Consortium Regulations

This is common where term loans are shared between financial institutions and banks, unlike other forms of mortgages, equitable mortgage is created without, advalorem stamp duty except in the State of Gujarat and hence it is widely accepted.

Some of the financial institutions insist on registered legal mortgage as per their own rules. However, they accept registered mortgage for a small token amount of the term loan, and the remaining by equitable mortgage, to reduce the heavy stamp duty burden.

In such cases, the borrower creates a registered mortgage for say Rs. 2 lacs out of Rs. 30 lacs term Loan with a participating commercial bank and creates mortgage by deposit of title deeds for the remaining amount. The bank where these mortgages are created is authorised by all the other participants to accept and hold the relative title deeds on their own behalf and on behalf of others as agents.

Financial institutions further insist that portion of the term loan covered by registered mortgage is stipulated to be repaid after all other portion of term loan covered by equitable mortgage are repaid. All other usual formalities such as etter ceding pari passu charge, interse agreement, joint hypothecatoin deed, common loan agreement, esolutions are obtained.

i) where the current assets and block assets are already charged to banks and or financial institutions, for the working capital finance and the term loans, further charge can only be created by way of second charge in favour of those desirous of securing their commitment/involvements with the borrowers;

ii) for creation of second charge, the borrower should be willing and the consent letter of the prior first mortgagee, is also required (usually, the first mortgage, contains a covenant or undertaking from the borrower that he will not further encumber or create a charge in favour of any other person without the consent of the first mortgagee).

iii) second charge on current assets or on moveable and moveable machinery etc. does not involve much of a difficulty, as there are no title deeds involved, and, the usual documents creating floating charge are obtained together with the consent letters of prior charge holders and the charge is registered with Registrar of Companies.

iv) in the case of fixed assets covered by title deeds relating to land & building, there are conflicting opinions expressed by eminent jurists like Mr. C. K. Daphtary and Mr. H. M. Seervai. Mr. H. M. Seervai is of the opinion that a second mortgage by deposit of title deeds is not legally possible notwithstand- ing whether the prior mortgage is legal or equitable. However, bankers and financial institutions like IDBI / IFCI and SFCS have accepted Mr. C. K. Daphtary's views that second charge can be created even by way of deposit of title deeds.

v) Accordingly, the first mortgagee who is in possession of the title deeds hands over the same to the borrower to enable him to re-deposit back with them with an intent to create a second mortgage in favour of the agreed institution. They will be holding the title deeds on their behalf as first mortgagee and as agent for the second mortgagee.

vi) No problem is envisaged if such a second charge is to be created by way of registered legal mortgage involving 'advalorem' stamp duty.

vii) Accepting a second mortgage by us is normally on basis of our estimation that the value of the property is so adequate as to satisfy fully the first mortgage and still leave some residue. Even where the security as on date is not adequate, the possible appreciation in its value in the inflationary economy will improve the second mortgagee's coverage, and hence, taking of a second mortgage may be stipulated for whatever it is worth in some cases.

viii) Branches are required to get all the connected documents, draft resolution, letters ceding pari passu charge, memorandum of entry, narration in title deed register etc. approved by our Legal Department before finalisation and execution of the second charge. Branches should remember that in as much as the equitable mortgage also get time barred after expiry of 12 years after its creation, the title deeds should be got re-deposited well in time to prevent limitation acting against us. In the normal course, care should be taken to see that the bank duas are recovered within the validity of the mortgage.

ix) Creation of equitable mortgage also needs to be registered with the Registrar of Companies under Indian Companies Act and therefore, branches should get the equitable mortgage registered in the books of the Registrar of Companies.

This condition is now being stipulated by many term lending financial institions as additional cover for their term loan in addition to first charge on block assets, though in effect, this charge is in the nature of a second charge, the first charge being in favour of bankers. The manner in which the above charge is expressed will probably put them ahead of second charge holders, if any.

In our bank, we have decided, that wherever we are the bankers for the working capital, if we are to furnish a no objection letter for the creation of such a charge as above, or a second charge on the current assets, we should not furnish the same as a matter of routine. If the institutions are prepared to cede a second charge on block assets that are charged to them, as an additional cover for our working capital, then, on a reciprocal basis, we may agree to cede the same.

(A) By ceding 'pari passu' charge, we agree to share the securities with other banks/institutions in relation to the liabilities of the borrower to the concerned banks and institutions. As this may involve dilution of the security, it should be ensured that the institutions in whose favour pari passu charge is ceded, also makes their contribution to the borrower's financial needs.

It should also be ensured that periodical fund based releases create further assets such that our security coverage is not diluted. Where a bank or financial institution agrees to fund the excess borrowing or arrears of interest or borrowings in excess of security cover (say arising on account of continuous cash losses) against paripassu charge, the other banks, or financial institutions agreeing to cede such a charge will be diluting their security.

Also, some of the financial institutions, demand paripassu charge, for interest free sales-tax loans for 'seed capital loans'. Generally such loans are not to be granted against any security at all. We should, therefore, ordinarily resist such a demand. The request should be examined in detail and its implication understood before ceding such a paripassu charge.

Once a pari passu charge is ceded, it should be borne in mind that we cannot take unilateral action in recalling the advance or for the enforcement of the securities. It will be legally necessary to consult all the other pari passu charge holders and initiate joint action for enforcement of the securities. This is a grave handicap.

(B) CEDING SECOND CHARGE

By ceding a second charge, we are recognising the financial/borrowing arrangement of the borrowers against the same security charged to us. The need for second charge should be clearly understood and examined. Unlike in the case of 'pari passu charge' we are not obliged to consult the second charge holder for recalling our advance or for enforcement of securities. However, having been put on notice, we are dutybound to hold the securities on our behalf and on behalf of second charge holders as their agents.

When the debt is satisfied or recovered out of sale proceeds of securities, the securities or its residue or residue of sale proceeds should be handed over to the second charge holders, and, not to the borrowers. As this is a legal right of the second charge holder,we should have a proper record of having ceded a second charge and, copies of the letters ceding pari passu charge or second charge should be kept along with the documents to avoid any possible omission on a later date. This is an important requirement.

(C) CEDING 'FIRST CHARGE'

When the existing assets are charged to us by way of first charge, borrowers/other subsequent lenders may require us to cede either a pari passu charge on all the assets or first charge on the new/fresh assets that may be acquired with the advance granted by them. Whether, as the first charge holder, it is adviseable to cede pari passu charge on all the assets or a first charge on the new assets will depend upon the circumstances of each case. This is illustated as under :

It can be seen from the above illustration that in case (1) by ceding pari passu charge, the margin coverage in bank's favour gets diluted and in the case (2), it gets improved. Therefore, banks should prefer ceding first charge on new assets proposed to be acquired, in favour of the new lenders in case (1), and, agree for pari passu charge in case (2).

As the documents creating a charge normally contains a provision for a floating charge on the existing and or future assets in favour of the lenders, the new lenders are obliged to seek the consent from the prior charge holders, and upon such a request being received, the prior charge holders should seek full details of the new borrowing arrangements, together with cost/means of finance etc, so that they can decide whether they should consent for ceding first charge on the new assets or for pari passu charge in favour of new lenders on all the assets.