Contract of pledge

Contract of pledge is a subset of a contract of bailment. Here, the goods bailed

are kept as a security for a debt or a performance of a promise. Pledge is
defined in Section 172 of the Indian Contract Act,1872 as “The bailment of
goods as security for payment of a debt or performance of a promise is called
‘pledge’. The bailor is in this case called the ‘pawnor’. The bailee is called
‘pawnee’.” It is covered under Chapter IX (Section 172- Section 181) of the
Indian Contract Act, 1872.

Essential features of a contract of pledge

A valid contract
Similar to the contract of bailment, all the basic essentials of a valid contract
should be present in a contract of pledge. Without these elements, the
contract will be void and won’t be enforceable in a court of law.

Delivery of possession
It is necessary that the possession of goods be delivered from the pawnor to
the pawnee. As mentioned in the definition, pledge is a bailment and this is
an essential element of bailment. The delivery can be either actual or
constructive. However, there might be exceptions where the possession
remains with the pawnor.

Ownership cannot be transferred

In the case of pledge, mere possession of the goods is transferred to the
pawnee. The pawnor of the goods is still the owner. The pawnee has
possession of the goods but has limited interest in the goods.

Security against debt

The goods must be pledged as security against an outstanding debt of the
pawnor. This outstanding debt can also be a promise for specific
performance.
Return of goods on repayment
Once the debtor the specific performance against which goods are pledged as
security is repaid or completed, the goods must be returned to the pawnor in
the manner specified by him.

Duties of the Pawnor and the Pawnee

Duties of the Pawnor:

To compensate expenses
The pawnor has the responsibility to compensate the pawnee for all the
ordinary and extraordinary expenses made by the pawnee in order to ensure
the well-being of the pledged goods.

To repay the entire amount due along with interest

The pawnor has to repay the amount which is due to the pawnee. This
amount is the total of the principal amount as well as any interest accrued on
that amount during the course of the contract.

To disclose all the faults in the goods

The pawnor before entering into a contract has to disclose all the faults in the
goods to the pawnee. If the pawnee incurs any loss later due to those faults,
the pawnor will be liable for those.

Duties of the Pawnee:

To take reasonable care of the goods

It is the pawnee’s responsibility to take care of the goods that are pledged.
The care taken by the pawnee must be just, fair and reasonable. It should be
as the pawnee took care of his personal belongings. If due to negligence of
the pawnee, the goods are damaged, he will be liable to compensate the
pawnor.

For example: If ‘A’ pledges his watch with ‘B’ for a sum of Rs. 100. Then ‘B’
must take reasonable care of A’s watch as if it is B’s own watch. The
condition of the watch should not deteriorate or be worse than at the time
when it was pledged.
To use the goods only for authorised purpose
The pawnee can use the goods pledged if only it is authorised by the pawnor.
If the goods are used for any purpose that is not authorised, the pawnee will
have to compensate the pawnor against the same.

For example: ‘A’ pledges his car with ‘B’. ‘A’ authorises ‘B’ to use the car for
his personal use. ‘B’ allows his cousin ‘C’ to drive the car and the car then
gets damaged. ‘B’ will have to compensate ‘A’ for the damages

To return the goods

As per the contract, once the amount against which the goods are pledged is
repaid, the goods must be returned to the pawnor. This return must be as
mentioned in the contract or as per the pawnor’s directions.

To return any profits arised from the goods

If at any time during the contract, the pawnee earns profit from the pledged
goods, the same shall be returned to the pawnor during the termination of
the contract.

Example: ‘X’ pledged his property with ‘Y’. The property was given on rent to
‘Z’. The rent received on the property must be returned to ‘X’.

To keep the goods separate

It is the pawnee’s duty to keep the pledged goods separate from his own
goods. If he mixes the pledged goods, all expenses to separate them will be
borne by the pawnee. If separating is not possible, the pawnee will be liable
for all the damages.

Rights of the Pawnor and the Pawnee

Rights of the Pawnor:

To redeem the goods

As per Section 177 of the Act, ”If a time is stipulated for the payment of the
debt, or performance of the promise, for which the pledge is made, and the
pawnor makes default in payment of the debt or performance of the promise
at the stipulated time, he may redeem the goods pledged at any subsequent
time before the actual sale of them, but he must, in that case, pay, in
addition, any expenses which have arisen from his default.”

For example: ‘A’ gave his watch to ‘B’ as a security against INR 800 that is
due. They agreed that the amount should be repaid within 1 month. If ‘A’
fails to do so, he can redeem his watch even after the expiry of the contract
given that ‘B’ has not yet sold the watch. However, if ‘B’ had to incur any
expenses to safekeep that watch, the same will have to be paid by ‘A’.

To get the goods back

Once the pawnor pays back the amount due along with the interest to the
pawnee, he has the right to get the goods back. After clearing the entire due
against which the goods were held as security, the pawnee cannot retain the
pledged goods.

Rights of the Pawnee:

To retain the goods

The pawnee has the right to retain the goods until the amount owed by the
pawnor is paid in full or the promise is completely performed. This amount
includes the expenses incurred by the pawnee as well as any interest accrued
on that amount. This is mentioned in Section 173 of the Act.

For example: ‘A’ pledged his house with a bank for a loan of INR 2,50,000.
The interest on the same was INR 10,000. The bank can retain the pledged
house until ‘A’ repays the entire amount along with the interest i.e. INR
2,60,000.

As per Section 174,”The pawnee shall not, in the absence of a contract to

that effect, retain the goods pledged for any debt or promise other than the
debt or promise for which they are pledged; but such contract, in the
absence of anything to the contrary, shall be presumed in regard to
subsequent advances made by the pawnee.’”

To get compensation for extraordinary expenses

It is implied that the pawnor will be liable to pay for all the necessary
expenses needed for the safekeeping of the goods. As per Section 175, if any
extraordinary expenses arise, the pawnor will only be liable for the same as
well. However, the pawnee cannot retain the goods for non-payment of such
expenses.
To sell the goods
As mentioned in Section 176, “If the pawnor makes default in payment of the
debt, or performance; at the stipulated time or the promise, in respect of
which the goods were pledged, the pawnee may bring a suit against the
pawnor upon the debt or promise, and retain the goods pledged as a
collateral security; or he may sell the thing pledged, on giving the pawnor
reasonable notice of the sale.” It is important to note that the pawnor must
be given proper and enough notice before selling the goods. It is further
mentioned, “If the proceeds of such sale are less than the amount due in
respect of the debt or promise, the pawnor is still liable to pay the balance. If
the proceeds of the sale are greater than the amount so due, the pawnee
shall pay over the surplus to the pawnor.”

For example: ‘X’ pledged his watch with ‘Y’ as security against INR 10,000.
‘X’ defaulted the payment even after enough notices. ‘Y’ went to sell his
watch. If the watch is sold above INR 10,000, the surplus amount must be
returned to ‘Y’. However, if the watch is sold for less, ‘X’ will still be liable for
the difference.

Relevant case laws

Lallan Prasad v. Rahmat Ali and Anr., 1996

Facts of the case

In this case, the plaintiff advanced INR 20,000 to the defendant against a
promissory note and a receipt. An agreement was signed by both the parties
where the defendant agreed to pledge his aeroscapes as collateral against his
debt. As per their agreement, the defendant had to deliver the aeroscapes to
the appellant and the goods would remain in his custody.

The plaintiff filed a lawsuit claiming that the above-mentioned goods were
never delivered to be in his custody and therefore, this agreement cannot be
considered as a contract of pledge. He claimed that he was entitled to
recover the amount loaned by him.

Issue involved in the case

1. Whether pledged goods were delivered in the plaintiff’s custody?

2. Was the plaintiff entitled to any compensation as he claimed that
there was no contract of pledge since the goods were not delivered?
Judgement of the Court
The judgement was in the favour of the defendant. It was held by the
Supreme Court that the pledged goods were delivered to the plaintiff. This
meant that this agreement did ripen into a contract of pledge. The Court also
stated that the plaintiff was not entitled to any compensation on his stance
that the goods were never pledged to him.

The Morvi Mercantile Bank Ltd. And Anr. v. Union of India,

1965

Facts of the case

In this case, a firm operating in Mumbai entrusted their goods worth INR
35,500 to Railways for its delivery to Delhi. The firm got their receipt for
these goods from the Railways. In order to get an advance of INR 20,000
from the plaintiff, the firm pledged these receipts as collateral for the same.

The goods were lost by the railways and they offered to compensate with
certain parcels to the plaintiff. The plaintiff rejected this and claimed that
those weren’t the goods that were pledged to them. The plaintiff, hence,
sued the railways to recover INR 35,500 against the value of goods pledged
to them including the damages.

Issues involved in the case

1. Whether railway receipts can be considered as valid goods under

contract of pledge?
2. Whether the plaintiff was the pawnee of the goods or the documents
of the good’s title?
3. Whether the plaintiff could sue for the entire value of the goods or
only what was advanced by him?

Judgement of the Court

The Supreme Court of India ruled in favour of the plaintiff. It was held that
railway receipts can be valid as goods under a contract of pledge. It was also
held that the plaintiff was the pawnee of the goods and not merely its
documents of title. It was stated that since the pawnee in a contract of
pledge has the authority as the owner of the goods, the plaintiff will be
allowed to sue for the entire value of the goods and not just the amount he
has advanced.
K. M. Hidayathulla v. the Bank of India, 2001

Facts of the case

In this case, on 10th December, 1993, the petitioner pledged certain gold
jewels with the respondent. These jewels were pledged against a certain
amount. The petitioner failed to repay the amount within the agreed time.
The bank held an auction for the jewels on 20th May, 1997 to recover the
debt. The petitioner claimed that as per Section 176, the bank had the right
to either file a suit against him for recovery or sell the jewels via an auction
after giving reasonable notice to the petitioner, however, it must have taken
place within the prescribed time for filing the suit.

Issues involved in the case

1. Whether any such condition was mentioned in Section 176 of the

Act?
2. Whether the pawnee could auction the goods after the prescribed
period?

Judgement of the Court

The judgement passed by the Madras High Court was in the favour of the
bank. It was held that the bank had two remedies; either to file a suit for
recovering the debt or selling the goods after reasonable notices to the
pawnor. It was found that there was no connection between the two
remedies. Merely because the period for filing a suit had passed, it did not
mean that the other alternatives could not be used. It was held that if the
pawnee resorted to any alternate course of sale, the prescribed period should
be extended for the same.

Difference between a contract of bailment

and pledge
Contracts of bailment and pledge are special types of contracts that are
regulated under the Indian Contract Act, 1872.

Contract of Point of Contract of

Bailment difference Pledge
 When certain
When certain
goods are
goods are
transferred
transferred
from one
from one
party to
party to
another as a
another for a
Meaning security
specific
against a
purpose, it is
debt, it is
called a
called a
contract of
contract of
bailment.
pledge.

It is covered It is covered
under under
Sections 148- Sections 172-
171 of the Provisions 179 of the
Indian Indian
Contract Act, Contract Act,
1872. 1872.

The sole
The sole
purpose for
purpose to
bailing the
enter into a
goods is for
contract of
the safe
Purpose pledge is for
custody of
security
the goods or
against a
repairs, at
debt.
most times.

The party The party

which bails which
the goods is pledges their
known as the goods is
‘bailor’ and Parties known as the
the party with ‘pawnor’ or
whom the the ‘pledger’
goods are and the party
bailed is which
known as the receives the
‘bailee’. goods is
known as the
‘pawnee’ or
the ‘pledgee’.

The presence The presence

of of
consideration consideration
Consideration
in a contract in a contract
of bailment is of pledge is
mandatory. mandatory.

The goods
The goods
cannot be
may be sold
sold by the
Right to sell by the
bailee in
pawnee or
such
the pledgee.
contracts.

The goods
can be used
by the bailee
The goods
only for
cannot be
specific
used by the
purposes Right to use
pawnee or
known to
the pledgee.
both the
parties or not
otherwise.