The forms of security, registration with the Registrar of Companies and CERSAI, drafting the default and the preference risk.
A settlement is only as good as the debtor's ability and willingness to perform it. A creditor who agrees to accept less than the claim, or to accept it over time, should ask what happens if the debtor fails again. Security is the answer: it converts a promise into a claim against something. This note describes the forms of security commonly taken in a recovery settlement and the formalities that make them effective. It is general information, not advice on a particular settlement.
Forms of security
- Post-dated cheques. A cheque for each instalment, drawn on the debtor's account. A dishonoured cheque given for a legally enforceable debt may be the subject of a complaint under Section 138 of the Negotiable Instruments Act. The cheque should be drawn for a debt that exists under the settlement, and the settlement should say so.
- Guarantee. A personal or corporate guarantee from a person with assets. The creditor should keep it alive, as discussed in the note on guarantees, and obtain the guarantor's written consent to any change.
- Mortgage or charge. A mortgage of immovable property under the Transfer of Property Act, 1882. A mortgage by deposit of title deeds and a registered mortgage are both used; a mortgage securing more than one hundred rupees can only be made by a registered instrument, except in the case of a mortgage by deposit of title deeds, which is available in certain towns.
- Hypothecation. A charge over movables, stock or receivables.
- Escrow or assignment of receivables. A direction that a customer of the debtor pays into an account that the creditor controls, with the balance released to the debtor after the instalment is met.
- Pledge of shares. Shares held in dematerialised form are pledged through the depository system.
Making the security effective
- Check title. Before taking a charge over property, confirm ownership, existing encumbrances and the debtor's authority, including any board resolution and shareholder approval required for a company to create security.
- Register the charge. A company must register a charge with the Registrar of Companies under Section 77 of the Companies Act, 2013, within thirty days of creation, with limited time to condone delay on payment of additional fees. An unregistered charge is not effective against a liquidator or other creditors.
- Register with CERSAI. Under Section 23 of the Securitisation Act, a security interest should be filed with the Central Registry within thirty days of creation, and the register is searched by later lenders.
- Pay stamp duty and register the instrument where the law requires. An under-stamped instrument is not admissible until the duty and penalty are paid.
- Take possession of documents where the security depends on them, such as title deeds or share certificates.
Drafting the default
The settlement should state the events of default, including a missed payment, the dishonour of a cheque, the debtor's insolvency, and the creation of competing security. It should say what follows: acceleration of the full amount, the right to enforce the security without further notice beyond what the law requires, and the reinstatement of interest and of any waived sum. A court will enforce reasonable terms, but it may reduce a sum that is out of proportion to the loss, under Section 74 of the Contract Act.
Combine with a decree
Where there is a pending suit, the settlement can be made a consent decree, so that security and default provisions have the force of a decree. Where there is no suit, the settlement can be a contract, and the creditor has to sue on it if the debtor defaults. The first position is stronger.
A caution on preferences
If the debtor later enters insolvency, security granted shortly before may be challenged as a preferential transaction under Section 43 of the Insolvency and Bankruptcy Code. A creditor taking security from a debtor in distress should document the new value or forbearance it gave in exchange, and should be aware of the look-back periods of one year and, for related parties, two years.
This note is general information on the law at the date of publication. It is not legal advice, and it should not be relied on without advice on the facts of a particular matter.
