Liability of Pledger/ Pawnor By CS Shubham Budhiraja


Can Banks make the Managing director personally liable for the dues of the company on basis of a cleverly drafted share pledge agreement? 

Company A took credit facility from the bank and that the MD signed the credit facility agreement in its official capacity. In addition to it, MD pledges its 20,000 shares through share pledge agreement in favor of bank against the credit facility taken by the Company A. There arises some default and bank initiated recovery proceedings before debt recovery tribunal (DRT) under Recovery of debt due to banks & financial institution (RDDBFI) Act which passes the order ex-parte against MD & the Company A and make them liable jointly and severally. DRAT confirmed the order in appeal by holding that the term “borrower” under SARFESI Act includes pledger, etc. Hence, Writ petition under Article 226 seeking prayer in nature of appropriate writ to quash the DRT order & subsequently recovery proceedings. The HC has held that

  1. DRAT has committed error by extending the definition of borrower under SARFESI to that under RFFBFI.

  2. Section 176 of Indian contract act, 1872 clearly states that in absence of any guarantee, the pawner cannot be made personally liable. He is liable only to the extent of shares pledged and not personally. Section 176 is literally read. In present case, MD has not executed any deed of guarantee in favor of bank. In absence of it, he cannot be made personally liable.

  3. Mere because Share Pledge agreement is drafted in a way which says “This agreement is for purpose of benefit of bank…….…” cannot make the MD personally liable because these agreements are drafted by banks in standard form and they cannot be read in their favor.

  4. Liability cannot be fastened on MD mere because same counsel appeared for Company A and MD before DRT and asked time for making payment. To taking a statement as admission of liability, it is first to establish that there is a liability.

Case Law

Relevant Remarks

State of Maharashtra Vs. M.N. Kaul AIR 1967, SC 1634

Whether the guarantee subject matter thereof was enforceable, held, “That depends upon the terms under which the guarantor bound himself. Under the law he cannot be made liable for more than he has undertaken”. It was further held that only when there is ambiguity, is the guarantee to be interpreted contra proferentem i.e. against the guarantor. It was however again emphasised that “the cardinal rule is that the guarantor must not be made liable beyond the terms of his agreement.”

In Central Bank of India Vs. Virudhunagar Steel Rolling Mills Ltd. (2015) 16 SCC 207

The letters of guarantee signed by the directors of the company did not make any mention of any old transactions, it was held that had the intent been to make the directors personally liable for the outstanding liabilities of the company also, it could have been so provided in the letter of guarantee and the directors were thus not personally liable for the dues of prior to the date they signed the letter of guarantee. It was further held that since the deed of guarantee was drafted by the bank, in case of doubt, had to be read against the bank. (It is common knowledge that banking documents are in standard form, got prepared by the bank, with signatures of the borrowers, guarantors etc. being obtained thereon).


SCHEME OF CONTRACT ACT- BAILMENT & PLEDGE

  1. Sections 172 to 179 of the Contract Act are found to be clubbed under the head “Bailment of Pledges” in Chapter IX titled “Of Bailment”, commencing from Section 148 of the Contract Act. Section 148 defines “Bailment” as 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 the same. The person delivering the goods is called the "bailor" and the person to whom the goods are delivered is called the "bailee". Section 171 empowers inter alia the bankers to, even in the absence of a contract to the contrary, retain as a security for a general balance of account, any goods bailed to them.

  2. Sections 172 to 179 provide for Bailments of Pledges. Section 172 provides that bailment of goods as security for payment of a debt is called a “pledge” and the bailor is called the “pawnor” and the bailee, the “pawnee”. Vide Section 173, the Pawnee is empowered to retain the goods pledged, not only for payment of the debt but also for the interest on the debt and all necessary expenses incurred in respect of the possession or for the preservation of the goods pledged. Vide Section 174, a pawnee, in the absence of a contract to the contrary, cannot retain the goods pledged for any debt other than the debt for which the goods are expressly pledged

  3. Section 177 empowers a pawnor to redeem the goods pledged at any time subsequent to the default in payment of debt but before the actual sale of the goods, by discharging the debt owed to the pawnee. Ultimately, Section 179 provides that where a person pledges goods in which he has only a limited interest, the pledge is valid to the extent of that interest.

  4. Pawnor, merely by his act of delivering his own goods to a creditor in consideration of a credit facility granted to the debtor/borrower, by legal fiction becomes liable for the entire debt, would be detrimental to trade and commerce, with borrowings becoming difficult to obtain owing to persons not agreeing to make a pledge of their goods for credit to another, for the fear of becoming liable for more than the value of the goods. It is thus felt that to interpret Section 176 so, would be detrimental to public interest

  5. Pawnor, if not otherwise liable for the debt as a borrower or as a guarantor or otherwise, does not merely from the act of making a pledge, become liable to the creditor/pawnee, for anything more than the value of the goods pledged.

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