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 pledgor (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).

A kind of bailment in which the goods are kept with the lender as security for the payment of a debt or fulfillment of the contract. There are two parties involved in the contract of pledge, i.e. pawnor, the one who pledges the asset and Pawnee, the one who grants a loan against collateral.

The title of goods remains with the Pawnor, but the possession of goods passes to the Pawnee. Deposit of goods with the lender is the precondition for the pledge. There can be actual or constructive possession of goods. It is the duty of the Pawnee, not to make unauthorized use of the pawnor’s goods and take reasonable care of the goods pledged.

In the case of the failure of payment by the borrower, the lender has the right to sell the asset held as collateral to recover the amount of the debt.

Examples of pledges are Gold /Jewellery Loans, Advance against goods,/stock,  Advances against National Saving Certificates etc


Hypothecation: It refers to a financial arrangement where the borrower borrows money by against the security of goods. Here goods mean movable property. In business parlance, hypothecation is defined as the charge created over the asset (usually inventories, debtors, etc.) for the repayment of debt of suppliers, creditors, and other parties.

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 remains 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].

Example of Hypothecation:

1) Vehicle loans (Auto/bike Loans) are the best example to understand the hypothecation. If an individual wish to purchase a car and doesn’t have sufficient funds to buy hard cash. He will surely approach the bank to get the vehicle loan. The bank will hypothecate the vehicle which is to be purchased and approve the loan.


Differences Between Pledge and Hypothecation

  1. The pledge is defined as the form of bailment in which goods are held as security for the payment of the debt or the performance of an obligation. Hypothecation is slightly different from the pledge, in which the collateral asset is not delivered to the lender.
  2. Parties to the contract of the pledge are the pawnor (borrower) and the Pawnee (lender) whereas in hypothecation the parties are hypothecator (borrower) and hypothecatee (lender).
  3. The pledge is defined in section 172 of the Indian Contract Act, 1872. On the other hand, Hypothecation is defined in Section 2 of Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002.
  4. In the pledge, the possession of the asset is transferred, but in the case of hypothecation, possession lies with the debtor only.
  5. In the pledge, when the borrower defaults in payment, the lender can exercise his right to sell the asset to recover the debt amount. Conversely, in hypothecation, the lender does not have the possession of goods so he can file a suit to realize his dues to take the possession first and then dispose of them.

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