Monday, March 25, 2013

MCA Circular: Secured Corporate Debentures and Public Deposit Norms – Part 2


[The following is a guest post from Vinod Kothari and Nidhi Ladha of Vinod Kothari & Company. The authors can be contacted at vinod@vinodkothari.com and nidhiladha@vinodkothari.com respectively.

This is a continuation from the first post in the series that can be accessed here]

Meaning of ‘mortgage of fixed assets’


The significant difference between mortgage and charge is that mortgage is a transfer of specific property, whereas a charge is a merely lien or obligation upon property to discharge a claim. The distinction between a sale, mortgage and charge needs to be clearly understood – sale is an absolute transfer of property, mortgage is specific transfer (that is, transfer only for securing a debt) in property, and a charge is a mere lien or obligation on property to secure a debt.

More clearly, in a sale, there is no underlying debt and consideration for sale flows from the buyer to the seller in lieu of transfer of absolute ownership of the property sold. As also defined in Benjamin on Sale, 8th Edition as:

“…Hence it follows that, to constitute a valid sale, there must be a concurrence of the following elements viz. (1) Parties competent to contract; (2) mutual assent; (3) a thing, the absolute or general property in which is transferred from the seller to the buyer; and (4) a price in money paid or promised.” 

A ‘mortgage’ has been defined in section 58(a) of the Transfer of Property Act, 1882 as:

“A mortgage is the transfer of an interest in specific immovable property for the purpose of securing the payment of money advanced or to be advanced by way of loan, an existing or future debt, or the performance of an engagement which may give rise to a pecuniary liability.”

Therefore, in case of mortgage of immovable property, there is a transfer of interest: that is, the property moves from the mortgagor to the mortgagee, but the transfer is only for the purpose of securing a debt. That is to say, the transfer is not absolute: it is a specific transfer. The property reverts to the owner once the debt is satisfied.

If the above definition of mortgage is read in context of movable property, it is to read as: A mortgage is the transfer of an interest in specific movable property for the purpose of securing the payment of money advanced or to be advanced by way of loan, an existing or future debt, or the performance of an engagement which may give rise to a pecuniary liability. Thus, to create a mortgage, the borrower/debtor not only creates an encumbrance on the property, but makes a specific transfer of property itself. Transfer of property does not necessarily mean transfer of ownership – transfer of usufruct, transfer of possessory rights, or transfer of any interest in property also creates a mortgage.

On the other hand, a charge, there is no transfer of interest in property at all. In fact, in case of charges, the property may be both present and future, as is the case with floating charges.  The concept of floating charge does not fit into the meaning of mortgages, as only specific property can be mortgaged.

How is mortgage of movable property done?


Since the meaning of a “mortgage” is transfer, there must be a transfer of property from the mortgagor to mortgagee to create a mortgage. This transfer will get reversed, or the property will get re-transferred, if the debt in question is discharged. Hence, the easiest way to create a mortgage in case of movable properties is by way of a conditional sale.

A mortgage by conditional sale has been defined in Section 58(c) of the Transfer of Property Act as:

“Where, the mortgagor ostensibly sells the mortgaged property –on condition that on default of payment of the mortgage-money on a certain date the sale shall become absolute, or on condition that on such payment being made the sale shall become void, or on condition that on such payment being made the buyer shall transfer the property to the seller, the transaction is called a mortgage by conditional sale and the mortgagee a mortgagee by conditional sale:

Provided that no such transaction shall be deemed to be a mortgage, unless the condition is embodied in the document which effects or purports to effect the sale.”

To conclude above, we can say that whereby the mortgagor transfers the property to the mortgagee upfront, and agrees with the mortgagee that in the event the mortgagor defaults in payment of the mortgage money on the due date, the conditional sale done upfront will become absolute, and if the debt is discharged, the conditional sale will either get reversed or get cancelled, we have a case of mortgage of movable property.

The issue of debentures secured by movable property by creating mortgage by conditional sale serves the purpose of all the parties: the issuers, the investors and the lawmakers as security is created for a value more or equals to the issue of debentures makes the investor comfortable and is exempted from the Deposit Rules, and at the same time, issuers are benefitted by creating mortgage on movable properties.

Though there is a transfer of property in case of a mortgage, such transfer is not a “sale” from the viewpoint of VAT or sales-tax laws, as the definition of “sale” under these laws specifically excludes mortgages.

- Vinod Kothari & Nidhi Ladha

[In a continuation of this post, the authors conclude by dealing with other laws affecting debentures generally (here)]

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