Contract of Pledge under Indian Contract Act

A contract of pledge is one of the most important concepts in the law of contracts and commercial transactions. The practice of pledging movable goods as security is not only common among banks and financial institutions, but also in various business and personal finance settings across India. 

The Indian Contract Act, 1872, under Sections 172 to 181, provides the detailed framework for pledges, distinguishing them from simple bailment and safeguarding the rights of both the person giving the goods (pawnor) and the person receiving them as security (pawnee). 

Meaning and Definition of Pledge

Section 172 – Definition of Pledge

Section 172 of the Act states:
“The bailment of goods as security for payment of a debt or performance of a promise is called ‘pledge’. The bailor in this case is called the ‘pawnor’. The bailee is called the ‘pawnee’.”

• The key aspect is that the goods are delivered as security and not transferred absolutely.
• The contract of pledge is always for the security of a specific debt or promise.
• Example: If A borrows ₹50,000 from B and gives his gold chain to B as security, A is the pawnor, B is the pawnee, and the gold chain is the pledged good.

Essentials of a Valid Pledge

A contract of pledge must satisfy the general essentials of a valid contract (consent, consideration, lawful object, competence) and some additional special requirements:

Delivery of Possession

• Delivery can be actual (physical handing over), constructive (by means of documents of title), or even symbolic.
• There must be a transfer of possession, not just ownership.
• If no delivery is made, there is no valid pledge.

Case Law: Lallan Prasad v. Rahmat Ali (1967)

• Facts: The plaintiff loaned money to the defendant and claimed the goods were never delivered to him as agreed.
• Judgement: The Supreme Court held that delivery of possession is crucial; without delivery, no pledge exists. Since goods were not delivered, no valid pledge was created, and the plaintiff could not enforce a pledge.

Purpose: Security for Debt or Performance

The bailment must be for the purpose of securing a debt or fulfilling a promise. If the goods are bailed for any other reason (for repairs, storage), it is a simple bailment and not a pledge.

Return of Goods

After the debt is paid or the promise performed, the pawnee must return the goods to the pawnor.

Ownership Remains with Pawnor

The pawnor retains ownership rights; the pawnee gets only a right to retain and (if necessary) sell, but not use, the goods unless authorised.

Statutory Provisions: Sections 172 to 181

Let’s go through each relevant section of the Act:

Section 173 – Pawnee’s Right of Retainer

This section allows the pawnee to retain the pledged goods not only for the payment of the principal debt or promise but also for:

• Interest on the debt
• All necessary expenses incurred for the possession or preservation of the pledged goods

Illustration: If A pledges his jewellery to a bank for a loan, the bank can keep the jewellery until A pays back the loan, interest, and any storage or security charges.

Section 174 – Pawnee Not to Retain for Other Debts; Presumption for Subsequent Advances

• The pawnee cannot retain the goods for any other debt or promise, unless expressly agreed.
• However, if the pawnee has made subsequent advances to the pawnor, it is presumed (unless there is an agreement to the contrary) that the same goods stand as security for those advances as well.

Example: If B pledges his shares to a bank for one loan and later takes another loan from the same bank, the bank is presumed to have the right to retain the shares for both loans unless stated otherwise.

Section 175 – Pawnee’s Right to Extraordinary Expenses

• The pawnee is entitled to recover extraordinary expenses from the pawnor for preserving the goods, e.g., cost of repairs due to damage by flood or fire.
• However, the pawnee cannot retain the goods for non-payment of such extraordinary expenses; the right is only to recover the amount.

Section 176 – Pawnee’s Remedies on Default by Pawnor

If the pawnor defaults in payment or performance at the stipulated time, the pawnee has two remedies:

1. Sue the pawnor for the debt or promise and retain the pledged goods as collateral security, or
2. Sell the pledged goods after giving reasonable notice to the pawnor.

If the sale amount is less than the debt, the pawnor is still liable for the balance. If the sale fetches more, the pawnee must return the surplus to the pawnor.

Case Law: K.M. Hidayathulla v. Bank of India (2001)

• Facts: The petitioner pledged gold to the bank. He failed to repay, so the bank auctioned the gold after giving notice, but the suit limitation period had passed.
• Judgement: The Madras High Court held that the pawnee (bank) had two independent remedies: filing a suit or selling the goods. The expiry of the limitation period for the suit does not take away the right to sell, as long as proper notice is given.

Section 177 – Defaulting Pawnor’s Right to Redeem

If the pawnor fails to pay on time but the pawnee has not yet sold the goods, the pawnor can redeem the goods at any time before the sale by paying the debt, interest, and any expenses due to his default.

Section 178 – Pledge by Mercantile Agent

A mercantile agent (an agent in the ordinary business of buying and selling goods) in possession of the goods with the owner’s consent can make a valid pledge, as long as the pawnee acts in good faith and has no notice of the agent’s lack of authority.

Case Law: Morvi Mercantile Bank Ltd. v. Union of India (1965)

• Facts: A firm pledged railway receipts (documents of title) to a bank to secure a loan. Goods were lost in transit.
• Judgement: The Supreme Court held that the pledge of documents of title (railway receipts) is valid. The pawnee is considered to have special property rights and can sue for the full value of the goods, not just the loan amount.

Section 178A – Pledge by Person in Possession under Voidable Contract

If the pawnor obtained goods under a contract that is voidable (due to fraud, coercion, etc.) and pledges them before the contract is rescinded, the pawnee obtains good title if he acts in good faith and without notice of the pawnor’s defective title.

Section 179 – Pledge by Person with Limited Interest

If a person with only a limited interest in the goods (e.g., a tenant or finder) pledges them, the pledge is valid only to the extent of that interest.

Section 180 & 181 – Suits Against Wrongdoers and Apportionment of Relief

• If a third party wrongfully deprives the bailee of the use or possession of the goods, both bailor and bailee have a right to sue the wrongdoer.
• Any compensation or relief obtained is divided between bailor and bailee as per their respective interests.

Rights and Duties of the Pawnor and Pawnee

Duties of the Pawnor

• Pay the Debt and Interest: Must repay the debt with interest and necessary expenses to reclaim the goods.
• Compensate Expenses: Responsible for ordinary and extraordinary expenses incurred by the pawnee for preservation.
• Disclose Faults: Must reveal any defects or faults in the goods that could harm the pawnee.

Rights of the Pawnor

• Redeem Pledged Goods: Right to redeem goods at any time before the actual sale, even after default, by paying the required amount.
• Receive Surplus: Entitled to any surplus amount if the pawnee sells the goods and realises more than the owed amount.
• Profits from Goods: If pawnee earns profit from the goods (like rent), it must be returned to the pawnor.

Duties of the Pawnee

• Take Reasonable Care: Must look after the pledged goods as a prudent person would look after their own goods.
• Not Use Goods Unauthorisedly: Cannot use pledged goods without permission; unauthorised use makes the pawnee liable.
• Return Goods: Must return the goods after the debt is paid or the promise is fulfilled.
• Keep Goods Separate: Should not mix pledged goods with his own goods.

Rights of the Pawnee

• Right to Retain: Can retain goods until full payment of debt, interest, and preservation expenses.
• Right to Recover Extraordinary Expenses: Can claim, but not retain, goods for such expenses.
• Right to Sell: May sell goods if the pawnor defaults, after reasonable notice; surplus returned to pawnor, shortfall can be claimed from pawnor.
• Right Against Third Parties: Can sue a third party who wrongfully deprives him of possession.

Difference between Bailment and Pledge

Practical Examples of Pledge 

• Gold Loans: Individuals frequently pledge gold ornaments to banks or finance companies for loans.
• Pledge of Shares: Companies and individuals may pledge shares or securities as collateral for credit.
• Agricultural Produce: Farmers sometimes pledge crops or warehouse receipts for seasonal loans.

Conclusion

A contract of pledge is an effective and widely-used legal tool for securing debts or performance of promises. The Indian Contract Act, 1872, provides a comprehensive framework that protects both the pawnor and the pawnee, ensuring a fair and transparent process. It is important for both parties to be aware of their rights and duties and to comply with all statutory requirements to avoid disputes.

Researcher: Urvi Gupta, a student at Vivekananda Institute of Professional Studies, Pitampura, Delhi.

Author: Aishwarya Agrawal