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 [email protected] and [email protected] 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)]

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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