WHAT IS THE BANKER’S RIGHT TO LIEN?
A CRITICAL ANALYSIS OF SECTION 171, INDIAN CONTRACTS ACT
Author: Navni Sisodia,
3rd year,
O.P Jindal Global University, Sonipat.
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| BANKER’S RIGHT TO LIEN |
Chapter 1: Banks as contracting parties
A bank is a contracting party and most of its contractual privileges are used in guarantees, loans, etc. A bank plays a major role in fulfilling contractual obligations, especially as a third party by being a guarantee. A guarantee is an undertaking by a third party, called a surety on the default of payment or performance of the obligations of the party who is primarily responsible for it i.e. the debtor. The surety then has to answer the principal and perform the obligations himself and for which he may be indemnified at a later stage by the debtor or as specified in the contract. A guarantee has been defined in Section 126 of the Indian Contracts Act, 1872, which states that: “A “contract of guarantee” is a contract to perform the promise, or discharge the liability, of a third person in case of his default. The person who gives the guarantee is called the “surety”; the person in respect of whose default the guarantee is given is called the “principal debtor”, and the person to whom the guarantee is given is called the “creditor”. A guarantee may be either oral or written.”
A bank guarantee is a very specific kind of guarantee which binds the bank as a surety and makes it liable for the non-performance or non-payment of the obligations contracted by the debtor with the principal. A bank guarantee is not just ‘banks’ but all guarantees given by lending institutions will come under the term of a bank guarantee. A bank guarantee enables a debtor to take out loans, buy goods, etc. A bank guarantee is usually given more preference because, unlike an individual, a bank will on the most occasions will have the means to fulfill the guarantee and do its part as the surety whereas an individual may default, leaving the principal defaulted. A bank guarantee is of different types, such as direct and indirect guarantees. Banks, when dealing with foreign or domestic businesses, usually use direct guarantee which are issued directly to the beneficiary. Bank guarantees can be broadly classified into:
1.1 Financial Guarantees
Financial Guarantees are usually issued when a contract is awarded to their customer/contractor, which is related to civil work, supplying of machinery, goods etc. by a government department or large industrial undertakings. Here the customer needs to make a cash deposit which will act as security which will be forfeited by the principal if the customer/contractor fails to perform or comply with the terms of the contract. The customer will then have the option to opt for a bank guarantee in lieu of the forfeited cash security. Such a guarantee is called a financial guarantee where the banks acting as a surety, undertake to pay that amount during a specific period when demanded by the beneficiary.[1]
1.2 Performance Guarantees
Performance Guarantees are those guarantees where the bank has to discharge the financial liability of the contract as agreed in the guarantee, if the contract is not performed at all or even if it has been partly performed. Such guarantees are issued on the behalf of a service contractor who is under obligation to perform certain conditions, prescribed in the contract. Usually in such type of contracts, where the conditions can be highly technical, the bank only associates itself with the finan
cial aspect of the contract, thereby assuming a great risk in doing so. Therefore, before issuing performance guarantees the bank ensures if the customer/service contractor has the capacity and means to carry out his obligations and has had sufficient experience in the particular line of business.
cial aspect of the contract, thereby assuming a great risk in doing so. Therefore, before issuing performance guarantees the bank ensures if the customer/service contractor has the capacity and means to carry out his obligations and has had sufficient experience in the particular line of business.
1.3 Unconditional & Conditional Guarantees
Along with that bank guarantees can also be divided on the basis of breach, i.e. conditional and unconditional. Unconditional guarantees are those guarantees where the bank/surety becomes liable without there being any proof of breach and as soon as the amount is demanded by the creditor the same amount has to be paid by the surety. In the case of conditional guarantees, the bank/surety only becomes liable when the proof of the breach of the contract and the proof of loss which has occurred due to the principal’s action is presented, without that the bank is not liable to pay the creditor. In Hindustan Steelworks Construction Ltd v Tarapore & Co., Hindustan Steelworks Construction Ltd had 14 bank guarantees given to them by the Bank of India at the instance of a contractor, who kept breaching the terms of their contract, and after many attempts and extensions given to the contractor, the company filed for the encashment of the guarantees for Rs. 1,49,76,580. The contractor filed for an injunction to restrain the company from encashing the guarantees, on the grounds that since the dispute between the parties was already being investigated by the arbitrators and the bank guarantees can only be availed after the Arbitrators confirm and conclude that the contract had been breached. The issues were that unless the circumstances are special or fraudulent, the creditor can avail the bank guarantees, irrespective of the fact that there in an ongoing dispute between the parties and that in this case it was to be decided if the situation can be called special or fraudulent since according to a term in the agreement if a party is the sole judge of quantifying loss and damage, then the agreement will be held invalid. Therefore the Court held the court will not interfere unless it is a clear case of fraud and that the High Court had erred in saying that an agreement with one party quantifying damages will be invalid since bank guarantees are separate agreement between the bank and the creditor and need not be qualified by the underlying transactions between the person at whose instance the bank has given the guarantee and the creditor and since it was an unconditional bank guarantee the bank is obligated in its role to pay the creditor.[2]
Chapter 2: Role of Banks in Agreements
2.1 Bank as a Bailee
In banking, when talking about the concept of bailment, the customer is considered a bailor and the bank is the bailee. The Indian Contract Act defines bailment in the Section 148:
“Bailment” “bailor” and “bailee” defined—A “bailment” is the delivery of goods by one person to another for some purpose, upon a contract that they shall, when the purpose is accomplished, be returned or otherwise disposed of according to the directions of the person delivering them. The person delivering the goods is called the “bailor”. The person to whom they are delivered is called, the “bailee”.
This concept of bailment is usually misconstrued in the case of the locker/safe box deposit system, a service provided by many banks where the customer gives the bank the responsibility of safekeeping their lockers. Here the ‘things are kept in a hired portion of the premises and not entrusted to the bank.’[3] In the case of Atul Mehra v Bank of Maharashtra, since there was no way of actually knowing what was in the locker, it could not be proved that there was jewellery in the locker at the time of the robbery. The Court also held that it could not be proved that the strong room of the bank where the lockers were situated was not made according to the specifications, the customer had no claim for damages.[4]When talking about the monetary transactions performed by the banks like depositing money in the accounts, such action and duties do not constitute as bailment since the money which is returned is not the same, i.e. the bank notes which are used are different and the ‘goods’ being the exact same are an essential part of the concept of bailment.
2.2 Bank as a Pawnee
The bank also has a part in the relationship which arise out of a pledge. In that case, the bank will be referred to as the pawnee and the customer will be the pawnor. This type of situation arises when there is a case of taking out a loan. When a bank gives a loan, it enters into an agreement with the customer and a collateral is set, which will later, if the loan is not paid, fall into the possession of the bank. Here the action of giving a collateral for the loan is called a pledge. A pledge is a promise, while a collateral is a physical asset. Pledge can be defined in the Indian Contracts Act,1872 as:
‘Section –172. “Pledge” “pawnor”, and “pawnee” defined—The bailment of goods as security for payment of a debt or performance of a promise is called “pledge”. The bailor is in this case called the “pawnor”. The bailee is called the “pawnee”. ‘
The term Pledge is used for actual physical possession of goods. On the other hand, Hypothecation, which also revolves around the concept of pledge is used to denote the constructive/notional possession of the goods which are pledged, here it will be called a hypothecation as the even if the goods are not in the actual possession of the pawnee, the goods will remain in the constructive possession of the pawnee until the purpose of bailment is complete. Therefore, when this is applied in the case of the banks and the process of giving out loans, the asset which is bought with borrowed money usually becomes the pledged asset with the bank as then the bank has direct access and knowledge of the asset and until the loan is paid the asset which even if it remains in the possession of the asset, it will still have constructive delivery as the customer uses that asset to help earn the money to repay the loan.
Chapter 3: Lien
3.1 What is Lien?
Lien essentially means “the right to retain a particular property in respect of which the charge is due.”[5] Lien has been categorised in the different section of the Indian Contracts Act, 1872. Section 170 of the Indian Contracts Act talks about particular lien, ‘Bailee’s particular lien – Where the bailee has, in accordance with the purpose of the bailment, rendered any service involving the exercise of labour or skill in respect of the goods bailed, he has, in the absence of a contract to the contrary, a right to retain such goods until he receives due remuneration for the services he has rendered in respect of them.’ Lien can be classified as a right of defence and therefore cannot be barred by limitations as would have been in the case, had lien been a right of action.[6]
3.2 Particular Lien
There are certain conditions which are required to avail the right, the case of particular lien. Firstly, the right to lien arises when the goods given are subject to the skill and labour of the bailee, and such that the skill and labour must lead to improvement of the good. Mere maintenance will not give a rise to the right to lien even if the maintenance of the good has cost the bailee money. Similar decisions were given in the case of Hutton v Car Maintenance, where a car owner had given his car to a company to maintain it and a fixed annual payment was given for three years, when after the end of time period an amount became due for the maintenance of the car, the company claimed lien on the car which was rejected by the court since the car was only maintained and not improved upon.[7]Secondly, the skill and labour exercised must be done with accordance to the terms and condition of the contract, with the purpose of bailment in mind. Thirdly, the bailee has the right to retain only those goods upon which he has invested time and money and not just any good lying in the custody of the bailee. This is the main difference between ‘particular lien’ and ‘general lien’. A particular lien can be converted into general lien by express contract, in the same way the right to lien can also be excluded.
3.3 General Lien
General lien is a right which is conferred upon specific parties under section 171, which are banks, factors, wharfingers, attorneys and policy broker. The right to general lien means that the right holders have the right to hold the goods which have been bailed as a security for the general balance of account.
Bank’s Lien
When banks and their right is considered, if a loan is taken out by a customer and two assets are given to the bank for the that but the loan has been taken out on only one of them, the bank still has the right to lien over both the assets until the loan is repaid. Such a right need not be expressed as it is implied unless expressed otherwise in an agreement. This is a result of a bailor and bailee relationship between the bank and the customer. In such case, goods can be pledged to take out a loan and then the bank has the possession over the goods as a bailee. One of the most important aspects of lien is that there can be no lien claimed over money. Along with that, the bank only has the right to claim the securities and the properties that are in the custody of the bank, which can also be constructive. This part applies whether the securities/properties are in one bank branch or another. The court in the case of Punjab National Bank Ltd. v Aruna Mal Durga Das, states in Paragraph 13 of the judgement that the use of the word lien, referring to money, though common is incorrect and that it is confined to the securities and properties in the bank’s custody.[8]
3.4 Negative Lien
Another type of lien which is used, when talking about banking is Negative Lien. Negative lien has not been defined anywhere in the Indian legislative enactment but can be explained as to when the borrower undertakes to not create a charge on his property with the getting the consent of the lender. Since there is no specific definition, a negative lien is considered a negative agreement “which restricts a person from creating any kind of encumbrance over his assets or otherwise disposing them without the prior consent of the other person in whose favour he has given such an undertaking.”[9] The High Court of Bombay in the case of Bank of India Ltd v. Rustom Fakirji Cowasjee stated:
“Under our law there is not, in case of a lien, any right of bringing the property to sale unless it is expressly conferred by statute. There are some kinds of lien where such right of sale is expressly recognised, e.g. the lien of an unpaid seller or of a pawnee of goods. But in case of many liens expressly recognised by statute there is no such right of bringing the property to sale and the right remains simply one of retention. Here I am concerned with a lien in favour of a bank (emphasis applied), and it is indisputable that the general lien of a banker expressly recognised by Section 171 of the Contract Act (which is a possessory lien) does not confer on the banker any right to bring the property to sale. There is no pleading, and no issue, before me relating to any negative lien of a banker which by usage or custom may be said to confer any such right of bringing the property to sale. It is difficult for me to see that when the positive general lien of a banker does not confer on him any power of bringing the property to sale, how such power can reasonably be implied in case of a negative lien, when the parties have not chosen to state that it was their intention that there was to be such, right and there are no other words from which such intention could be inferred. The words “negative lien” in the resolution, in my judgment, does not in any way add to the effect of the assurance whereby the airline company became bound to keep its assets unencumbered. But as I have already observed the negative lien is given in the form of a declaration and an assurance contained in the resolution itself and, if anything, the expression “negative lien” seems rather incompatible with any implied right to bring the property to sale.” [10]
3.5 Lien in case of Two Accounts /Joint Account Holders
In the case of two accounts of a customer, the bank has the authority to transfer money from the deposit account to the loan account of the bank without any prior specific instructions to the bailor. As in the case of SBQ Steels Ltd v Indian Bank, the court held the action of the bank to freeze the account of the customer due to his default on the loan as valid.[11]
Again in the case of Syndicate Bank v Vijay Kumar, it was held by the Supreme Court that banker’s right could be exercised in the case of joint accounts as well as fixed deposits.[12]Also when talking about fixed deposits, the lien over fixed deposits was explained in the case of Tilendra Nath Mahanta v United Bank of India, where the court held that a fixed deposit is a loan in the hands of the bank and could not be used to establish a connection to another account and that an amount in another account could not be adjusted against a claim in any suit.
3.6 Possessory Lien
Possessory Lien basically grants the right to the creditor, to keep the property in possession under lien until the debtor successfully discharges his debt. In the past, it acted as a mean to get relief against service charges where the service providers were not able to otherwise, sue for a reasonable value of the services.
Chapter 4: Government Participation
4.1 Welfare State
The government acting as a helping hand to the farmers especially in the recent years, has spent crores to facilitate the waiving of the loans taken by these farmers, which usually were given by attaching their cultivating lands as the security. In such circumstances the government has worked to help in waiving off these loans, due to the farmer’s inability to pay back the loan, which would then lead to the claim of these lands which were attached to the loans and therefore taking away their livelihood.
The Maharashtra government has transferred Rs 12,381 crore so far, in the accounts of more than 3.1 million farmers under the farm loan waiver scheme.[13]Along with the Karnataka government, which got the approval from the bank for the Rs 48,000 crore farm loan waiver.[14]Therefore, almost every state government as well as the central is bringingout similar plans and schemes and being ordered by the High Courts and Supreme Courts do so as well in certain cases.
Conclusion
The above chapters shed light on some of the specified functions, rights and privileges of the bank with respect to the Indian Contract Act. All these functions of the banks are present for the welfare of the society and at the same time protecting the banks from certain disrupting elements which if had not been in effect would, along with banks, also have an extremely unfortunate effect on the public.
Therefore, such rights like the right to lien, bring out the sense of fairness and justice before the such cases make their way to the judiciary.
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[1] “What Are the Different Types of Bank Guarantees?” Banking School. Accessed October 18, 2018. https://www.bankingschool.co.in/loans-and-advances/bank-guarantee-fee-based-credit-facility/.
[2] Hindustan Steelworks Construction Ltd v Tarapore & Co., 1996 SCC (5) 34
[3] Singh, Avtar. Law of Contract and Specific Relief. Lucknow: Eastern Book Company, 2018,673.
[4] Atul Mehra v Bank of Maharashtra, AIR 2003 P H 11, II (2003) BC 570
[5] Singh, Avtar. Law of Contract and Specific Relief. Lucknow: Eastern Book Company, 2018, 698.
[6] Polluck, Fredrick, and Dinshaw Fardunji Mulla. The Indian Contracts and Specific Relief Acts. 14th ed. Vol. 2. Gurgaon, Haryana: LexisNexis, 2013, 1548.
[7] Hutton v Car Maintenance Co, (1915) 1 Ch 21.
[8] Punjab National Bank Ltd. v Aruna Mal Durga Das, AIR 1960 Punj 632.
[9] Vora, Trushil, and Aashita Monani. “Mandatory Registration of ‘Negative Lien’ as a ‘Charge’ under the Company Laws of India.” India Law Journal. 2007. Accessed October 27, 2018. http://www.indialawjournal.org/archives/volume7/issue-1/article4.html.
[10] Bank of India Ltd v. Rustom Fakirji Cowasjee, AIR 1955 Bom 419.
[11] SBQ Steels Ltd v Indian Bank, AIR 2014 NOC 452 (Mad).
[12] Syndicate Bank v Vijay Kumar, AIR 1992 SC 1066
[13] Ghadyalpatil, Abhiram. “Maharashtra Farm Loan Waiver: Rs12,381 Crore Reaches Accounts of 3.1 Mn Farmers.” Https://www.livemint.com/. February 26, 2018. Accessed October 29, 2018. https://www.livemint.com/Politics/A61IDl1h10pb3cLrQUsl6M/Maharashtra-farm-loan-waiver-Rs12381-crore-reaches-account.html.
[14] Ravi, Anusha. “Government Gets Banks’ Backing for Rs 48,000 Crore Farm Loan Waiver.” The New Indian Express. July 25, 2018. Accessed October 29, 2018. http://www.newindianexpress.com/states/karnataka/2018/jul/25/government-gets-banks-backing-for-rs-48000-crore-farm-loan-waiver-1848175.html.