RESERVE BANK OF INDIA COLLEGE OF AGRICULTURAL BANKING GANESHK HIND ROAD, PUNE 411 016 LEGAL ASPECTS OF LOAN

DOCUMENTS INTRODUCTORY Documentation is one of the most important elements of the lending operation of a banker. For realization of the loan amount together with the other dues and repayable amount, the document taken as security, from the borrower, or/and, the guarantor, for repayment of loan amount together with the other dues, is the main basis of the claim of the banker and thus realization of the Bank dues depends to a large extent upon the precision and completeness of the documents obtained from the borrower. It is precisely because of this reason that the banks have adopted the standard forms to security documents, which are prepared by their legal departments with the due care to ensure that there is no possibility of an important legal provision being overlooked at the time of loan sanction. Thus, the legal aspects of loan documents in so far as it relate to the inclusion of requisite covenants relating to then rights and obligations of the bankers, the borrower/or the borrowers, are ensured by the legal experts of the banks. The Branch Manager or the officer of a bank is required to select the right type of document according to the facts and circumstances of each case and ensure that the proper and valid execution of a loan document is completed. Therefore it becomes necessary for bank officers to know what the legal provisions are relevant to the subject of the documentation, in so far as it relate to its proper and valid execution, and its enforcement. It is, therefore, also essential to know the fundamental aspects of documentation. 2. WHAT ARE "DOCUMENTS?

As per the definition under Section 3(18) of the General Clauses Act, 1987 " a document shall include any matter written, expressed or described upon any substance by means of letters, figures or marks or by more than one of those means which is intended to be used or which may be used for the purpose of recording that matter. A document in the present context of commercial transactions is therefore, the substratum of commercial law. The application received from the borrower, and the other written agreements executed by the borrower and/guarantor, in connection with a particular loan transaction, constitute documents. 3. DOCUMENTATION

The process of obtaining proper documents and completion of the necessary formalities connected therewith is called, "Documentation".

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NEED FOR "DOCUMENTS"

The documents are necessary to be procured for the following reasons:i. ii. iii. iv. v. vi. vii. to identify the borrower; to identify the security; to have a written evidence of the transactions of lending made by the bank; to ensure due repayment of the loan by the borrower/or guarantor; to entitle the bank to take legal steps for recovery of the loan, in the event of nonpayment by the borrower/or guarantor; to create a valid and effective security in favour of the bank and to create charge on security; because in the absence of a document capable of being legally enforceable the bank would find it hard to prove and establish before a court of law that the amount was lent and the same has not been repaid;

5. The objective as stated under para 4 above, could be achieved only if the document obtained is legally valid and enforceable. As stated above to ensure that a document is valid and enforceable, the precautions to be taken by the branch Managers/or the other officials, of a bank, are mainly relating to the execution of a document and the period of limitation available in case of a particular document. Important Points to be borne in mind in Execution of Documents i. ii. The document should mention the date, month and year of execution: for determining the period of limitation; Document must mention Place of execution: This is for determing the jurisdiction of courts in case of disputes and for purposes of payment of proper stamp duty, according to the law applicable to particular place. Details of the Security/Collateral Security must be mentioned Stamping Registration

iii. iv. v.

6. The fulfillment of the purposes, as stated under para 4 above, would depend mainly on two factors, i.e. firstly, the document is legally valid and capable of being enforced and secondly that the document contains the requisite covenants to create the necessary right and obligations in favour of the bank and the borrower, or/and the guarantor. 7. As stated above under the introductory column, the Branch Manager, and/or, the other officer of a banks is expected to take care of the aforesaid first aspect, as the bank's legal department, and/or the bank's solicitors are expected to ensure and take care of the above said second aspect. Banks normally use the standard forms for such documentation and the Branch Manager or the officer concerned is required to select the proper document depending upon the type of transaction.

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The Validity of a document in relation to the aforesaid first aspect would mainly depend on the following factors; i. ii. Selection of proper documents Competence of the executants

In determining the validity of a contract, for evidencing which document has been taken would also depend on the capacity and competence of the parties thereto, in addition to the terms and conditions of the contract. Any person executing the documents should be competent to enter into contract; and should not be a minor, lunatic and undischarged insolvent, as they are not competent to enter into a valid contract under the Indian Contract Act. iii. iv. v. vi. Mode of Execution: Different modes of execution have to be adopted depending on the type of the borrower/guarantor etc. Date, Month and Year of execution: for determining the period of limitation. Proper Stamping: The documents must be properly stamped so that they can be admitted as evidence in the court of law. Registration: Some specified operation/transactions are required to be effected by means of proper documents, i.e. they must be in writing and also be duly registered. (Sec. 54 of the Transfer of Property Act.)

The legal aspects which the officer at branch of a bank is expected to know and to take care in order to protect the validity and enforceability of a document are dealt with under the different heading, with an object to provide a general legal background to such officers. As stated above, the validity of a document would also depend on the mode of execution and the manner of execution of a document and would depend on type of borrower, and to avoid any cause for effecting the validity of a document, the branch manager/or the other officer of a bank should take into consideration the following level aspects in so far it relates to the different types of borrowers/their competence, and mode of execution to be adopted in their case. Borrower/or Guarantor 1. Minor A minor under the Indian law is a person who has not completed 18 years of age. In case a guardian of his person or property is appointed by court of law before he completes his 18 years, the period of minority Act, 1875 Section 3) A contract by a minor is void abinito and not merely voidable, and hence a minor cannot be sued. An advance to a minor even if it is supported by the guarantee of a third party cannot be recovered from the guarantor. The minor being not liable a principal debtor, the original agreement will be void; the ancillary agreement of guarantee of guarantee will therefore also be invalid.

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A minor cannot be compelled to pay the money borrowed by him except under the circumstances mentioned in Section 65 of the Indian Contract Act, 1872, Viz. for necessaries suited to his condition and supplied to him. But such position is the only exception and supplied to him. But such position is the only exception to the general legal aspects relating to the general capacity of a minor. The minor cannot act himself and he/or she, has to act through his/her guardian. For purposes of obtaining immovable property belonging to a minor, as security by way of charging such properties, a banker has to ensure that a guardian natural guardian/or the guardian appointed by the competent court, is there to act on behalf of the miner. As stated above, the guardian of a minor is legally competent to create charge on the property belonging to a minor, in the event of borrowing for the need of a minor. A guardian in case of a Hindu minor is appointed normally by the court of District, Judge, in accordance with the provisions of Hindu Minority and Guardianship Act, 1956 and permission to the guardian of minor, for creating any charge or encumbrance over the property belonging to a minor, for obtaining loan and for the benefit of a minor is given by the said court, on application by the guardian, and satisfaction of the bank that the proposed transaction is for the benefit of the minor. Now in some of the states, which have adopted the recommendation of 'Talwar Committee and framed their State Legislation laying down the requisite provision in respect of creation of charge in favour of a bank/property of charge/recovery of loan as arrear of land revenue by the competent authorities as prescribed by the State Govt. and provisions for making 'Distrait' and 'Sale' of the hypothecated property etc. has also laid down the specific provision there under in respect of giving permission to the guardian of a minor for creating a charge over the property belonging to a minor, for borrowing loan for the benefit of a minor and offering property as security by way of creation of charge over the same. For example, in the state of U.P., such act is named as U.P. Agricultural Credit Act, 1975. The prescribed authority under the aforesaid act of exercising the powers to grant requisite permission to a guardian of a minor is District collector and he in turn normally vests with the Addl. Distt. Collector with such powers. In case of agricultural land belonging to a minor, or even non-agricultural land, normally in accordance with the provisions of Land Records Manual Land Revenue Act/or any other similar enactments in terms of which the land records are maintained by the revenue department of the State, 'Record of Right' and Record of Possession' are maintained in relation to the landed property, and the name of natural guardian or the guardian appointed by the court is mentioned in such record along with the age of the minor, owner of the lank. A banker is expected to take note of such record though the same is required to be duly examined by the Advocate/or Solicitor of the banker, while doing the investigation of title and submitting title report. Permission of the competent court (if any) as per the above should be obtained in the event of accepting minor's property as security by way of creating charge over the same by the guardian of the minor, and the certified copy of the Court's permission should also be placed on the bank's record.

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For the reason discussed above, a minor cannot be a guarantor for any body. 2. Lunatics

A person of unsound mind can avoid a debt if he or his legal representatives can prove that he was of unsound mind at the time of borrowing. Normally a banker avoids to deal with a lunatic borrower/or customer. However, here may be a person who is not a permanent lunatic and suffers from temporary mental disorder. In such cases a banker has agreed to advance money to him or accept his guarantee, to avoid the aforesaid chance of disowning of his liability with the plea of his unsound mind at the time of execution of document, a banker should obtain a certificate from two reliable medical officers, or preferably from the Chief Medical Officers of the Govt. hospital, regarding his mental soundness at the time of execution of documents/making advance. 3. Drunken persons

As one of the conditions of a valid contract is that it must be entered into between persons who are of sound mind. A person is said to be of sound mind for the purpose of making a contract, if, at the time he makes it, he is capable of understanding it and of forming a rational judgment as to its effect upon his interests. Though in the event of taking such plea of being under state of intoxication by an executant of a document, to disown his liability arising out of extended document the one of proof would be on the person taking such plea, a banker should take due care to avoid such situation and ensure that the executant is not in a state of intoxication at the time of execution of document. 4. Insolvents

A banker should not lend with or without security to an undischarged insolvent or a person against whom insolvency proceedings are pending. 5. Married Women

A married woman can be made liable only to the extent of her separate estate. In any case her husband would not be liable for the debts incurred by her as a borrower/or pecuniary liability undertaken by her as a guarantor, unless her husband has specifically undertaken for her such liability. Therefore, a banker should ensure before accepting the document executed by a married woman as a security, that she owns an independent estate. 6. Local Authorities

A banker before making advance to a local authority and accepting the document executed on behalf of the local authority should ensure that such authority has power to borrow and person executing the document has requisite power either by way of resolution/or under a power of attorney.

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Normally such powers should be got examined by the legal department/or the solicitor/or the advocate of the bank. 7. Partnership firm

Partnership is the relation between persons who have agreed to share the profits of a business carried on by all or any of the acting for all. Partners collectively are called a 'firm'. A partner is the agent of the firm for the purpose of the business of the firm and can bind the firm, which authority is called implied authority. Every partner is liable, jointly with all the other partners and also severally, for all acts of the firm done or instruments executed while he is a partner, provided the act is done or the instrument is executed in the firms name and relates to the kind of business carried on by the firm. all documents of security/loan, in case of partnership firm must be signed by the partner concerned as a partner of the firm. all documents executed by way of security for a loan in case of a partnership firm and also in their individual capacity. By obtaining the signature in both the capacities as indicated above, the banker will have a right set off on any private account of the partner in respect of the firms debt. Additionally the bank will have a right to prove concurrently against the firm assets as well as the property of each partner in the event of insolvency. A banker should also insist for furnishing a declaration signed by all the partners accepting joint and several liability for the firms borrowings. Such declaration should also contain the statement and assertion of the partners of the firm that unless a change in the constitution of the firm has been communicated to the bank in writing and acknowledged by the bank, the joint and several liabilities of the partners will continue. 8. Pardnasheen lady

There is no such restriction imposed by the law in relation to the competence of pardansheen ladies or about the mode of execution of documents by them. However, having regard ton the current of judicial authorities, which have examined the issues disputing the execution of documents by pardansheen ladies, it is always advisable for Solicitor/pleader/or notary and preferably to also obtain a certificate from such person regarding the execution of the particular document by such ladies in their presence. This helps in proving the execution. 9. Literates/Illiterate Persons

There is no distinction under law, as far as the execution of documents is concerned, between a literate and illiterate person, and the requirements of a proper and valid execution of a document are same for both of them. While in case of a literate person his consent to the contents of document and execution thereof is indicated and proved in case of dispute with reference to his signature on such document, in case of an illiterate the said object is achieved with reference to his thumb impression. Though there is no specific rule for taking L.I.T. /or R.T.I. but normally as per practice Left thumb impression is taken in case of ladies. The law also does not prohibit to take thumb impression in case of literate persons, but having regard to the fact and modes of proof for proving execution of a document the signature could be proved easily in case of literate persons and perhaps it may be difficult to prove as to what could be a reason for a literate person to put thumb impression if signature has not been obtained. It is also advisably to get the thumb impression attested by some person preferably on advocate or notary, if available. Below thumb impression it should be mentioned I.T.I. or R.T.I. as the case may be. Further in order to avoid any dispute to the awareness of the contents of the documents, even though execution is proved, it is also advisable to obtain a
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certificate with the person witnessing such execution, that the contents of documents, were fully explained to the executant. Stamp Duty on Documents A. Rules relating to stamping of documents

1. Amount of Duty: This must be in accordance with the law prevailing in the State where the document is first executed. 2. Kind of Stamps : Normally these are either general stamp papers or adhesive/ special adhesive stamps. In normal documents like hypothecation or pledge both kinds can be used, but special adhesive stamps are affixed only by the Stamp Office and cancelled by them before execution. A promissory note bears a revenue stamp. For bills of exchange and share transfers there are different kinds of special adhesive stamps. Kinds of stamps differ in different states in accordance with the prevalent rules. 3. Writings on a stamp paper: If general stamp papers are used for a document, each paper should have some substantial part of the document written or typed on it. The action of affixing general stamp papers on printed forms is unlawful. Pasting of stamps with the printed documents is not proper. 4. Time on stamping and execution: A document should be stamped before it is executed. The date of execution should always be subsequent to the date appearing on the stamp.

5. Place of stamping and execution: A document should bear the stamp of that State in which it is first executed. If any executant is in another State, the excess duty, if any, in the other state is to be paid there. 6. Cancellation of Stamps: A stamp must be cancelled in such a way which would ensure that it would not be used again. Special adhesive stamps are cancelled by stamp office. Revenue stamps on Promissory Notes and Other adhesive stamps should be cancelled as stated above. B. Consequences of not stamping a document according to law

If a document is not stamped properly, it violates any of the six rules mentioned above. As to the consequences of not properly stamping, documents are divided into two classes:i. Those documents which are not admissible in evidence at all if any of the rules is violated. These are (a) Promissory Notes, (b) Bills of exchange and (c) Instrument chargeable with a duty of _____ paise. (These are different states). Inadmissible in evidence means they cannot be produced and relied upon in any suit for establishing any right there under.

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ii.

All documents other than these stated above are admissible in evidence after payment of penalty which cannot exceed ten times the deficit duty.

There are provisions in the different Stamp Law in all States authorizing the stamp authority to enter upon any promises for inspection when they have reason to believe that certain instruments are not properly stamped. The stamp authorities have powers to impound any improperly stamped found on inspection. C. 1. 2. Adjudication and impounding Any document can be presented to the Stamp Office for adjudication of stamp duty thereon (i) before execution or (ii) within one month of the date of execution. The stamp authorities certify the document to be properly stamped on charging adjudication fees and deficit duty, if any. Such as adjudication certificate is conclusive that the instrument is properly stamped. Stamp authorities have power to impound any instrument coming before them.

3.

VARIOUS TYPES OF DOCUMENTS 1. DEMAND PROMISSORY NOTE

Following are the ingredients of Demand Promissory Note:a. b. c. d. e. f. g. h. Payable on demand dated, for a certain sum of money only, an unconditional undertaking, made for valuable consideration, signed by the maker, the bank's printed form meets all the above requirements, bearing revenue stamps of appropriate value as per details given below: for amount upto Rs.250.00 for amount over Rs.250.00 but upto Rs.1,000.00 20p.

25 p.

Over Rs.1,000.00 irrespective of the amount 25 p. It is sometimes misconceived that if the signature of the maker is attached or witnessed on the Demand Promissory Note, it becomes a BOND. This point was challenged in Mysore. High Court Raghunath Balkrishna Deshpande Vs.Biharilal Krishna Prasad Dave (A.I.R. 1972 Mysore 15 p.) It was held by the Court that the Promissory Note even if attested does not become a Bond. All the Joint Makers of Promissory Notes need not put their signatures on separate revenue stamps. Neither it is necessary that the signatures of all the makers should appear on revenue stamp. Any effective method of cancellation of stamps will suffice. The propose of cancellation is that it should not be used again.
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It is wrong to believe that the Law of limitation can be avoided by keeping the Demand Promissory Note undated. The stamp of the date later than the actual date of execution is likely to create problems of serious nature and may weaken the bank's case in the Court of law. An unstamped or understamped D/P Note cannot be accepted as legal evidence and no amount of penalty can restore its validity. The signatures of the directors in their individual capacity on the Demand Promissory Note do not make them co-borrowers, they will remain the guarantors. (5. Chattantha Karayalar Vs. Central Bank of India - A.I.R. 1965 Court 1856) (1956 Company Law Cases 610) 2. LETTERS OF CONTINUITY

Letters of continuity must be obtained in addition to the Demand Promissory Note where the advance is likely to fluctuate or adjusted or revived. The signatures should be obtained in the same fashion as on the Demand Promissory Note. It requires to be stamped like any other agreement. It is not necessary to take letter of Continuity where the advance is given by way of loans. 3. AGREEMENT FOR HYPOTHECATION

The hypothecation is an equitable charge where neither the ownership nor the possession of the property is transferred by the borrower to the lender. The rights in the goods are created by virtue of an agreement called "The Agreement called "The Agreement for Hypothecation".

The agreement invariably contains provision, which authorises the bank to take possession of the hypothecated goods at its will. The agreement needs to be stamped in accordance with the rules applicable to agreements in a particular State. The declaration of a stock as given by the borrower to the lender. The rights in the goods are created by virtue of an agreement called "The Agreement for Hypothecation".

The agreement invariably contains provision which authorizes the bank o take possession of the hypothecated goods at its will. The agreement needs to be stamped in accordance with the rules applicable to agreements in a particular State. The declaration of a stock as given by the borrower from time to time constitute the basis for calculating the drawing power. It is important to inspect the stocks periodically and ensure that the stocks are according to the statements and stock register. Although, the possession of the hypothecated stock can be taken without approaching the court of law, in practice some difficulties invariable arise where the borrower does not cooperate with the bank. In certain cases the borrower may even go to the extent of charging the banker for an offence of trespassing in his premises, and harass the latter with the help of the police. In such cases, the better course for the banker would be to approach the police
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first and seek their help in enforcing the rights arising out of hypothecation created through the agreement. EXECUTION This agreement need not be signed by the guarantor, partners in their individual capacity, co-parceners or directors of a limited company. It is necessary to remember that this agreement should not be attested or witnessed. When the possession of goods hypothecated is taken by the banker from the borrower, the charge of hypothecation will be automatically converted into pledge and thereafter the relationship between the borrower and the banker shall be that of the pledger and pledges. and the rights of the parties will be governed by provisions contained in the Indian Contract Act 1872 as related to the pledge. Under Section 125 of Companies Act 1956, the charge of hypothecation, when created by a Limited Company, requires to be registered with the Registrar of Companies on Form No.VIII within 30 days of its creation. The Modification of charge also requires to lbe registered with Registrar of Companies. When the charge is fully satisfied, form Bo.XVIII should be sent to the Registrar. 4. AGREEMENT FOR PLEDGE OF GOODS

Pledge is bailment of goods as security against an advance. Bailment means the delivery of goods by one person to another on the condition that as soon as the purpose for which they are given is accomplished, they shall be returned or disposed of in accordance with the instructions of the person giving the delivery. No writing is necessary for creating the charge of pledge. But, in order to lay down clearly the terms and conditions on which the advance is granted the bank insists on obtaining this agreement. the pledge agreement also widens the scope of the borrower's liabilities and curtails the extent of his rights as pledge of goods. 5. GUARANTEES

Guarantees are in either of the following forms:a) b) D.F. Note signed by the guarantor jointly with the borrower. It binds both of them to be jointly and severally liable. A separate guarantee agreement.

The first method of taking guarantee is adopted only where the relevant guarantee form is not available.

Wherever the relevant form is available the guarantee should be obtained on that form because it will give the bank certain additional rights to which the creditor is not normally entitled. The guarantee will be valid only if the following requirements are complied with :Sr.No. /FIGB Channel/Loan Documents-Updated/Aug.2007/Eng./13 pgs./Version 1

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1)

2) 3)

Sufficient information is required by the guarantor is made available by the banker. The banker need not volunteer the information but at the same time he is not supposed to withhold any information or keep silent about the quarries raised by the guarantor. Since it is doubtful as to what extent the giving of information by the banker is justified, it is better to obtain an Authority Letter from the borrower. The guarantor is not under undue influence, fraud, mistake, mis-representation or coercion. The guarantor is not a minor undischarged insolvent or insane.

It is not necessary for the bank to exhaust all remedies against the borrower before proceeding against the guarantor, because the liability of the guarantor, because the liability of the guarantor is co-extensive with that of the principal borrower (Section 128 of the Indian Contract Act). The guarantee form does need to be signed by the borrower. If the borrower's signature is also obtained in the guarantee form, it is likely to create misunderstandings and legal complications. Revocation and Termination of Guarantee The guarantee can be revoked for future transactions on happing of the following events: a) b) c) On receipt of notice of revocation from the guarantor in that case the guarantor has to give three months notice if necessary. Provision is male in the agreement Notice of death, insolvency, insanity of the principal borrower or. Change in the constitution of the principal borrower when it is a partnership firm The guarantee shall stand revoked for future transaction from the date of receipt of notice about the change in constitution either by admission or retirement or expulsion of a partner etc.

Law of Limitation Law of limitation limits the period within which a suit can be filed against the borrower for recovery of advance. Please note that these are limitations on 'actions', i.e. proceedings in court of Law. They are bars to remedies as distinguished from rights which may continue to be exercisable when no legal action is required, e.g. realization of secrecies when there is a power of sale and the title can be transferred without recourse to the court. When the period of limitation as applicable in a particular case has expired the advance becomes time barred or stature barred. Any suit filed after expiry of period of limitation shall be dismissed by the court with court with costs. The advances which are secured against the D.P.Note becomes time barred after three years from the date of D.P.Note.

EXTENSION OF PERIOD OF LIMITATION

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Right of action may be revived by : a. b. c. fresh set of documents; acknowledgement of debt, part payment

a. Fresh set of documents A fresh set of documents must be obtained well before expiry of three years. But in case where it has not been done or, a fresh set of documents can be obtained even after expiry of the original documents because past consideratio0n (including time barred advance is a consideration. A fresh set of documents will revive the old advance, which had actually become time barred. The fresh set of documents must be dated according to the date of execution and not according to the date of expiry of the original documents. Under no circumstances, the documents should be kept blank as it would not help in avoiding the law of limitation. b. Acknowledgement of debt Letter of acknowledgement of debt obtained before the expiry of the original documents will revive the debt. Where acknowledgement is taken the period of limitation shall start running from the date of acknowledgement t and not from the date of the original documents. The acknowledgement must comply with the following requirements in order to extend the period of limitation. It must be : (i) in writings (ii) signed by the borrower; (iii) addressed to the lender (Bank); (i) bearing revenue stamps of appropriate. The acknowledgement binds only those persons who have signed it. In case of joint debts, if the acknowledgement is not signed by all the borrowers, the advance will be recoverable only from those who have signed it. In case of guaranteed debts, the signature of the guarantor shall also be obtained on the acknowledgement. The acknowledgement obtained after the advance has become time barred, shall not be valid for extension of the period for limitation.

c. Part payment Part payment also extends the period of limitation. Where part amount, either in respect of principal or interest etc. has been deposited by or under the authority of borrower shall revive the debt and the limitation period will start running from the date on which such payment has been made. It should be noted that a part payment not authorized by the borrower shall not be effective for extending the period of limitation. In case of joint debts, part payment by any of the borrowers shall revive the debt against all who were originally liable. LIMITATION AND GUARANTEES

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a. Surety's right against principal debtor for recovery. Three years from the date of payment to the creditor. b. Three years from payment of excess against excess against co-sureties.

Although the cases decided by courts are not identical, the advance may be recoverable from the guarantor even if it has become time barred as against the principal borrower. But the better course would be to renew the guarantee at the time of obtaining fresh set of documents and not to rely on the preceding point of law.

Prepared by Shri B B Tewari, Member of Faculty (1992) Revised by Shri C V Alexander, CAB, Pune (March 2007)

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