The people are always confused between Charge and Hypothecation which seems to be similar but in legal parlance holds two different grounds. For the simplification of these terms, this article will provide the legal background to both these terms and illustrates the usability of the same.
Charge
‘Charge’ is defined under Section 100 of the Transfer of Property Act, 1882. According to the said provision when a person by the means of the act of the parties or by operation of the law secures the immovable property for the payment of money to the other party, the said act of security upon the property would be called as ‘Charge’ and would not be called as ‘Mortgage’. The provision of the Simple Mortgage would be equally applied to the property secured as Charge.
A Charge can be created against both immovable and movable property. But for the charge against the immovable, the charge can be created on the current or future property of the owner. For the creation of charge, the essential prerequisite that the charge can only be created upon the immovable property only if the ownership lies in the hands of the person from whom the payment is due. There should be a clear intention that the party wants to charge his/ her property. from whom the payment is due. The third condition provides that there should be a clear intention for utilizing the property as a security for the payment of money. A Charge can be of two types Fixed Charge and Floating Charge. ‘Charge’ which is on the ascertainable assets like land, building, etc are fixed charge and while the charge on the non-ascertainable asset would be called as Floating Charge. The Floating charge can be crystallized into a fixed charge upon the trigger of specific events. Thus, the person has to satisfy these conditions before putting charge over the property:-
- There should be clear intention to charge the property to utilise it for payment;
- If the immovable property is charged, then an instrument in writing needs to be drawn for the enforceability of the same;
- Charge on an immovable property can only be charged if the ownership lies in the hands of the person from whom the payment is due.
- A charge shall not amount to a mortgage but the provisions applicable to a simple mortgage shall be applied to the charge.
- A charge can be created by an act of the parties by mutually entering into an agreement;
- ‘Charge’ can also be created by operation of law.
- A charge shall not be created on an immovable property that also constitutes trust property in favour of the trustee, who incurs expenses for the maintenance of the trust out of that property.
- Registration of Charge by a company needs to be done as per Section 77 of the Companies Act, 2013 in Form CHG-1.
Hypothecation
The Transfer of Property Act, 1882 does not define the term ‘Hypothecation” but while driving inference from various judicial precedents it can be said that it is the charge on the moveable property. However, the Reserve Bank of India under clause (i) of Section 2 of Creation and Enforcement of Security Interest by Banks and Financial Institutions Act, 2001 has defined hypothecation as a charge on the movable property (both tangible and intangible) existing in present or will exist in future, which the borrower creates without delivering the possession of the property. The delivery can be actual or constructive, which would be made to stand as a security for financial assistance. Hypothecation according to this definition also includes floating charge and crystallization of such charge into fixed charge however, the term hypothecation does not include a pledge of movables as defined under Section 172 of the Indian Contract Act, 1872. Thus, in legal parlance, hypothecation means providing something as collateral for any type of debt.
Hypothecation is also defined under clause (n) of Section 2 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002. According to this provision, Hypothecation is a charge on movable property, existing now or will exist in future which the borrower creates in favour of a secured creditor without delivering the possession of the said property to give security to the financial assistance. This definition is similar to the definition of Creation and Enforcement of Security Interest by Banks and Financial Institutions Act, 2001.
In simple terms, hypothecation can be charge on the property but not all charges would be considered as hypothecation. Hypothecation is similar to pledge but the only difference which lies between the two is possession in the case of a pledge is with the lender, while in the case of hypothecation is with the borrower.
As per the definition above, the following essentials of the term ‘Hypothecation’ can be drawn:-
1. Charge is only on the moveable property.
2. There is no delivery of possession of the property.
3. It includes floating charge and crystallization of floating charge into a fixed charge.
4. It needs to be executed by an Agreement of Hypothecation.
5. It is created in favour of secured creditor;
6. It is created as a security for financial assistance;
7. Registration of hypothecation needs to be done as per Section 77 of the Companies Act, 2013.
Difference between a Charge and a Hypothecation
| Basis of Distinction | Charge | Hypothecation |
| Meaning | When one person charges a property to security the payment to the other person. | When a charge is created on movable property to secure the payment to a secured creditor without transferring the possession of the property. |
| Use | To create a right on the property by the borrower in the name of the lender. | To give guarantee to the secured creditor |
| Defined under | Transfer of Property Act, 1882 | SARFAESI ACT,2002 |
| Indicates | Transfer of interest in assets | Security for payment |
| Applicable for | Both immovable and movable property | Only movable property |
| Term | Long and short, both | Short |
| Legal Document | CHG-1 | Agreement of Hypothecation |
| Scope | Wide, it include pledge, hypothecation | Narrow, as it is only charge on movable properties. |
| Properties as collateral | Land, Building, car, goodwill, etc. | Car, Motorcycle, etc. |
| Transfer of Property | No transfer of Property | No Transfer of Property |
Article by Ms. Harshita Agarwal in April, 2021 while interning at the Chambers of Advocate Shankarlal Raheja.
Disclaimer: The views herein are personal and while careful attention has been given to ensure that the information is accurate the author assumes no liability or responsibility for any reliance thereon. This article is merely an information-sharing activity and is not a substitute for legal advice. It must be noted that we shall not be liable for any loss or damage caused due to any reliance thereof.