Loans and Advances

Unit 4
By
Dr Virupaksha Goud

Syllabus
Loan and advances against pledge- Hypothecation- Mortgage – Lien- Advances against goods-
Document to title to goods – Life insurance policies – Stock exchange securities-Fixed deposit
receipts –Book debts- Supply bills- Real estates – Advance against collateral securities

Types of Security against Loan from Banks and Financial Institution

Security in banking terms and specifically in relation to a bank loan refers to any asset on which
a charge is created by a bank in its favour; where any default occurs, i.e., the borrower (loan
taker) is not able to pay the loan amount back, and then this asset is the Bank’s refuge!

The Bank will utilize this asset on which it has a charge, in the manner(s) allowed by various
laws, and recover its dues. Thus Bank’s interests (the loan amount and interest on the loan) are
secured by creation of a charge on some assets which belong to the borrower – hence known as a
security.

Type of Charge Is created on Such as And the possession of the

asset is with
I. Mortgage Immovable Land and Building Borrower…i.e., the one who
Properties has taken the loan.

II. Pledge Movable Share Certificates/NSC Lender, i.e., the Bank =

goods or Certificates/Gold Pledgee
property jewelley
III. Movable Plant and Machinery/ Borrower.
Hypothecation goods or Automobiles Usually for car/vehicle
property loans…
IV. Lien Paper security Shares/Debentures/Mut
ual Funds/ Bonds
V. Personal Is nothing but By 3rd parties Like a guarantee
Liability personal
guarantee

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Pledge

Pledge is used when the lender (pledgee) takes actual possession of assets (i.e. certificates,
goods). Such securities or goods are movable securities. In this case the pledgee retains the
possession of the goods until the pledger (i.e. borrower) repays the entire debt amount. In case
there is default by the borrower, the pledgee has a right to sell the goods in his possession and
adjust its proceeds towards the amount due (i.e. principal and interest amount). Some examples
of pledge are Gold /Jeweler Loans, Advance against goods,/stock, Advances against National
Saving Certificates etc.

Hypothecation

Hypothecation is used for creating charge against the security of movable assets, but here the
possession of the security remains with the borrower itself. Thus, in case of default by the
borrower, the lender (i.e. to whom the goods / security has been hypothecated) will have to first
take possession of the security and then sell the same. The best example of this type of
arrangement is Car Loans. In this case Car / Vehicle remain with the borrower but the same is
hypothecated to the bank / financer. In case the borrower defaults, banks take possession of the
vehicle after giving notice and then sell the same and credit the proceeds to the loan account.
Other examples of this hypothecation are loans against stock and debtors. [Sometimes, borrowers
cheat the banker by partly selling goods hypothecated to bank and not keeping the desired
amount of stock of goods. In such cases, if bank feels that borrower is trying to cheat, then it can
convert hypothecation to pledge i.e. it takes over possession of the goods and keeps the same
under lock and key of the bank].

Mortgage

Mortgage: is used for creating charge against immovable property which includes land, buildings
or anything that is attached to the earth or permanently fastened to anything attached to the earth
(However, it does not include growing crops or grass as they can be easily detached from the
earth). The best example when mortgage is created is when someone takes a Housing Loan /
Home Loan. In this case house is mortgaged in favour of the bank / financer but remains in
possession of the borrower, which he uses for himself or even may give on rent.

There are two ways of mortgaging immovable property.

1. By an Equitable Mortgage
2. By a Registered/Legal Mortgage.

Equitable Mortgage
A mortgage by deposit of title deed is ordinarily called equitable mortgage. It can be created by
an agreement, expresser implied, that an equitable interest in the property shall pass to the

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mortgagee as security for a debt due or become due. Thus, an equitable mortgage may be
affected in the following ways.

1. A deposit of title deeds together with registered memorandum showing the object and
condition of deposit.
2. A simple deposit of title deeds with an intention to create a security thereon for the debt;
otherwise there is no equitable mortgage.
3. An acknowledgement of the title deeds is usually issued and sent to the mortgagor by
registered A.D. post.

Equitable mortgages accompanied by deposit of the title deeds do not require registration.
Sometimes, a memorandum in writing regarding the deposit of title deeds, is executed by the
borrower is required. It is the easiest and most economical, as it is created by a simple deposit of
original title deeds. Equitable mortgages are valid only if title deeds are deposit with bank’s
branch situated in a place which has been notified under the Transfer of Property Act or by the
Government.

Legal Mortgage

A legal mortgage may be defined as the creation by deed of a legal estate or interest in land as a
security for the payment of money due or to become due in favor of the person who takes the
security, subject to the mortgagor’s right to have the estate so created extinguished on repayment
of the loan with interest. Legal mortgage gives the banker rights against the property itself, quite
apart from any personal action against the borrower and there is no need to seek the co-operation
of mortgagor. Legal mortgage is a perfect form of security.

When legal mortgage is desired, mortgage deed is drawn up by bank’s legal adviser and is
executed on a stamped paper of appropriate value by the mortgagor and to register with the
Registration office. It should be noted that a mortgage given as security for a debt is not a sale of
the property.

ASSIGNMENT

An assignment constitutes an action taken with a contract. Assignment occurs when the owner
of a contract, known as the assignor, gives a contract to another party, known as the
assignee. The assignee assumes all responsibilities and benefits of the contract. When it comes
to loans, assignment can relate to life insurance policies and mortgage contract from one party to
another. Mortgages and other contracts sometimes contain provisions limiting or stipulating
conditions for assignment.

One example of assignment is 'transfer by the holder of a life insurance policy (the assignor) of
the benefits or proceeds of the policy to a lender (the assignee), as a collateral for a loan'. In
such case in the event of the death of the assignor, the assignee is paid first and the balance (if

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any) is paid to the policy's beneficiary. However, insurance policies other than life
insurance may not be used for this purpose.

LIEN
A lien is a form of security interest granted over an item of property to secure the payment of a
debt or performance of some other obligation. The owner of the property, who grants the lien, is
referred to as the lienee and the person who has the benefit of the lien is referred to as the lienor
or lien holder. In many countries, the term lien refers to a very specific type of security interest,
being a passive right to retain (but not sell) property until the debt or other obligation is
discharged. Liens Enable Creditors to Assert Rights over Property.

Types of Liens

Consensual
o Purchase-Money Security Liens
o Non-Purchase-Money Security Liens
Statutory
o Mechanic's Liens
o Tax Liens
Judgment

Consensual Liens Are Voluntary

As the name implies, consensual liens are those to which you voluntarily consent, as a result of a
loan or other advance of credit. The property purchased secures the buyer's obligation to pay for
the property. One common example is the residential mortgage: a home buyer consents to a bank
taking a security interest in the home when a mortgage is obtained. Similarly, a security interest
also is created when a car dealer arranges for financing for a car buyer.

There are two broad classes of consensual liens:

 Purchase-Money Security Interest Liens. Here, the creditor extends credit to the debtor
specifically for the purchase of the property that secures the debt. Examples include a
first mortgage on a home, a car loan, and situations in which the seller finances the
purchase of property, such as furniture, through a credit agreement.
 Non-Purchase-Money Security Interest Liens. Here, the debtor puts up property he or she
already owns as collateral for a loan. The loan proceeds are then used to pay expenses (or
perhaps to buy other property). Examples include a second mortgage (or refinancing of a
mortgage) on a home or a loan used to pay operating expenses with previously owned
office equipment put up as collateral.

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Both types of consensual liens are usually non-possessory. This means that the creditor does not
take or retain possession of the property; rather, the debtor takes, or retains, possession of the
property.

The other common types of liens are statutory liens and judgment liens.

Statutory and Judgment Liens Arise by Operation of Law

In addition to consensual liens, there are many different types of liens that creditors can use to
get at your assets to satisfy a debt. In certain circumstances, creditors obtain security interests by
the operation of state (or federal) laws. These liens include:

 Mechanic's Liens. This type of lien arises when a contractor or mechanic performs work
on property and is not paid. Examples include a contractor who installs a furnace in a
home, or an auto mechanic who performs repairs to a car. This lien is a security interest
in the property. If the owner tries to sell the property, the debtor will have a secured
interest in the portion of the proceeds needed to pay the debt. In addition, having a
mechanic's lien can delay or prevent the sale of real property until debt is satisfied and
the lien released.
 Tax Liens. This type of lien is placed against property by the local, state or federal
government, as authorized by statute, for delinquent taxes, including property, income
and estate taxes.

LOAN AGAINST PLEDGE OF GOODS OR DOCUMENT OF TITLE TO GOODS

Advances against goods are allowed to traders for their trading activities, to manufacturers and
producers for their requirements of raw materials etc and also to enable them to sell their
products at better prices. The account is to facilitate the borrower to hold on to the goods for a
short period, by creating a pledge in favour of the Bank. This is a type of account where the
credit for a specified period of time, generally for one year and release of goods are allowed any
number of times during the currency of the limit, within the limit/Drawing power. This limit
cannot be allowed to be operated by the borrower by issuance of cheques or by deposit of cash
and other instruments for collection.

Advances against goods are allowed on the basis of pledge or hypothecation of goods depending
upon the credit worthiness and the requirements of the borrower, keeping in mind that the
security by way of pledge, where possible and practical is always preferable to hypothecation.

Advances should not be made against goods which are not the sole property of the borrower or
where the borrower’s right to sell is restricted.

Pledge of goods means bailment of goods as security for payment of debt or performance of a
promise. This is a voluntary transfer of possession of goods. Delivery may be either physical or
constructive. Pledge is created when the actual possession of goods is transferred to the Bank as

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security or by any other means by which delivery is affected, as in the case of endorsement and
delivery of a document of title to the goods. About 2/3 of the total secured advances are
sanctioned by banks against the security of goods which include food articles, industrial raw
material plantation products, manufactured articles and minerals. Goods have many distinct
advantages over other forms of securities:

(i) They are easily realizable on account of their having a ready market.
(ii) Their value can easily be ascertained from the market.
(iii) They are tangible assets and, therefore, can be realized in case the necessity arises.
(iv) Loans against commodities are of a seasonal character. They are repaid before the
commencement of the next season. Therefore, there is no unnecessary locking up of
funds.
(v) In case of commodities which are used as necessaries of life, there is not much of
price fluctuations.

However, goods as ‘security’ have their own limitations.

(i) Effective supervision over goods may not be possible particularly when they are
hypothecated. Dishonest persons may cheat the banks.
(ii) Quality of goods is difficult to verify. The goods actually pledged may be quite
different than those which were promised to be pledged.
(iii) Goods deteriorate in quality with the passage of time. This results in erosion in
bank’s security.
(iv) Heavy transportation costs may have to be incurred for realizing the best possible
price for the goods.

Guidelines for Loan against titled Goods

1. While granting facilities on hypothecation basis, limited companies are preferred since
charges on the securities can be got registered with the Registrar of Companies.
Exceptions are made in case of borrowers who maintain good inventory control system.
2. When facilities are cash credit basis, It is necessary that the borrower should pass through
the cash credit account all his business dealings.
3. Advances against seasonal commodities should be got liquidated by the end of the
season.
4. The other instructions contained in the chapter on Advances against goods Manual of
advances should be followed.
5. Goods should be readily marketable and fast moving.
6. Easily perishable and inflammable goods should not be accepted.
7. The advances should be granted against the security of those goods in which the borrower
normally deals in.
8. Seasonal goods should not be retained for more than one year without sanction.

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 9. Goods whose quality and value cannot be easily determined should not be accepted
10. In the case of manufactured goods, Credit Manager should verify the manufacturers
invoices
11. While examining the invoices, it should be ensured that the goods are not held by the
borrower on consignment basis or that supplier has a charge either on the goods or on
their sale proceeds
12. License or permits for dealing, storing, transporting or handling the relative goods where
required from the concerned authorities should be held.

LIFE INSURANCE POLICIES

Life insurance is a contract between an insured (insurance policy holder) and an insurer or
assurer, where the insurer promises to pay a designated beneficiary a sum of money (the
"benefits") in exchange for a premium, upon the death of the insured person. Depending on the
contract, other events such as terminal illness or critical illness can also trigger payment. The
policy holder typically pays a premium, either regularly or as one lump sum.

Life-based contracts tend to fall into two major categories:

 Protection policies – designed to provide a benefit, typically a lump sum payment, in the
event of specified event. A common form of a protection policy design is term insurance.
 Investment policies – where the main objective is to facilitate the growth of capital by
regular or single premiums. Common forms are whole life, endowment policies and
ULIPs

Given below are the basic types of life insurance policies. All other life insurance policies are
built around these basic insurance policies by combination of various other features.

Term Insurance Policy

 A term insurance policy is a pure risk cover policy that protects the person insured for a
specific period of time. In such type of a life insurance policy, a fixed sum of money
called the sum assured is paid to the beneficiaries (family) if the policyholder expires
within the policy term. For instance, if a person buys a Rs 2 lakh policy for 15 years, his
family is entitled to the sum of Rs 2 lakh if he dies within that 15-year period.
 If the policy holder survives the 15-year period, the premiums paid are not returned back.
The advantage, apart from the financial security for an individual’s family is that the
premiums paid are exempt from tax.
 These insurance policies are designed to provide 100 per cent risk cover and hence they
do not have any additional charges other than the basic ones. This makes premiums paid
under such life insurance policies the lowest in the life insurance category.

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Whole Life Policy

 A whole life policy covers a policyholder against death, throughout his life term. The
advantage that an individual gets when he / she opts for a whole life policy is that the
validity of this life insurance policy is not defined and hence the individual enjoys the life
cover throughout his or her life.
 Under this life insurance policy, the policyholder pays regular premiums until his death,
upon which the corpus is paid to the family. The policy does not expire till the time any
unfortunate event occurs with the individual.
 Increasingly, whole life policies are being combined with other insurance products to
address a variety of needs such as retirement planning, etc.
 Premiums paid under the whole life policies are tax exempt.

Endowment Policy

 Combining risk cover with financial savings, endowment policies are among the popular
life insurance policies.
 Policy holders benefit in two ways from a pure endowment insurance policy. In case of
death during the tenure, the beneficiary gets the sum assured. If the individual survives
the policy tenure, he gets back the premiums paid with other investment returns and
benefits like bonuses.
 In addition to the basic policy, insurers offer various benefits such as double endowment
and marriage/ education endowment plans.
 The concept of providing the customers with better returns has been gaining importance
in recent times. Hence, insurance companies have been coming out with new and better
ULIP versions of endowment policies. Under such life insurance policies the customers
are also provided with an option of investing their premiums into the markets, depending
on their risk appetite, using various fund options provided by the insurer, these life
insurance policies help the customer profit from rising markets.
 The premiums paid and the returns accumulated through pure endowment policies and
their ULIP variants are tax exempt.

Money Back Policy

 This life insurance policy is favoured by many people because it gives periodic payments
during the term of policy. In other words, a portion of the sum assured is paid out at
regular intervals. If the policy holder survives the term, he gets the balance sum assured.
 In case of death during the policy term, the beneficiary gets the full sum assured.
 New ULIP versions of money back policies are also being offered by various life
insurers.
 The premiums paid and the returns accumulated though a money back policy or its ULIP
variants are tax exempt.

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ULIPs

 ULIPs are market-linked life insurance products that provide a combination of life cover
and wealth creation options.
 A part of the amount that people invest in a ULIP goes toward providing life cover, while
the rest is invested in the equity and debt instruments for maximising returns. .
 ULIPs provide the flexibility of choosing from a variety of fund options depending on the
customers risk appetite. One can opt from aggressive funds (invested largely in the equity
market with the objective of high capital appreciation) to conservative funds (invested in
debt markets, cash, bank deposits and other instruments, with the aim of preserving
capital while providing steady returns).
 ULIPs can be useful for achieving various long-term financial goals such as planning for
retirement, child’s education, marriage etc.

Annuities and Pension

 In these types of life insurance policies, the insurer agrees to pay the insured a stipulated
sum of money periodically. The purpose of an annuity is to protect against financial risks
as well as provide money in the form of pension at regular intervals.

Loan against Insurance Policies

Loans against life insurance policy are becoming a popular choice for customers, since a lower
rate of interest is charged in comparison to a personal loan. One additional benefit of loans
against life insurance policy is that the policy value does not change with the market as in the
case of loans against gold or shares.

Features of Loan against Insurance

 Term insurance policies are not eligible for any loans

 The loan amount is a percentage of its surrender value. Loans can be up to 85-90%
against traditional plans with guaranteed returns.
 The policy is assigned to the lender. This means that all rights of the policy are
transferred to the lender, and the loan is sanctioned to the borrower thereafter.
 Banks link the rate of interest with their base rate, in most instances. Since banks
consider loans of this nature like an overdraft facility against pledging of the insurance
policy.
 Upon taking a loan against a life insurance policy, policyholders need to continue paying
premiums.
 The loan should be repaid during the term of the policy. The policyholder has the option
of either paying back the principal along with interest or only the interest amount.

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LOAN AGAINST STOCK EXCHANGE SECURITIES

Shares of public limited companies are one of the popular types of security accepted by
commercial banks for lending. Advancing against stock exchange securities involves the
important task of proper selection. All securities are not worth accepting. The bank must advance
only against approved shares quoted on stock exchange.

Those securities which are dealt in on the stock exchanges are known as quoted and those which
are not dealt in on stock exchanges are known as unquoted securities.

Banks usually prepare a list of approved shares against which they may consider financing. The
following precautions are taken in this rearward:

1. Selection of shares: The suitability of shares as security for bank advance depends upon their
price stability and easy marketability which in turn depend upon the success of the enterprise
which in turn depend upon the success of the enterprise which they represent. Bankers, therefore,
accept only those shares which they approve aft ere through screening and examination of all
aspects of company’s working. Generally a list of the approved securities is prepared after they
are satisfied as regards the following:

 The nature of the business of the company: The types of business activity, its importance
in the national economy, its future prospects and the company is being managed by
persons of proven competence, integrity and honesty, the banker can take it a plus point
for inclusion of the security in its approved list.

 The quality of the management: The quality of a security depends primarily upon the
competence and caliber of management. If the company is being managed by persons of
proven competence, integrity and honesty, the banker can take it a plus point for
inclusion of the security in its approved list.

 Past-working results: The pat performance of the company in terms of production, sales,
profits, dividends etc., can be suitable basis for performance of the company in future.
The various accounting ratios based on previous income statements and balance sheets
will help the bank in ascertaining the financial position of the company.

 Market trends in values of the shares of the company: The trends in value of the shares of
the company are indicators of the value of company’s shares in future. Securities cannot
be taken at their face or nominal values; it is the market value which is the relevant
factor, but sometimes market values may not be reliable; especially when they are
abnormally high or low. In such cases the banker will be required to arrive at his own
values by considering such variables as the present and the prospective yields, earning in
competing firms etc.

 Company’s financial reputation and its policy regarding the building up of reserves.

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2. Valuation of securities: After approving the securities offered by the customer, the banker
should ascertain their present market prices. The valuation of securities dealt on stock exchange
can be done on the basis of stock exchange quotations published in the daily newspapers and
financial periodicals. In case of shares which are transacted very rarely. The banker should ask
the secretary of the company to quote the price at which the last transaction took place.

3. Creation of charge over the securities: There are two ways of creating a charge on stock
exchanges securities, viz.
 By giving a legal title in favor of the banker.
 By creating an equitable title
Legal Title: In case of legal title the securities are transferred by the borrower to the bank when
either the banker or his nominee is registered as a shareholder in the books of the company. From
the bankers’ point of view transfer of legal title is very desirable but the borrower shows his
reluctance to do so because of the following reasons:

 The registration of transfer and re-transfer of the shares entails expenses which are
payable by the borrower himself.

 The reputation of the borrower is lowered down because the fact of charging security
becomes public.

 The borrower is deprived of voting and other rights attached to the securities for the
period they stand in the name of the bank. In case the borrower was holding directorship
of a company on the basis of these shares, he may lose that also.

Equitable Title: An equitable mortgage on shares is created when the customer deposits the
relevant share or stock certificates with the bank with an intention to create a charge. The
securities continue to stand in the borrower’s name in company’s records. The equitable charge
may be created by way of the following methods:

 By memorandum of deposit: A mere deposit of shares is not enough. The banker must
require a memorandum of deposit form the customer specifying purpose of such deposit
to make the equitable mortgage effective. The memorandum also authorizes the banker to
sell the securities, if the customer defaults in making payment or in maintaining the
required m aging as per terms of agreements. It also authorizes the banker to debit the
customer’s account with the amount that the banker might have to pay towards payment
of call on partly-paid hares deposited by the customer.

 By blank transfer: The customer may be required to deposit with the bank together with
blank transfer forms duly signed by him. In case of blank transfer the name of the
transferee is not filled in the form. The advantage of such a transfer is that the bank may
at any time fill its own name or that of any other person to whom it has sold the securities
for recovering the loan. The bank or such other person can get legal title to the securities

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 by sending the transfer form duly filled in together with securities to the company for
registration.

 By power of attorney: The bank may get executed form their customers in respect of
securities deposited, special powers of attorney either in its own favor or in favor of its
nominees. The power of attorney will empower the bank or its nominees to deal in the
securities so deposited on behalf of the customers. The power of attorney will protect the
banker form all possible risks.

Documents need for bank loan against shares

1. Application for advance

2. demand promissory Notes
3. Letter of continuity (in case of overdraft account)
4. Letter of General Lien
5. Original share scripts with blank transfer deeds signed by the shared holder duly
witnessed but undated 9if the shares are not transferred in the name of the bank).
6. Letter of guarantee (if the share stands in the name of persons other than borrower)
7. Irrevocable letter of mandate in duplicate for collection of dividend, bonus etc. addressed
to relative companies by the shareholder (a copy thereof should be sent to the company
concerned under cover of a forwarding letter).
8. Notice of pledge by the shareholder to the related companies.
9. Declaration regarding ownership, title and encumbrances of shares pledged.
10. In case of renewal of documents in addition to full set of documents, Letter of
Acknowledgement of Debt should be obtained.

LOAN AGAINST FIXED DEPOSIT RECEIPTS

A fixed deposit (FD) is a financial instrument provided by banks which provides investors with a
higher rate of interest than a regular savings account, until the given maturity date. It may or may
not require the creation of a separate account. Each depositor in a bank is insured up to a
maximum of Rs.1,00,000 (Rupees One Lakh) for both principal and interest amount held by
customer.

When you invest in a bank fixed deposit, you can easily get a loan against it without having to
break it. This is similar to a personal loan. However, the loan is structured as an overdraft facility
against your fixed deposits.

FEATURES

1. There is no specific tenure; you can avail of the loan till the deposit matures. If unpaid till
maturity, the loan is adjusted against the fixed deposit proceeds.
2. Banks offer a loan anywhere between 75 and 90 per cent of the deposit after maintaining
a 10-25 per cent margin. The latter may vary with each bank and every customer.

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 3. Interest will be charged on the amount drawn and not the limit set. It is around 2-2.5 per
cent over the fixed deposit rate
4. Advances against Bank’s deposits are granted by way of Overdraft or Loans.
5. Such advances should be normally made to depositors in whose names the deposits stand.
6. Advances to third parties against Banks Deposits can be made with due sanction of the
Authorities to whom powers are granted duly complying with the prescribed norms.
7. Deposits in the name of minors can be considered only for the benefit of minor depositors
and an undertaking letter to the effect that the amount of advance would be utilized for
the benefit of the minor should be obtained from the guardian.
8. The maximum duration may be from the date of advance to the date of maturity of the
deposit.
9. No. advance shall be made against the deposits belonging to a minor with guardian
appointed by a court without court order.
10. No. advance shall be made against deposits of other banks.
11. The interest rate chargeable in respect of advances shall depend upon the category of the
borrower and the purpose of the advance.
12. There are no prepayment penalties to foreclose the loan.
13. There is no restriction on the end use of funds. It can be used to meet financial
requirements, business, and direct investment in India or for buying property.
14. Salaried individuals cannot get tax benefits on the interest paid on loans against fixed
deposits. Self-employed individuals using the funds for the purpose of business can
deduct the interest paid as a business expense from their business income and pay tax on
the remaining amount only.

BANK LOAN AGAINST BOOK DEBTS

Sometimes a customer of a bank may seek bank loan against book debts which have either
become due or will accrue due in the near future. The customer may have to receive the money
from them for goods contract or will form a third party. While extending such facilities, the
terms of contract with the drawee companies should be studied to ensure that the period of credit
does not exceed 90 days generally. Though advances against book debts is now being classified
as secured advances (HOC 189/2000), there is a ceiling to be observed while exercising the
delegated powers.

The debt which the customer has to realize form debtors is assigned to the banker. The
established principle is that once the debt is assigned and the third party (i.e., the debtor) is given
notice of the assignment, he is under duty to pay the debt to the bank and not to the customer.

(Section 130 of the Transfer of Property Act 1882 permits the assignment of an actionable claim
to anyone except to a judge, a legal practitioner or an officer of the Court of Justice. According
to section 3 of the said Act, “actionable claim” means a claim to any debt or any beneficial

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interest in movable property not in the possession of the claimant which the Civil Courts
recognize as affording grounds for relief, whether such debt or beneficial interest be existent,
accruing, conditional or contingent.”)

A debt secured by mortgage of immovable property or by hypothecation or, pledge of movable

property, is not included in actionable claim. The person who assigns an actionable claim is
called the assignor and the person to whom it is assigned is called the assignee. Assignment of
debt may be with or without consideration.

Disadvantages of bank loan against book debts

1. Advances against book debt are not looked with favor by the banker. Because, this is,
after all, unsecured in nature and a clean advance, for its repayments entirely depends on
credit worthiness of the client. If the debtor refuses to pay, the bank will seek the legal
remedy for its recovery. The value of debts as a security is mainly dependent upon the
creditworthiness of the debtors of the customer.

2. The realization of book debts is not an easy job and is risky.

3. In the case of book debts, the banker is placed in the position of a debt collector.

4. If the book debts are subject to a prior charge or a counter-claim of the debtor, the banker
will not be able to get the full benefits of the book debts.

Books debts are, therefore, not accepted as main security but are taken as collateral security
along with the principal security.

Only where the debtors are solvent or, where the dues are form the government on contracts or,
in the case of debenture of a good company having a charge on the property or, where the
assignment is of money payable form a special fund, book debts are worthwhile for acceptance
by the bankers as security for advances.

Precautions and Checks

Book debts are furnished as security by assigning them to the bank. When the debtors are given
notice of such assignment, they become duty-bound to pay the money to the bank. When the
debtors are given notice of such assignment, they become duty-bound to pay the money to the
bank.
Even if the customer goes bankrupt, his trustees cannot deprive the bank of his right of claiming
the amount form the third party debtors. The banker should take the following precautions while
advancing on the security of a book debt.
Precautions and Checks
 Legal Assignments
 Notice in writing
 To acknowledge the notice

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 Notice of joint debtors
 Execution By limited company
 Future debt

1. The banker must enquire into the solvency of the debtor who owes money to the
customer. The bank should also check the validity of the debt.

2. Legal Assignment: The assignment of book debt must be effected by execution of an

instrument in writing signed by the transferor or his duly authorized agent, clearly
expressing his intention to transfer his interest in the debt to the assignee. He may pass an
order to his debtor to pay the assigned debt to the banker. If the debt is in the form of a
promissory note, the assignment must be made on the note itself.

3. Notice in Writing: The banker should give notice of assignment to the debtor. Notice of
assignment must contain particulars, such as, name of assignor, name of assignee and the
debt assigned. This is necessary to prevent the debtor form making payment of debt to the
customer. Non-service of notice does not render the assignment ineffective or invalid but
it is essential so as to make debtor liable to make payment to the assignee.

4. To acknowledge the notice: The debtor should be requested to acknowledge receipt of

notice and to confirm the debt. They should also be requested to furnish details of earlier
assignment, if any, and the right of set-off which they might have against the debt.

5. Notice of joint debtors: In order to bind all the debtors, it is necessary that notice should
be given to all joint debtors or point trustees and, if the debtor is dead, to all his executors
or administrators.

6. The borrower must authorize the bank to receive the debt of the party by executing a
power of Attorney in his behalf. An undertaking should also be obtained from the
borrower that money, if received by him from the debtor in respect of assigned debt, will
be paid to the banker.

7. The assignment should be of the whole debt and not of a part of it.

8. Execution by limited company: Where the assignment is executed by a limited

company, it must be registered with the Registrar of Joint Stock Company. Failure to get
such registration renders the charge void against the liquidator and any creditor of the
company.

9. After the assignment of debt, all rights and remedies of the transferor, whether by way of
damage or otherwise, shall vest in the transferee, and the latter may sue or institute
proceedings for the same in his own name against the debtor without obtaining the
transferor’s consent and without making him a party to the suit.

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 10. The assignment, however, does not entitle the assignee (i.e., the banker) better rights than
what the assignor had against the debtor. For example, if the debtor has a counter-claim
against the assignor, he continues to have the power to set-off such claim against the
amount due to the assignee.

11. The transferee of an actionable claim shall take it subject to all the liabilities and equities
to which transferor was subject in this respect at the date of transfer. (Section 132 of
transfer of Property Act, 1882).

12. Future Debt: Future debts may not be accepted as security. In contract of sale of goods
by installments or some construction contracts where the amounts are to be paid
according to the progress of the work, it is likely that the customer may not strictly carry
out the terms of contract and thus nothing becomes payable by the third party. Even if the
work has been properly carried out its quality may be disputed by the debtor.

Modes of Credit Facility

The facility of granting advance to customer against book debts can be given in two ways:

1. The customer sends the invoices and the sale documents to the bank. The bank examines
the documents and credits the account of the customer with the value of acceptable
invoices less margin. It returns the rest of invoices to the customers. The bank also keeps
the account of the debtors and on collecting money from them credits their account. The
borrower’s account is also credited with the balance of money collected by the bank
which was not credit originally on account of margin.

2. The borrower may send a list of eligible debtors to the bank. The bank after going
through list and satisfying itself regarding the validity of debts and solvency of debtors,
determines the amount of advance to be given after keeping sufficient margin.

Documents
1. Demand promissory Note
2. Letter of continuity (in case of overdraft account)
3. Legal assignment of debt
4. Power of attorney executed by borrower in favor of bank to receive debt of the borrower.

BANK LOAN AGAINST SUPPLY BILLS

You may sanction a bank loan against supply bills. Here we provide a detail procedure of bank
loan against supply bills. The Government, Semi-Government, Autonomous Bodies and
corporations are the largest purchasers of goods, articles or materials.

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Before effecting purchase of some goods and materials in bulk they call for tenders form the
enlisted contractors for supply. The tendered, whose tender has been accepted, enters into a
contract for supply of the contract. When supply is made he is entitled to receive payment there
against.

What is Supply Bills?

In this case the supplier dispatches the goods/materials through Rail (R/R), Steamer (S/R) or by
roads. Sometimes supply is made locally through challans.

When the supply is made by Railways or Steamer etc, the numbers and dates of the R/R’s, S/R’s
etc. are noted in their bills. Moreover, before dispatch of the goods they are inspected by an
official of the parties to whom the supply is made.

On being satisfied, these inspector issuers a note which is called an inspection note certifying
that the goods are as per terms of contract. After the goods have been supplied according to the
order, supplier draws a bill for the agreed value along with inspection notes.

Sometimes the supply is made locally when the receiving party, on receipt of the goods, signs
one copy of the challan signed by the receiver is called receipted challan. The bill for local
delivery is accompanied by receipted challan.

Similar, the contractor undertakes to perform a contract work for Government or Semi-
Government institutions as per latter’s specification. He also prepares bill on completion-part or
whole-of the contract and gets an inspection note from the concerned department certifying the
extent of work done by him.

These bills of the suppliers and the contractors are known as Supply Bills

The bills in both these cases are passed for payment by an appropriate authority after the goods
supplied or contract is completed wholly or practically as per terms and conditions of
supply/contract.

Normally, it takes some time to process a bill in the government or Semi-Government

departments and, hence, these suppliers/contractor s approach bank for accommodation to bridge
the gap form the date of supply to the date of payment by the departments. Advances are allowed
against the security of such bills on production of evidence of supply of goods or part/whole of
the completion of the contract work.

Procedure of Collection

The R/R, S/R or the bill of landing for the relative goods in sent director by the
supplier/contractor to the relative department and the bill for the amount is sent for collection
through banks empowering them either by a Power of Attorney or an endorsement on the bill to
receive payment from the concerned department.
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The bills are accompanied by inspection notes approving the quality and quantity of the goods
or, by the necessary receipted challans or, passing certificated indicating that the goods have
been actually received and accepted by the government department.

For evidencing the supply of goods, the bill should contain the number of R/R, S/R or bill of
landing sent to the concerned department. In case of contract work, inspection note from the
concerned department certifying the extent of work done by the contraction is accompanied.

Precautions and Checks

1. Advances against supply bills require careful handling and, slight negligence may involve
the lending bank is an irreparable loss. Advances against supply bills should, therefore,
be confined to first class parties who are not only honest and reliable but also have
enough business experiences and familiarity with the working of ht government
departments concerned.

2. The original contract which authorizes the contractor to supply goods to the Government
should be scrutinized and attested copy thereof is to be kept in the bank’s file. This will
give the banker and idea of the amount and size of the transactions, the period within
which the goods have to be supplied/contract completed, the rates accepted by the
department and other terms of the contract. A strict compliance by the borrower of these
conditions will be necessary.

3. An irrevocable Power of Attorney should be executed by the borrower in favor of the

bank and the same should be registered with the particular department authorizing the
bank to receive payment on behalf of contractors/suppliers in all cases whether the bills is
sent directly to the purchaser or thorough the bank. Usually, while registering the power
of attorney, the Government absolves itself of any responsibility in case the amount of
the bill is paid direct to the supplier. It does happen at times that the amount is
inadvertently sent direct to the supplier instead of the banker. The banker relies on the
integrity of the customer and also takes a formal letter from him with an undertaking to
pay to the banker any amount received by him direct form the Government.

4. The bill must be accompanied with the inspection notes or the receipted challans,
certifying approval, acceptance and receipt of the goods mentioned therein. The banker is
to see whether the bill has been drawn in conformity with the said note or challan. If not,
the bill should not be advanced against.

5. Each bill must be discharged by the drawer under the words “Received Payment” on
appropriate revenue stamp and a separate endorsement should be made to make payment
of the bill to the bank.

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 6. An appropriate margin-with a minimum of 25% depending on the creditworthiness of the
borrower, the nature of the transaction and the previous experience, if any, in this regard
should be maintained while advancing on the security of the interim bill.

7. All the papers relating to the bills including the covering letter sent by the bank should be
properly stamped with bank’s crossing and other stamps. the bills should then be
promptly forwarded by registered post with an acknowledgement-due to the respective
departments for payment together with a covering letter stating that the bank has made an
advance to the supplier/contractor against the bills and the proceeds of the bills should be
remitted to the bank direct.

8. There is every possibility of any bill being held-up for payment or rejected or refused.
There may be heavy deduction from the bill. It is also possible that forged bills are
offered for collection. In all these cases, only careful and constant follow-up can save a
banker. Banker is such case will press the borrower for reimbursement of the amount
advanced against unpaid bills. It is, therefore, more necessary that the banker should be
very cautious in the selection of parties and only those parties should be accommodated
who are reliable and of means for such type of work.

9. Bills remaining unpaid for two months or more are generally treated by the bank as
overdue bills under collection and the amounts advanced there against be recovered from
the borrower.

10. These supply bills are not covered by any tangible security and advance against them are
more or less clean advance. In view of the risky nature of such advance, banker should
demand some collateral or additional security from the borrower. It may be an equitable
mortgage of landed property or assignment of the insurance policies or personal
guarantee of a creditworthy person.

Documents required for bank loan against supply bills

1. Demand Promissory Note
2. Letter of continuity
3. Irrevocable power of Attorney executed by the borrower in favor of ht bank.
4. A letter of authority given by the borrower to the department concerned to receive
payment by the bank on behalf of the borrower.
5. Mortgage of property as collateral security.
6. Letter of guarantee from third party.

Some Major Disadvantages of Supply Bills

Disadvantages of supply bills

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 1. The collection of supply bills takes time and there mains the possibility about the undue
delay in getting payment form the government department due to procedural matter.

2. Supply bills are not bills of exchange. They do not, therefore, enjoy the legal status of
negotiable instruments; being not unconditional in character and neither the amount nor
the date of payment is certain. The security available to the bank in the case of advance
against supply bills is by way of assignment of debts represented by the supply bills. Here
the drawback is that despite the assignment of the debt of the bank, the department still
has a right of set-off against the supply bill amount for any amount due to it.

3. The debtor, usually the Government in this case, could pay the amount direct to the
creditor unless the assignment is registered with the debtor and the debtor undertakes to
pay the amount to the assignee only.

4. Since the goods are already supplied, the bank has no other security other that the supply
bill furnished by the contractor.

5. The amount claimed by the supplier/contractor may be reduced by the drawee for short
supply or defective supply or defective work.

6. The payment may be refuse if there be any defect or default on the part of the drawer in
observing the terms and conditions of the contract.

In case the sanctioning authority refuses, for any reason, to make payment of the bill the bank
will have no security except the personal security of the borrower.

LOAN ON REAL ESTATE PROPERTY

Though the proposals of Real Estate Property Developers and Builders will continue to be
regarded as low priority, proposals of such categories may be entertained subject to fulfilling the
eligible norms. Real estate is "property consisting of land and the buildings on it, the term ‘Real
estate’ indicates all types of immovable property which are attached or unattached to land or forming part
of land. Thus, it includes such tangible assets as land, buildings, factory premises, etc.

As a matter of policy, bankers have always been reluctant to make loans on the mortgage of real
estate. Here is the detail procedure of bank loan against real estate. One of the principles of
sound bank lending is that an advance should be salt-liquidating. Advances against immovable
property fail to achieve the objective of self-liquidity. Besides, the banker’s reluctance to accept
real estate as security is largely due to the following difficulties and legal complications.

 Title of the owner,

 Difficulty in valuation of property
 Legal formalities and time consuming
 Absence of ready realization

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Documents needed for bank loan against real estate

1. Application for advance

2. Demand promissory Note
3. Memorandum of deposit
4. Letter of lien
5. Letter of continuity (in case of overdraft)
6. Letter of guarantee (if the securities stand in the name of third party)
7. A declaration from the party that the security is the property of the borrower and free
from all encumbrances.

Major categories in India and the Asian Subcontinent

 Builder flats
 Villas
 Row Houses
 Lal Dora – Where people carry out commercial and residential activities both.

COLLATERAL SECURITIES

A collateral security is a security belonging to and deposited by borrower himself or by a third

party to secure loans and advances. Collateral security in a wider sense is used to denote any type
of security that runs parallel to or side by side with the personal right of action against a debtor in
respect of an advance.

Collateral security may be direct or indirect.

Collateral security obtained from the borrower himself to secure his own account is known as
direct collateral security. Advance against hypothecation of stock-in-trade which is considered a
weak security is strengthened by equitable mortgage of title deeds of house property of the
borrower.

Indirect collateral security means any form of security given by a third person to secure a
customer’s account. A guarantee is an indirect collateral security because it is given by one
person to secure another person’s indebtedness.

These collateral securities are advantageous from the banker’s standpoint because, in the case of
insolvency of the customer, the can prove for his whole amount of debt against the assets of the

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debtor and receive from the customer’s estate all he can in the course of distributing by the
official assigned, and thereafter fall back upon the collateral security for the deficiency.

The usual practice should be to obtain a memorandum of deposit of security in a proper form.
This is most essential because even thought in law such memorandum is not necessary, the
banker, by using it, protects himself by inserting in the clauses necessary for such protection.

The most significant categories of security lodged as cover are:

 Goods and commodities
 Fixed Deposit Receipt
 Real estate iv) stock exchange securities
 Life Insurance policies
 Gold and gold ornaments
 Documents of title to goods
 Book debts
 Supply bills.

Each of these properties is of different type and need to be dealt with differently. But it must be
clearly borne in mind that every form of security has its drawbacks, and there is nothing like an
absolutely perfect security.

Each has its own special merit, and it is all a question of comparative advantages and
disadvantages.

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