Hypothecation
Hypothecation in Indian Lending and Net Worth Proof
Security over movables where the borrower keeps possession and carries on using or trading them, as with vehicles and stock.
Read the definitionNet Worth & Solvency Glossary · Net Worth Mechanics
How Pledged Shares Affect Certified Net Worth
noun · "to pledge" an asset is to hand it over as security · "pledged holdings" is what a demat statement calls shares marked in a lender's favour
Definition
A pledge is security over movable property, such as gold, goods or shares, in which possession or control passes to the lender while ownership stays with the borrower.
A share pledge does this through a depository entry instead of physical delivery. The pledged asset still belongs to the borrower until the pledge is invoked.
Who holds what in a pledge
Ownership and possession come apart. That is the whole mechanism.
The borrower keeps
- Ownership of the asset
- The asset on their own statement, at its own value
The lender gets
- Possession or control of the asset
- A claim the statement discloses against it
Until the pledge is invoked. On invocation the asset passes to the lender, leaves the borrower's statement, and the loan reduces.
The mechanism
What a pledge is and what possession has to do with it
Possession is what makes a pledge a pledge, and it separates a pledge from other security over movables.
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Gold
Handed to the lender
Gold handed to a lender against a loan is pledged. Possession passes by physical delivery.
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Shares
Marked in the demat account
Shares marked as pledged in a demat account are pledged. The depository entry stands in for handing over certificates.
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Stock
Under the lender's control
Stock held in a warehouse under the lender's control is pledged. Possession passes by control of the place it is kept.
The one test
Does the borrower keep the goods and go on using, selling or replacing them?
Then it is hypothecation, not a pledge, whatever the document calls it.
A certifying CA reads what actually happened to the asset, not the heading on the agreement.
Section 172 of the Indian Contract Act, 1872 defines a pledge as the bailment of goods as security for payment of a debt or performance of a promise. Under section 176, if the pawnor defaults, the pawnee may sue on the debt and keep the goods as collateral, or sell them after giving the pawnor reasonable notice; any shortfall stays payable by the pawnor, and any surplus goes back to the pawnor.
On a certified statement
Treating pledged securities when certifying an asset position
A pledged asset still belongs to the borrower, so it stays on the statement at its own value. The pledge, the lender and the amount it secures are disclosed against it.
- The assetStays on the statement at its own value
It still belongs to the borrower, so it is neither removed nor written down for being pledged.
- Against itThe pledge, the lender and the amount it secures
Disclosed next to the asset, so the claim is read beside the thing it is secured on.
- The reader seesBoth the asset and the claim
Neither half on its own gives the position.
On a personal financial statement, "pledged" means exactly this: the asset is yours, but it secures a debt and cannot be freely sold.
One more caution for shares
Their value moves daily
A fall in price can trigger a margin call that changes the position without anything being sold. The certificate therefore states the price used and the date it was taken, and does not suggest the figure holds beyond that date.
- States
- The price used
- And
- The date it was taken
- Never
- That the figure holds beyond that date
The most common overstatement
A pledged holding shown without its pledge
It is also easy to detect, because the pledge appears on the same depository statement.
If the pledge has already been invoked
The shares are gone and the loan has reduced
The statement records both.
The record
Demat pledge entries, NSDL and CDSL records and loan-against-shares practice
Pledged securities leave a clear record in India. A demat pledge is created through the depository system, and the holding statements issued through NSDL and CDSL show the pledged quantity separately.
What a CA reads
The depository holding statement, directly
Issued through NSDL or CDSL, it shows the pledged quantity separately from the free holding, so the pledge is visible on the same page as the shares.
Not a substitute
A broker's summary or a portfolio screenshot
These often show quantity and value without showing what has been pledged.
What these words mean on a demat statement
"Pledge holding" or "pledged holdings" on a demat statement means the shares marked in favour of a lender. They are still in the borrower's account, but they cannot be sold or transferred freely.
Loan against shares
What the facility does to the statement, stage by stage
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1
Sanction
The sanction letter sets the margin the borrower must maintain, and the lender's right to invoke the pledge if the margin is breached.
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2
Until invocation
The shares remain the borrower's, and dividends and voting rights usually stay with the borrower. The statement shows the shares with the pledge disclosed against them.
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3
Invocation
The shares move to the lender outright and leave the borrower's statement, and the loan reduces.
Written by Subham Jhunjhunwala · Reviewed by CA Sundram Gupta
Sources: the Indian Contract Act, 1872 and the depository holding statements issued through NSDL and CDSL. This entry describes Indian practice in general terms and is not legal advice on a particular pledge.
Need help with a certificate that uses pledge? See our Net Worth Certificate.