Understanding Pledge In Contract Law

You might have come across a situation in life where you were in need of money, so you asked your friend to lend it to you. Your friend agrees to it on the condition that you will give something valuable in return. This kind of arrangement is called a pledge in contract law.

In pledge, as explained above, one person gives his property to another and uses it as a means to secure the repayment. Once the amount is paid back,the owner gets his property back.

However, many people are not aware of the pledge and its role in contract law. Don't worry!

In this article, we will understand everything about pledge, its rights, duties and obligations are available to the parties involved.Let's understand the legal nuances involved in pledge!

Pledge Under Indian Contract Act, 1872

Pledge in contract law is defined as a contract in which some goods are bailed as a security for a debt or performance of a promise. To bail goods means that the ownership of some goods is transferred to another person. So, pledge is a part of contract of bailment through which the title of goods is transferred to another. The purpose of it is to pay some loan or perform a promise.

Section 172 of the Indian Contract Act, 1872 (ICA) defines pledge, pawnor and pawnee.

Pledge: Pledge is a contractual setting where one person gives his goods as a security for payment of debt or performance of a promise.

Pawnor:The person who gives his goods as a security is called the pawnor.

Pawnee: The person to whom goods are delivered is called the pawnee.

Lets understand this concept with an example:

T borrows Rs. 10,000 from F and gives her gold watch as a security. Giving security ensures that T will pay back the amount and if he fails to pay, F can use the gold watch to get back his money. Here, T is the one who is baling his goods, so he becomes the pawnor. F is the one to whom goods are delivered, so he is the pawnee.

Essential Elements Of Pledge

As per the definitions of pledge, these are the essentials for it:

1. Valid contract

For any contract to be valid, it must be legal. This means that it should be entered between competent major parties, and the consideration should be legal. There is an offer made by one party which is accepted by another.

Also Read : How Do I Know If My Contract Is Valid?

2. Delivery of goods

The whole point of the pledge is that goods are delivered by the pawnor to the pawnee. So, delivery of goods is important. Delivery can be made in these two ways:

• Actual delivery: Actual delivery occurs when the goods are delivered physically from the pawnor to the pawnee.
• Constructive delivery: Where the physical possession of goods is absent while transferring goods, it is constructive delivery.

For example, If H has to pledge his house to P. H gives the key to his house to P, instead of physically delivering his house, which can be impossible. It is a form of constructive delivery of goods.

3. Security For Debt Or Performance Of Promise

We have understood that the goods are pledged as a security. It can be either to perform some obligation or pay off some loan.

4. Specific Property

The subject matter of pledge are goods that are capable of being delivered. Any existing goods, documents or valuable things can be pledged. It generally includes movable property. Some examples of it may be pledging of shares, insurance policies or receipts.

5. Agreement To Return The Goods

Pledge also requires an agreement between both the parties that when the amount is paid back, the goods will be returned to the owner. So, in the above example of T and F. When T pays back Rs. 10,000 to F, F will return his gold watch.

Types Of Pledge Agreements

Pledge agreements can be divided as follows:

1. Agreements to pawn: Here, the pawnor becomes the borrower of money who gives his goods to pawnee as a form of security for his loan.
2. Hypothecation: Hypothecation is when the borrower of money instead of giving goods to the pawnee keeps his goods with himself. But if in any case, default happens then pawnee can sell off the goods.
3. Lien of goods: Lien means retention of goods. In this agreement, the lender is allowed to give goods with him until the loan is paid back to him.
4. Security agreements: These are certain legal documents through property that are legally transferred to another person.

Rights And Duties Of The Pawnor And Pawnee

Pledge is a sub-contract of bailment. Similar to rights and duties in bailment, pledge also adds few rights and obligations for the parties.

Rights Of The Pawnor

• Right to redeem the goods: Section 177 of the Contract Act provides that pawnor can redeem his goods. This can be done when he pays back the money. This way, the ownership of goods is restored back to him.
• Right of inspecting goods: The pawnor also gets the right to inspect goods he pledged. He inspects to ensure that the pawnee is taking good care of his property.
• Right to be notified: When a pawnor commits any default or violates any term of the contract, he has the right to be notified about it. By notice, he is given a timely chance to rectify his mistakes.
• Right over the increased value of goods: If the value of goods increases in the time when goods are with the pawn, then the pawnor can claim that increased value of goods.

Rights Of The Pawnee

• Rights to retain goods: Section 173 of the Contract Act provides the pawnee the right to lien. A lien is a right where the pawnee can retain the goods with him as long as the amount due is not paid to him.
• Right to sell or dispose of goods: If the pawnor fails to perform the contractual duties, the pawnee can avail of this remedy. In such cases, he can sell or dispose of goods to get back the unpaid amount. This is provided under Section 176 of the Contract Act.
• Right to interest and cost: Pawnee can claim interest and cost on the outstanding amount. He can also claim a refund of the amount he spent while taking care of the goods pledged.

Duties Of The Pawnor

• Transferring ownership: The pawnor is required to transfer the goods to the pawn. It's his duty to physically provide custody of goods to the pawnee.
• Conferring title of goods: When the pawnor is transferring ownership of goods to the pawnee, he is basically implying that he has the right to give away these goods. This means that the goods are free from any claims by other persons, and the pawnor has legally transferred them to the pawn.
• Maintenance of goods: The goods are given as a security to the pawnee, so their exact state should be maintained. They should be protected as without these goods, there is no pledge between the parties.
• Providing compensation to the pawnee: The pawnor needs to compensate the pawnee for any extraordinary expenses he incurs to take care of the goods pledged.
• Disclose material information: The pawnor, while pledging goods, needs to be transparent if there are any defects in the goods. If the pawnee faces loss as he failed to communicate defects in goods, then it becomes the duty of pawnor to compensate for that as well.

Duties Of The Pawnee

• Managing goods: Pawnee received these goods as a security and he is under a duty to take care of these goods as if they are his own. He is expected to act with caution and protect these goods from any possible damage.
• Inspecting goods: To ensure transparency, the pawnee should inspect the goods when he receives them. He should maintain a record of when the pawnor comes to see the goods and check their condition afterward.
• Duty to not mix goods with his own: The pawnee is under an obligation not to mix the goods pledged with his own. If he mixes these goods, he is bound to compensate the pawnor.
• Duty when default occurs: If the pawnor commits any default, such as failing to pay back the amount, then the pawnee has to inform him about his default. In such cases, before the pawn takes any action, he has to give notice to the pawnor so that he gets a chance to fix his default.
• Using goods without authorization: The Pawnee has goods in possession, but he can't use the goods unless the pawnor authorizes it.

Also Read : Rights And Duties Of Pawnor And Pawnee

Legal Remedies For Breach Of Pledge

A pledge is a form of contract, so the same remedies that are available for breach of contract apply to pledge as well:

1. Right to sell goods: In case of default, the goods can be sold and the amount of loan can be recovered from it.
2. Right to lien: The pawnee has the right to retain goods if the pawnor commits any default.
3. Injunction: It is a court order through which the party is asked to stop any attempt to interfere with the property. It prevents parties from claiming the goods without taking the matter before the court.
4. Damages: If any party suffers loss whether due to damage of property or financial loss, the other party can claim damages.
5. Specific performance: In this remedy, if monetary compensation provided to a party is insufficient, it can ask the court for specific performance. It means that the party will be bound to perform their part of the contract.

Difference Between Pledge And Other Forms Of Security Agreements

Advantages And Disadvantages Of Pledge Agreements

Advantages

1. Pledge agreement is a secure and valid form of security for the creditors. Keeping goods as a security as per pledge agreements ensures that it is reliable and trustworthy.
2. These agreements are flexible which means that the term of security, amount of loan can be decided by the parties
3. Being a legal contract, in case of breach, there are legal remedies available for both the parties.
4. It gives easy access to money without having to sell the property.
5. It is an easier way to obtain loans in comparison to other forms of security.

Disadvantages

1. For exercising the rights of pledge agreements, the pawnee needs to have physical possession of goods. In case pawnor takes away his property by force or fraud, he is left with no remedy.
2. Properties are subject to depreciation. It means ta with time, their value starts to decrease.
3. If there are legal disputes on the title of property, it can create difficulty for the pawnee.

Practical Applications Of Pledge In Business Transactions

Pledge can be used in business transactions in the following way:

1. It can be used for bank loans. It is very common to pledge goods like gold or shares and get a loan from the bank.
2. In transactions of trade and commerce, goods are pledged as a security to get credit advances. For example: X is a businessman and he pledges his goods to a financier to get advance money.
3. There are pawnshops who function on the basis of pledge agreements. People pledge their goods and get loans in return. For example, H can pledge his watch to a pawn shop and get a loan in return.

Landmark Cases On pledge

State bank of India vs. Ghamandi Ram (1969)

In this case, the pawnor gave defective goods as security. Later, the court highlighted the duties of the pawnor and stated that he should disclose any defects in goods before he gives them to the pawnee.

Jaswantrai Manilal Akhaney vs. State of Bombay (1956)

This case covers the concept of rights of pawnee. This case led to the conclusion that as soon as the pawnor pays off his debt, he has the right to get his goods back. The pawnee loses right over it.

PTC India financial services ltd. vs. Venkateshwarlu Kari (2022)

The Supreme Court recently held that in case of default by pawnor, the pawnee can not sell the goods to himself. The facts are that V pledged some shares in favor of PTC. When the debt was unpaid, PTC sold the shares to itself. The court stated that the pledged goods can be sold only to third parties.

Conclusion

In Pledge in Contract Law, a pledge is a vital tool for securing loans while transferring the asset’s possession without complete ownership. Pledge agreements provide financial flexibility for borrowers and secured rights for lenders. Knowing the legal framework, rights, and obligations associated with pledge agreements can help businesses and individuals utilize this arrangement effectively.