to retain possession of goods belonging to another not only for a particular charge but also for a general balance of the account. 

NO AGREEMENT FOR CREATION OF LIEN NECESSARY:

No agreement is necessary to create the right of lien, for under the law, such an agreement is implied by the terms of Section 171 of the Contract Act, 1872 so long as the same is not expressly excluded. But banks sometimes take a letter of lien to avoid future dispute. In order that the lien should arise (a) the property must come into the hands of the banker in his capacity as a banker, (b) there should be no entrustment for a special purpose inconsistent with the lien; (c) the possession of the property must be lawfully obtained in his capacity as a banker; (d) there should be no agreement inconsistent with the lien;

Negative Lien – This is an undertaking from the borrower that during currency of the loan, the assets/goods deposited against the loan shall not be charged in any manner without the banks permission.

WHY BANKER’S LIEN IS TREATED AS IMPLIED PLEDGE ? WHAT IS THE RIGHT OF BANKER ON THE GOODS PLACED UNDER HIS PLEDGE ?

Bankers are entitled to General Lien but it also goes a step further to realise the security of his customer in case of default. Banker’s lien is equal to implied pledge and can sell the security after reasonable notice to the debtor provided the property comes into the hands of the banker in the ordinary course of business. The right of lien can be exercised on goods or other securities standing in the name of the borrower only and not jointly with others. However, the banker’s right of lien is not applicable to the following properties of the customer viz. Safe custody deposits, bills of exchange or other documents entrusted for special purpose etc.

WHY IT IS SO IMPORTANT TO OBTAIN ACCEPTANCE FROM THE WORK ISSUING AUTHORITY REGARDING CLIENT’S ASSIGNMENT OF BILLS IN FAVOUR OF THE BANK ?

It is so important to obtain an acceptance from the Work Issuing Authority regarding client’s assignment of bills in favour of the bank because on assignment on any property, the assignee gets absolute control over it.

GIVE INSTANCES OF AT LEST TWO CASES OF CREDIT FACILITIES WHERE D.P. NOTE IS NOT OBTAINED ?

a)  Letter of Credit (L/C)

b)  Letter of Guarantee.

LAW OF LIMITATION:

The period of limitation for filing a suit for the recovery of money, lent under D.P. Note against the securities pledged/hypothecated is 3 years from the date of execution of the document. Even in case of temporary OD  the suit must be filed within 3 years from the date of the OD. To determine the period of limitation, the cases may be categorised as follows:

-           Where demand for repayment is necessary.

-           Where demand for repayment is not necessary (i.e. in case of advances where D.P. Notes have been obtained).

a)      In the first case the period of limitation does not begin to run until demand has been duly made.

b)      In the second case, the period of limitation begins to run from the date of the debt (i.e. from the date of borrowing/the date of execution of D.P. Note and documents).

The period of limitation within which a suit for recovery of the loans/advances lies, is the ordinary period of 3 (three) years from the date on which the advance was made:

a)         In case where the advance is made for a fixed period, the limitation period of 3 years begins to run from the date of expiry of the fixed period.

b)          For term loans payable in instalments, the limitation period is 3 years for each instalments, starting on the due date of each such instalments.

c)          The limitation period for mortgage is 12 years beginning on the date of the mortgage deed. This is applicable only for enforcing personal liability of the borrower, the suit must be filed within 3 years from the date of repayment of the Term Loan or the date of mortgage deed.

Generally, the bank takes equitable mortgage and in order to obtain a decree against the borrower personally (as for example, for attaching his other properties), the suit must be filed within 3 years of the date of the advance.

For extending the validity of the pro-note for further years, the following procedures are to be followed:

a)        A letter to be obtained from the borrower(s) acknowledging the liability before the expiry of the limitation period of three years on the basis of the pro-note taken earlier;

b)       Confirmation over appropriate Revenue Stamps of the balance of a particular date (Balance confirmation);

c)       Part payment of interest or principal, provided the deposit slip is signed by the borrower (maker of the Pro-note);

d)       A fresh pro-note duly signed by the borrower(s).

e)       If part payment is made by cheque before expiry of the limitation period, the limitation period is extended for a further period of 3 years from the date when the cheque was tendered and the debt does not get time barred even if the cheque is cashed after the expiry of limitations. But if the cheque is dishonoured, the period of limitation will not be extended, but such dishonoured cheque will give a fresh cause of action against the borrower.

PRIMARY AND COLLATERAL SECURITIES:

The securities tangible or intangible, that the banker advances against directly are treated as Primary Securities i.e. those securities are primary ones on the basis and valuation of which the advances are allowed. In case of a clean advance the borrower’s personal security becomes the primary security.

Collateral securities are obtained in addition to the primary securities to improve the overall security position of the advances and against which no drawing is allowed. A collateral security may be obtained from the borrower or from a third party by way of guarantee accompanied with the guarantor’s tangible securities as arranged for.

MORTGAGE:

A mortgage is the transfer of an interest in specific immovable property as a security for repayment of a debt. The banker is usually concerned with English mortgage or equitable mortgage or registered or legal mortgage for the purpose of making advances where the ownership of the property is transferred to he mortgagee by registration of the mortgage deed.

Normally, the possession of the property remains with the mortgagor who has a right to redeem the property on payment of the outstanding advances.

An officer responsible for completion of documentation must look into the following:

a) Registered Mortgage:

Before execution of mortgage deed either equitable or registered clearance from the Bank’s Legal Adviser/Retainer must be obtained that the property documents are in order and the mortgagor has the right title over the property with draft deed duly authenticated by the Legal Adviser/Retainer.

            In case of lease-hold property, permission from the appropriate authority must be obtained for execution of mortgage deed in favour of the Bank.

            After execution of mortgage deed in favour of the Bank in the office of the Sub-Registrar, officer concerned must ensure that the Delivery Receipt of the mortgage deed has been duly discharged (must agree with the signature given by the mortgagor in the mortgage deed) by the mortgagor  otherwise it will be difficult to collect the original mortgage deed from the Sub-Registrar’s Office.  

PLEDGE:

Pledge means bailment or delivery of goods or documents of title to goods by the borrower to the creditor with the intention of creating a charge thereon as security for debt. The ownership remains with the pledger subject to certain interests of the pledgee in the security concerned. In a pledge the debtor-customer delivers the possession of the securities to the banker and the banker holds the possession of securities until the debt is discharged.

This is the essence of a pledge which is a bailment of movable property by one person to another to secure repayment of the securities is held by the banker (pledgee) the ownership thereof lies with the debtor (pledger) who is entitled to return of the same upon repayment of the debt including interest and other expenses. If the debt remains unpaid the banker has a right of sale of the securities and can exercise this power with or without recourse to the court after giving a proper notice to the pledger.

Generally, goods, produces and other merchandises of bulky nature are stored in the borrower’s godown. Other securities namely stock exchange securities are stored in the bank’s own strong-room. Wherever the pledged securities are stored, the banker has to keep them under his lock and key and to maintain watch and ward. Also, the securities are required to be adequately covered by insurance against fire and R.S.D. risks.

All pledges should be accompanied by pledge letters or memorandum of deposits duly signed by the pledger. The pledger need duly receipt all deliveries made by the banker.

HYPOTHECATION:

Mortgage of movable property is called hypothecation. The securities remain in possession of the borrower and are only equitably charged to the banker under documents executed by him. The particulars of the securities and their quantities are declared by the borrower through periodical statements on the basis of which the drawings are regulated by the banker.

VALUATION OF SECURITIES:

The valuation of the primary securities are made by the banker conservatively and realistically so that at any time the forced sale value of the securities does not fall below the outstanding advance. It is usually done on the basis of the average ruling market prices of the securities and in case of imported goods, ruling market prices or landed cost whichever is lower.

WHAT IS A MARGIN AGAINST LOANS AND ADVANCES ? HOW DOES IT DIFFER FROM DRAWING POWER ?

Margin means the difference between the value of the securities/goods and the amount upto which the borrower is allowed to draw. The difference  between the market value of the pledged/hypothecated goods to secure a loan/advance and the amount of the loan/advance (normally the drawing power) is known as “MARGIN”. The value of the securities in excess of the banker’s advances is called the borrower’s “Margin”. Margin is obtained against loans and advances to cover the loss of value of the stock of goods due to price fluctuation, as well as accrued interest on the outstanding loans.

Drawing Power (D.P.) means the value of securities/goods less margin. Drawing power is the amount of advance which the client can draw from the bank against the sanctioned limit out of the total value of stock pledged/hypothecated while the margin is the portion of the value of stock pledged/hypothecated which is retained by the bank by way of deduction from the total value of stocks at the agreed percentage.

Md. Nahid Absar Emon