For hypothecated stocks the customer has the right to sell them or replace them (with similar goods)

but overall security value should remain intact and no permission is required. The borrower retains
ownership and possession of the collateral / stock, but the creditor has the right to seize possession if
the borrower defaults. By virtue of Letter of Hypothecation bank can take possession of the
hypothecated goods in case of default of the borrower.

1.1 PLEDGE
An arrangement in which the both the possession and right to sell an asset passes on to the creditor or
lender but not the title of the collateral security / asset is called as pledge.

Under the pledge arrangement borrower enters into a formal contract whereby he / she agrees to
deposit Goods / Documents (without transfer of title) with the Creditor on the condition that those will
be re-delivered to the depositor if the debt is repaid or can be sold by the creditor if the borrower
defaults. After recovery of dues from the sale proceeds, the surplus if any is paid back to the borrower.
Since the stock / goods are already under the bank’s physical possession, therefor in case of default
bank can easily sell the goods to recover its dues.

1.2 LIEN
Creditor's conditional right of ownership against a debtor's asset or property that bars its sale or transfer
without paying off the creditor. In a contractual arrangement, a lien is the right of a contracting-party to
take possession of a specific asset of the other contracting party, in case the contract is not performed
according to its terms. In simple words it is a security interest or legal right acquired in one's property by
a creditor. A lien generally stays in effect until the underlying obligation to the creditor is satisfied. If
the underlying obligation is not satisfied, the creditor may be able to take possession of the property
involved. In other words it is the right of a person in possession of the securities or goods of another
person to retain them until the owner discharges his debt or meets other obligations towards the
possessor.

If the customer fails to meet his /her obligation than the Banker can dispose-off the goods / securities
for recovery of debt after serving proper notice to them. Banks have a right of “General Lien” also which
they can apply towards recovery of the lent amount. Under this arrangement the bank’s usually do not
have the possession of the under lien security with them, but through the letter of lien and right to set-
off they can enforce their right. All liens are for a limited period, apply only to the asset or property that
forms part of an express or implied contract, and must be properly registered to be valid and
enforceable. In case of a default, the party holding the lien generally does not except in the case of a
special lien have an automatic right to seize and sell the asset or property, but must obtain a foreclosure
order after giving a reasonable notice to the debtor or obligor.

1.3 MORTGAGE
A legal agreement that conveys the conditional right of ownership on an asset or property by its owner
(the mortgagor) to a lender (the mortgagee) as security for a loan. The lender's security interest is
recorded in the register of title documents to make it public information, and is voided when the loan is
repaid in full. In other words it is the conveyance of interest in specific immovable property by the
borrower or third party (mortgagor) to the lender (mortgagee) as security for payment of debt, wherein
the physical Possession of Mortgaged property is not transferred to Bank

Virtually any legally owned property can be mortgaged, although real properties are usually mortgaged
to secure bank loans. When personal property (appliances, cars, jewelry, etc.) is mortgaged, it is called a
chattel mortgage. In case of equipment, real property, and vehicles, the right of possession and use of
the mortgaged item normally remains with the mortgagor but the mortgagee has the right to take its
possession at any time to protect his or her security interest. In practice, however, the courts generally
do not automatically enforce this right when it involves a dwelling house, and restrict it to a few specific
situations. To be legally enforceable, the mortgage must be for a definite period, and the mortgagor
must have the right of redemption on payment of the debt on or before the end of that period. The
document by which this arrangement is effected is called a mortgage deed, or just a mortgage.

In banking industry there are three main Types of Mortgages which are in current practice:

Registered Mortgage: is a transaction whereby the borrower executes a formal written instrument that
can be construed as a conveyance of their interest in land as security for a loan. The written instrument
is recorded in the land records as a conveyance or a lien against the land. If the loan is not repaid, the
lender can take possession of the land. If the loan is repaid, the rights granted to the lender under the
mortgage are extinguished and the lender must release their interest to clear the title to the land. In
many jurisdictions this is simply referred to as a mortgage or a deed of trust. Under full registered
mortgage, the amounts of registration fee and stamp duties paid are equal to the full loan amount and
the cost of this mortgage is on a higher side.

1. Equitable Mortgage: is an arrangement that involves borrowing money with the understanding
the borrower's land will secure the loan or some other situation where a lien on the owner's real
estate is implied by some credit arrangement. However, a formal mortgage document is not
executed and recorded in the land records. It can arise under different circumstances and can
also be referred to as an implied or constructive mortgage. A problem with equitable mortgages
is that there is no notice to the public in the land records in most cases and the property could
be sold without the loan being paid. Generally, if an equitable mortgage is not paid it must be
enforced in a court of equity by a court decree against the debtor. In equitable mortgage
process since there is no formal deed executed with revenue department therefore an
additional GPA is usually executed which enables bank to sell the property in case of default and
moreover a memorandum of deposit of title deeds is also got signed from the customer.

2. Token Registered Mortgage: this type of mortgage is very similar to the registered mortgage and
a proper deed is made between the bank and he customer. But the difference is that rather than
paying the stamp duties and registration fees on the full loan amount, payment for a token
amount (usually PKR 100,000/-) is done and the rest of amount is covered through equitable
mortgage. This type of mortgage is allowed under law for all the bankers so that the cost factor
can be minimized and borrowers are able to raise debt at a lower cost.

If a mortgage or charge, which requires registration under the Companies Ordinance 1984, is
not registered, it does not mean that the transaction is altogether void or the debt is not
recoverable. The only consequence is that the security created by the mortgage or charge
become void as against the liquidator and other creditors. The omission to register does not
 prejudice any contract or obligation for repayment of the money secured by the charge, and
where the charge becomes void for want of registration, the money secured by it immediately
becomes payable. It must, however, be noted that as against the company itself, so long as the
company does not go into liquidation, the mortgage or charge is good, and may be enforced

1.4 GUARANTEES
Guarantee (personal) is a legal document obligating a third party / Borrower called surety or guarantor,
to repay the debt if the borrower defaults. It is an Agreement that makes one liable for one's own or a
third party's debts or obligations. A personal guarantee signifies that the lender can lay claim to the
guarantor's assets in case of the borrower default. It is equivalent of a signed blank check without a
date. The lender is generally not required to seek repayment first from the obligor's assets before going
after guarantor's assets. The lender's actions are usually based on whose assets are easier to take
control of and sell. Once signed, a personal guarantee can only be cancelled by the lender.

As collateral a guarantee cannot be treated as dependable repayment source. It rather results in loss of
a good relationship when invoked.

a. Personal Joint & Several Guarantee: When two or more than two persons are entering into a
guarantee along with the principal lender such person (s) is usually referred to as a co-
guarantor. The liability under such guarantees is considered as joint and several. Joint liability
means that all the guarantors are each liable up to the full amount of the guaranteed debt.
Therefore, if one of the Guarantors died or disappeared or was declared bankrupt, the others
will remain fully liable for the entire amount of the guaranteed debt. Accordingly, the Lender
can pursue the remaining guarantors solely, the original borrower solely or all the guarantors
and borrowers for the full amount. It would then be a matter for the Guarantor who pays out
the full liability to seek reimbursement from the co-guarantor. Provided in personal capacity by
borrower, property owner, guarantor to secure bank’s credit.

b. Continuing Guarantee: Continuing guaranty refers to a guaranty in which the guarantor will not
be liable unless a specified event occurs. This guaranty relates to a future liability of the
guarantor under successive transactions that continue the guarantor’s liability, or from time to
time renews it, after it has been satisfied is called a continuing guaranty. A continuing guaranty
may be revoked at any time by the guarantor in respect to future transactions, unless there is a
continuing consideration as to the transactions that the guarantor does not give up. Sometimes
a Guarantee will specify a fixed amount but frequently the Guarantee is a “Continuing
Guarantee”. This means that even if the current debt, which you are guaranteeing is fully paid
off, the Guarantee will continue to exist unless expressly terminated by agreement with the
Lender to whom you have given the Guarantee. The default position is that the Guarantee will
continue to exist and if the Debtor, subsequently obtains fresh borrowings from the lender, then
effectively the Guarantee will continue to exist in respect of those new borrowings.

c. Corporate Guarantee: A guaranty to a lender that a loan will be repaid, guaranteed by a

company other than the one who took the loan. Typically, a larger company (often a parent
company or another related company) will make the guarantee on behalf of a smaller company
who may not be well known or have developed a relationship with the lender. Such guarantees
 are usually taken in case of group concerns and are provided by corporate entities for paying off
bank’s liabilities.

1.5 INDEMNITIES
An indemnity contract arises when one individual takes on the obligation to pay for any loss or damage
that has been or might be incurred by another individual. The right to indemnity and the duty to
indemnify ordinarily stem from a contractual agreement, which generally protects against liability, loss,
or damage. The concept of indemnity is based on a contractual agreement made between two parties,
in which one party agrees to pay for potential losses or damages caused by the other party.

Most bank Guarantees are not only a Guarantee, but they is also an Indemnity. An Indemnity is an
agreement by the Guarantor (Indemnifier) to pay the amount set out in the “Guarantee”, regardless of
whether the bank has demanded payment from the Debtor. In effect, this means that the Lender does
not have to bother to pursue the Debtor at all for the debt and can just decide at any time to seek
repayment of the full amount of the guaranteed debt from you.

Therefore, if the underlying loan agreement between the Debtor and the Lender was legally
unenforceable for whatever reason, the Guarantee executed, because it is also an Indemnity, will still be
enforceable in any event. This allows the Lender to recover the debt from borrower even if it’s not
legally entitled to recover it from the Debtor.

1.6 CHARGE
Charge means right of payment out of certain property. In a charge there is no transfer of interest or
property. It is a right over some tangible asset of the borrower. It is a legal transaction as result of which
the lender acquires certain rights over the property and the borrower is refrained from dealing in them.
In a charge there must be a notice to the subsequent transferees, otherwise the charge is not effective
as to the subsequent transferees.

As per 1882 transfer of property act “a charge is security for the payment of a debt or other obligation
that does not pass ‘title of the property’ or any right to its possession to the person to whom the charge
is given”. Charge creation is usually associated with registered companies and fixed and floating charges
are used to secure borrowing by a company. Charge on a company's assets must be registered with SECP
and may also need to be registered in some other way, e.g. a charge on land and buildings must also be
registered at the Land Registry.

1.6.1 Types of charge

As per their nature, there are broadly two main categories of charges:

1. Fixed Charge: A fixed charge is a mortgage on a specific fixed-asset (such as a piece of land,
building, machinery etc.) to secure the repayment of a loan. In this arrangement the asset is
assigned over to the creditor and the borrower would need the lender's permission to sell it.
The lender also registers a charge with the competent authority, against the asset which
remains in force until the loan is repaid. This is the most secure and specific type charge but with
a fixed charge the creditor do not has a lot of options to recover its debit if the security value
deteriorates drastically. But on the safer side the debtor is also extremely limited in disposing of
his assets under fixed charge.
 2. Floating Charge: A floating charge is a particular type of security/ mortgage on an asset that
changes in quantity from time to time (such as an inventory) to secure the payment of a loan.
The special nature of the floating charge is that the company can continue to use the assets and
can buy and sell them in the ordinary course of business. It can thus trade with its stock and sell
and replace plant and machinery, etc. without needing fresh consent from the mortgagee. The
charge is said to float over the assets charged, rather than fixing on any of them specifically.

If a default occurs, or the borrower goes into liquidation, the floating asset ‘freezes’ into its then current
state ‘crystallizing’ the floating charges into a fixed charge and making the lender a priority creditor.

Depending upon the security level / Rights, there are three types of Registered Charges:

I. First Exclusive Charge: First exclusive charge would mean that the creditor who had given credit
facilities to a debtor on the basis of a security of any type over which charge is created has an
exclusive right over the security over and above all other persons/ creditors(if any). This is a
legal right under which the owner of the first charge has the right to decide on what to do with
the property/ security if the borrower fails its obligation. In case of liquidation the liabilities of
the lender having first charge will be paid off prior to paying off liabilities of any other lender.

II. Paripassu Charge/ Joint Paripassu Charge: Paripassu is a Latin phrase that literally means "with
an equal step" or "on equal footing." It is sometimes translated as "ranking equally“. The term
paripassu charge is used when a number of banks / financial institutions lend to a borrower and
the banks / financial institutions agree that they shall share the charge on the security property.
In such an arrangement the proceeds of the security will be shared between the banks /
financial institutions in proportion to their outstanding liabilities.

III. Second/Inferior charge: A second (mortgage) Charge typically refers to a secured loan (or
mortgage) that is subordinate to another loan against the same property. Such charges are
inferior to all the charges defined earlier and banks usually create such charges only if the
borrower has ample amount of Assets to be charged against outstanding loans. The Banks
having second charge mortgage would receive repayments only when the banks having first
charge or joint paripassu charge have been paid off fully.

2 GUARANTEES
Guarantees are a very common form of security for all classes of borrowing. So far as borrowing for
business purposes is concerned, a bank frequently obtains a guarantee from company directors or major
shareholders. This is on the basis that they should be prepared to show faith in the business and in their
own business acumen by guaranteeing all or part of the debt. A guarantee is simply a promise by a third
party to repay the lender if the borrower fails to pay. There are three parties to a guarantee: • The
lender in whose favor the guarantee is granted • The guarantor who signs the deed • The borrower on
whose behalf the guarantee is given.
A guarantee is not a tangible security such as stocks and shares, or a life policy. It is a form of personal
security, totally dependent on the financial standing of the guarantor. Unless the guarantee is supported
by some other form of security (collateral security), it is only as strong as the person who grants it. So far
we have looked at security provided by borrowers for their own borrowing – direct security. We now
examine guarantees which are a third party security.