Concept of Pledge under the Indian Contract Act, 1872

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Abstract:-

This article explains the concept of Pledge under the Indian Contract Act, 1872, which is a special type of contract involving the delivery of goods as security for a loan or promise. Covered under Sections 172 to 179, a pledge is essentially a kind of bailment where the borrower (pawnor) gives movable property to the lender (pawnee) as collateral. The article discusses the essential elements of a pledge, such as delivery, valid contract, and specific property. It also explains different types of pledge-related agreements like hypothecation and lien. The rights and duties of both parties are clearly defined to ensure fairness—while the pawnee can retain and even sell the goods on default, the pawnor has the right to redeem them before the sale. The pledge contract plays a key role in securing debts and encouraging trust in financial transactions, making it an important part of India’s contract law system.

Keywords: Pledge, Indian Contract Act 1872, Bailment, Section 172, Pawnor, Pawnee

Introduction:-

The Indian Contract Act, 1872, is the key legislation governing contracts and agreements in India and its territories. It establishes the legal framework for creating, enforcing, and resolving breaches of contract. The Act outlines essential elements of a valid contract, like offer, acceptance, consent, consideration, etc. But it is not limited to these basic principles. The Law of contract is compiled of broadly two parts- the General Principles of Law of contract and the Special Kinds of contracts. One such special kind of contract under Chapter IX of the Indian Contract Act is the “contract of pledge”.

Understanding the Contract of Pledge:-

It’s possible that at some point in your life, you needed money and requested a friend to lend it to you. Your colleague consents to it if you promise to provide something of value in exchange. In the Law of Contract, this kind of contract is known as a pledge.

This illustration highlights that a contract of pledge, often referred to simply as a pledge, is a special type of contract that holds significant importance in economic transactions. In general terms, a pledge involves placing a good or its title as security, either for repaying a loan from the creditor or to fulfil an obligation made under a promise. Both in India and in the common law of England, a pledge is regarded as a type of bailment since both involve the delivery and possession of goods. The Contract of Pledge is thoroughly covered in the Indian Contract Act Chapter under the heading of Chapter IX of Bailment, subheading Bailment of Pledges. Sections 172 to 179 cover the concept of pledge under the Act.

“Pledge” is defined under Section 172 as “The bailment of goods as security for payment of a debt or performance of a promise is called pledge.” Pledge is also known as “Pawn”. Pawnor and Pawnee are the parties to the contract of Pledge. They are also defined under Section 172. “The bailor, i.e. who provides the goods as security, is called the “pawnor”. The bailee, i.e who receives the goods as security, is called the “pawnee”. In a pledge contract, one party pledges any good or the good’s title to the other as security for the money that the latter party advances. Making a promise is thus a prerequisite for receiving financial advances. Pledge can also be defined as, when a debtor delivers items to a creditor in exchange for payment of a debt or other contractual obligation; the given item is returned to the pledgor after the obligation has been fulfilled or the debt money has been paid back.

“An Illustration for a pledge is- A borrows Rs. 100000 from C, and provides his silver jewellery as security to C. This transaction will be a pledge under the Indian Contract Act. A is the Pawnor and C is the Pawnee.”

Essentials of Pledge:-

As per the definition of pledge under Section 172 of the Indian Contract Act, 1972, the essential elements of pledge are:-

1. Delivery of Goods- A valid contract of pledge requires the delivery of possession of goods. This delivery of goods can happen in two ways. One being the Actual delivery of goods. This type of delivery involves the transfer of physical possession of goods to the pawnee. The second type of delivery is Constructive Delivery, which involves delivery by way of attornment through symbolic means without physically transferring the goods.
2. Existence of a valid contract- The contract of pledge must fulfil the general principles of a valid contract as per section 10 of the Indian Contract Act, 1872. This can be defined as “All agreements are contracts if they are made by the free consent of parties competent to contract, for a lawful consideration and with a lawful object, and are not hereby expressly declared to be void.”
3. Right on the pledge– The pawnee only has possessory rights over the pledged goods. The juristic right or ownership/title remains with the pawnor itself. The pawnee holds a special property interest, which allows them to retain the goods only till the debt or obligation is discharged. This distinguishes a pledge from a sale of goods, where full ownership is transferred.
4. Timing of Delivery– It is not necessary that the delivery of goods and advance of money is simultaneous. A valid pledge may also be created after the advance is made, provided there is an intention to create a security interest. The English case of Blundell Leigh v. Attenborough illustrates this principle, affirming that a pledge made subsequent to the loan can still be valid in the eyes of law.
5. Specific property- The subject matter of a pledge must be movable property capable of delivery. This includes existing goods, documents of title, and other valuables such as shares, insurance policies, and receipts. Only such property that can be lawfully delivered and possessed by the pawnee is eligible to be pledged.

Types of Pledge Agreements:-

Contract of pledge can be categorized into different types based on the nature of possession and the rights of the parties involved. The key forms of such agreements are:

1. Agreement to Pawn– In a typical pledge or “pawn” agreement, the pawnor (borrower) delivers goods to the pawnee (lender) as security for a debt or obligation. The Pawnee retains possession of the goods until the debt is repaid. In the event of default, the pawnee is entitled to either retain the goods or sell them after giving due notice to the pawnor.
2. Pledge by Hypothecation– Unlike a pledge, hypothecation involves the creation of a charge over the borrower’s goods without transferring possession to the lender. The borrower retains control over the goods but agrees that the lender can take possession and sell the goods if the borrower defaults. This form of agreement is commonly used in cases involving stocks, vehicles, or other movable assets.
3. Lien on Goods– A lien refers to the right of a creditor to retain possession of goods until the debt owed is satisfied. Unlike pledge or hypothecation, a lien does not give the creditor the right to sell the goods unless specifically provided by law or contract. This is a passive right that simply allows the creditor to retain the goods as security.
4. Security agreements– Security agreements are broader in scope and typically involve the legal transfer or creation of an interest in property—movable or immovable—to secure the performance of an obligation. These agreements are formalised through legal documentation and can cover a wide range of collateral.

Rights of the Pawnee under Indian Contract Act, 1872:-

1. Right to Retain Goods (Section 173)- As defined under section 173 of the Indian Contract Act, 1872, The pawnee, who is the person holding the goods as security for a debt or promise, has the lawful right to retain possession of the pledged goods. This right extends beyond just the principal amount owed; it includes any interest accrued on the debt and all reasonable expenses that the pawnee has incurred in taking care of or preserving the goods while in their custody. This means the pawnee can keep the goods until the pawnor fully discharges all these obligations.
2. Right to extraordinary expenses (Section 175)- Apart from normal expenses related to safekeeping, if the pawnee has incurred any extraordinary expenses to protect or maintain the pledged goods (for example, repair or special storage costs), the pawnee is entitled to be reimbursed for such expenses by the pawnor. This ensures the pawnee is not unfairly burdened with costs beyond ordinary care.
3. Rights incase of Pawnor’s Default (Section 176)- If the pawnor fails to pay the debt or perform the promise at the agreed time, the pawnee has two main remedies: (a) the pawnee may file a legal suit against the pawnor to recover the debt while retaining the goods as collateral security, or (b) the pawnee may sell the pledged goods after providing the pawnor with reasonable notice of the intended sale. In either case, if the sale proceeds are less than the amount owed, the pawnor remains liable to pay the remaining balance. Alternatively, if the sale produces surplus funds, the pawnbroker must return the excess amount to the pawnor. This legal framework balances the interests of both parties fairly.
4. Right Not to Retain for Other Debts (Section 174)- The pawnee cannot hold the pledged goods as security for any other debt or promise than the one originally agreed upon, unless there is an express contract allowing such retention. However, if the pawnee has made additional loans or advances to the pawnor after the original pledge, the law presumes that the pawnee is entitled to retain the goods for those subsequent debts as well, unless proven otherwise. This protects the pawnee’s interests in situations involving ongoing credit.

Rights of the Pawnor under Indian Contract Act, 1872:-

1. Right of the Defaulting Pawnor to Redeem the Goods (Section 177): As per Section 177 of the Indian Contract Act, 1872, grants the pawnor a right even in the event of default. When a specific time for repayment of the debt or performance of the promise secured by the pledge is fixed, and the pawnor fails to meet this obligation on time, he does not lose all rights immediately. Instead, the law allows the pawnor to redeem or reclaim the pledged goods at any time before the goods are actually sold by the pawnee. However, this right to redeem after default is subject to one important condition: the pawnor must also pay any additional expenses or costs that have been incurred as a direct result of his failure to pay or perform on time. These expenses could include costs related to preservation or safekeeping caused by the delay.

Duties of the Pawnor and Pawnee in a Contract of Pledge

In the legal framework governing contracts of pledge, the roles and responsibilities of the parties involved—namely, the pawnor and the pawnee—are clearly delineated to ensure fairness and protection of interests. Understanding these duties is essential to grasp the nature of the pledge contract and its enforceability.

• Duties of the Pawnee– The pawnee, as the custodian of the pledged goods, bears the responsibility of diligent care. He must manage and protect the goods with the same degree of caution as he would his own property, ensuring no damage or depreciation occurs while the goods remain in his custody. To maintain transparency and trust, the pawnee is required to conduct an inspection upon receipt of the goods and maintain accurate records of such inspections, including any subsequent visits by the pawnor. The pawnee must also uphold the integrity of the pledged goods by refraining from mixing them with his personal property. Such commingling, if done without authorization, would compel the pawnee to compensate the pawnor for any resultant loss or diminution in value. In cases where the pawnor defaults on his obligation—such as failure to redeem the pledged goods—the pawnee is duty-bound to notify the pawnor of such default. Importantly, the pawnee must afford the pawnor a reasonable opportunity to remedy the default before initiating enforcement actions, thereby ensuring procedural fairness. Finally, possession of the goods does not grant the pawnee any right to use the pledged goods without express authorization from the pawnor. Unauthorized use would constitute a breach of the pawnee’s duty and could attract legal consequences.
• Duties of the Pawnor– The pawnor, who pledges the goods as security for a debt or obligation, is under several fundamental duties. Primarily, the pawnor is obligated to transfer possession, and effectively the ownership rights in the goods, to the pawnee. This transfer is not merely physical but also implies that the pawnor holds a valid title over the goods, free from encumbrances or claims by third parties. Such transfer confers upon the pawnee lawful possession and a right to retain the goods until the debt is satisfied. Moreover, the pawnor must ensure the goods remain in their original state. Since the pledge is contingent upon the value and condition of the goods, any deterioration could prejudice the pawnee’s security interest. The law, therefore, imposes on the pawnor the duty to maintain the goods appropriately or, if the pawnee incurs extraordinary expenses in their upkeep, to provide just compensation for such costs. Transparency is another crucial obligation incumbent upon the pawnor. Any latent defects or material information relating to the pledged goods must be disclosed to the pawnee at the time of pledge. Failure to communicate such defects, which later cause loss or damage to the pawnee, may give rise to the pawnor’s liability to compensate the pawnee accordingly.

Conclusion

In conclusion, the contract of pledge under the Indian Contract Act, 1872, plays a vital role in securing debts and obligations by enabling the delivery of goods as collateral. It establishes a balanced legal framework protecting the rights and duties of both the pawnor and pawnee, ensuring fairness and clarity in transactions. The pledge safeguards the pawnee’s interest by granting possession and retention rights while preserving the pawnor’s ownership rights, allowing redemption before sale in case of default. The detailed provisions under Sections 172 to 179 outline essential elements such as delivery, valid contract formation, and specific property, along with the rights to retain, recover expenses, and sell pledged goods upon default. Moreover, the defined duties of both parties—such as careful custody by the pawnee and disclosure and maintenance obligations by the pawnor—help prevent misuse and disputes. Overall, the pledge contract fosters trust and security in commercial dealings, reinforcing its importance in India’s contract law framework.