Charge on pledge of assets

In India, out of the over 5000 listed companies, promoters of 4274 companies had pledged all or some of their shares, according to an analysis by Securities and Exchange Board of India as quoted in the RBI Financial Stability Report. Pledge of shares has increasingly become a common practice resorted to by the corporate world to raise finances.

Definition of Pledge

Section 172 of the Indian Contracts Act, 1872 defines a pledge as:

"The bailment of goods as security for payment of a debt or performance of a promise is called "pledge"." *(Section 172, Indian Contract Act, 1872). The bailor is referred to as the “pawnor/ pledgor” and the bailee as the “pawnee/ pledgee”. Bailment means delivery of goods by one to another for some purpose, upon a contract that they shall, when the purpose is accomplished, be returned or otherwise disposed of according to the directions of the person delivering the them.

In simple terms a pledge is a security created on movable goods of the borrower or pledgor for the payment of a debt wherein the lender or pledgee takes actual possession of the goods until the entire debt amount is repaid by the borrower. The pledgee may retain the goods pledged, not only for payment of the debt or the performance of the promise, but for the interests of the debt, and all necessary expenses incurred by him in respect to the possession or for the preservation of the goods pledged.

Distinction between Charge and Pledge:

According to the generally accepted definition, a ‘pledge’ is a bailment of personal property as security for some debt or engagement, redeemable on certain terms, and with an implied power of sale on default. It consists of a delivery of goods by a debtor to his creditor as security for a debt or other obligation, to be held until the debt is repaid along with interest or other obligation of the debtor is discharged, and then to be delivered back to the pledger, the title not being changed during the continuance of the pledge. Unlike a pledge, a ‘charge’ is not a transfer of property of one to another. It is a right created in favour of one, referred to as “the lender” in the immovable property of another, referred to as “the borrower”, as security for repayment of the loan and payment of interest on the terms and conditions contained in the loan documents evidencing charge. Both a pledge and a charge are the result of voluntary act of parties. Both create security but the nature of the security is different.

Meaning of Charge:

As stated in section 2(16) “charge” means an interest or lien created on the property or assets of a company or any of its undertakings or both as security and includes a mortgage;

As stated in section 78(1) It shall be the duty of every company creating a charge within or outside India, on its property or assets or any of its undertakings, whether tangible or otherwise, and situated in or outside India.

Whether there is need to create charge on pledge of securities?

Earlier there was a list of transaction on which charge was required to create. With the enactment of the Companies Act, 2013, tire list of charges requiring registration done away with. Thus, in the absence of a specific list of charges to be registered, and the wide definition of the word “charge”, ‘pledges’ and ‘liens’ were also required to be registered.

The companies creating pledge over shares are compulsorily required to register the charge, which was not the case with its predecessor. This is unfair, for example, there is absolutely no sanctity in registration of a pledge as a pledge is a possessory security interest and the asset is already with the lender. A pledge on movables neither creates an interest or a lien but rather is a special property.

i. If Company taking loan from the bank and pledge the shares of the promoters as security for such loan. Whether company need to create charge on such security:

-  As per definition of the Charge, Company need to create charge only on the assets of the Company, shares of the promoters are not the assets of the Company. Therefore, there is no need to create charge in this situation.

-  But for the precautionary measures Bank force to create a charge on the pledge of the shares of the promoters. It may be because of the variation of the value of the shares and Bank wants to secure its position. Hence we can say that to create a charge on the pledged shares of the Promoters is a mutual decision between the borrower and lender. But as per law it’s not mandatory.

ii. If Company taking loan from the bank and pledge the investments (share, Security, Bond) of the Company. Whether company need to create charge on such security.

-  Yes, Investments of the Company are assets of the Company and there is no exemption under CA-2013 for charge on pledge of securities. Therefore, in this situation Company need to create charge by filing of e-form CHG-1.

In the twenty First reports on the Companies Bill, 2009, the suggestion was made to the MCA for exclusion of creation of charge on pledge of shares be specifically excluded from registration requirements.

While replying to the above said suggestion, the Ministry in their written submission stated as follows: The provisions in the Bill propose to provide that every charge on the property of the company should be registered with the Registrar of Companies to enable Registry to have complete picture about solvency and creditworthiness of the company.

Hence from the above we can analyze that MCA is also very clear on the registration of every charge.

Other Condition:

Before a company proceeds with the creation of pledge, it must have the special resolution authorizing the creation of charge on the shares proposed to be pledged *[Section 180 (1) (a) of the Companies Act, 2013 (exempted for the Pvt. Ltd. Co.] and failure to do so will strike at the root of the transaction. Also, if a company other than parent company intends to offer pledge of shares as security in connection with any loan taken by another company, the former has ensure that the mischief of Section 185 of the Companies Act, 2013 is not attracted. 

Conclusion:

A charge in the nature of pledge of a movable property was a notable exception from such registration requirement under Companies Act, 1956. But there is no exception under CA-2013 for creation of charge. Therefore, Companies need to create charge on the pledge of shares also.