Collateral Management Obligations - Complete Legal Breakdown

Collateral Management is not just holding security, it creates bailment. Therefore every party has statutory obligations under Indian Contract Act 1872, RBI Master Directions, Depositories Act 1996 and SEBI Regulations.

I. OBLIGATIONS OF PAWNEE / BANK / COLLATERAL MANAGER

This is the heaviest burden. When you take possession, you become bailee.

1. Duty to Take Reasonable Care - Sec 151 & 152 Contract Act

The pawnee must take as much care of goods bailed as a man of ordinary prudence would take of his own goods of same bulk, quality and value.

Case Law: Mahendrakumar Chandulal vs Central Bank of India, 30 March 1983
Court held Sec 152 protects pawnee only if he proves he took care under Sec 151. He is required to take ordinary care. But he can contract out of Sec 151 by special contract. Bank failed to maintain warehouse lock, goods stolen - held liable.

Case Law: Gurco Pharma P Ltd vs Syndicate Bank, Delhi HC 7 Dec 1984
Same ratio: Degree of care is that of ordinary prudent man under similar circumstances. If goods pledged deteriorate due to bank's failure to insure, ventilate, fumigate - bank liable.

2. Duty NOT to Make Unauthorized Use - Sec 154

If pawnee uses pledged gold, shares, machinery for own purpose, he is liable for loss even without negligence.

Example: Bank pledges customer's gold further to another bank without consent - illegal.

3. Duty NOT to Mix Own Goods with Pledged Goods - Sec 155, 156, 157

If bank mixes, and goods can be separated, must bear separation cost. If inseparable, must share loss proportionately.

Practical relevance: Gold loan - bank storing 100 borrowers' jewellery in one locker without separate pouches/tags is breach.

4. Duty to Return on Repayment - Sec 160, 161, 163

Once debt repaid, collateral must be returned immediately. If bank fails, liable for loss from date of demand.

NEW LANDMARK OBLIGATION - Making Charges + Stones:

Canara Bank vs B.K. Balaraju, Karnataka State Consumer Commission, Appeal No. 556/2020, Order dated 30 July 2026

Facts: Borrower pledged 120.8 gm and 133 gm gold for two loans of Rs 1.5 lakh each. Jewellery stolen in robbery while in bank custody. Bank paid only net gold value Rs 2,600/gm and Rs 2,500/gm.

Held: Bank cannot limit compensation to net gold value. When ornaments lost in bank custody, bank must pay prevailing rate including 20% making charges + 3% stone value + 9% interest + Rs 30,000 compensation + Rs 10,000 litigation. Making charges are ordinarily levied, invoice not needed.

This is now leading case on pawnee's obligation to compensate full ornament value, not melt value.

5. Duty to Give Reasonable Notice Before Sale - Sec 176

Most litigated obligation.

Balkrishan Gupta vs Swadeshi Polytex (1985) 2 SCC 167
Lallan Prasad vs Rahmat Ali AIR 1967 SC 1322
PTC India Financial Services Ltd vs Venkateswarlu Kari (2022) INSC 479

Rule: On default, pawnee has 2 options:
a) Sue pawnor and retain goods as collateral security, OR
b) Sell after giving reasonable notice of sale.

What is reasonable? Not fixed period, but must give time to redeem under Sec 177.

PTC India 2022 Clarification for Demat Collateral:
Recording yourself as beneficial owner under Reg 58(8) SEBI Depositories Regulations is NOT sale. It is only procedural step to enable sale. You must still give Sec 176 notice and sell to third party. Sale to self is void. Pawnor can redeem till actual sale to third party.

If bank sells without notice, sale void and pawnor can sue for damages or redemption.

6. Duty to Account for Surplus & Right to Sue for Deficiency

If sale proceeds > debt, surplus to pawnor. If < debt, can sue for balance.

II. OBLIGATIONS OF PAWNOR / BORROWER

Duty to Repay & Bear Extra Expenses - Sec 177: If he redeems after default time, must pay extra expenses due to default.

Duty to Disclose Defects - Sec 150: If goods have hidden defects causing loss to bank (e.g. spurious gold, defective shares), pawnor liable.

Duty to Indemnify if Title Defective - Sec 179: Where pawnor has only limited interest, pledge valid only to extent of interest. If he pledges goods he doesn't own, liable.

III. BANK'S SPECIAL OBLIGATION - GENERAL LIEN UNDER SEC 171

Balagam Sri Vijaya Bhargavi vs Union Bank of India, AP HC WP No. 6724 of 2026, 2026 LiveLaw (AP) 220

Facts: Gold loan Rs 2.85 lakh for 67.1 gm repaid, but bank retained ornaments citing general lien for husband's housing loan where petitioner was co-applicant.

Held: Under Sec 171, bank has general lien over goods bailed in absence of contract to contrary. Court examined Clause 11 of Gold Loan Pledge Form which said ornaments shall be security for all debts already granted or to be granted, solely or jointly.

Since petitioner herself authorized bank to retain for all debts, bank can retain. If no such clause, bank cannot retain gold loan ornaments for unrelated loan.

Obligation: Bank must prove explicit clause authorizing retention for other debts. Cannot retain without notice and cannot use gold loan collateral for third party's dues.

IV. OBLIGATIONS OF DEPOSITORY PARTICIPANT & PLEDGEE IN DEMAT COLLATERAL

Under Sec 12 Depositories Act + Reg 58 SEBI:

1. DP must make entry on intimation of pledge.
2. DP must not register pledgee as beneficial owner unless pledge deed and invocation letter provided.
3. DP must maintain audit trail.

Failure = SEBI penalty + civil liability.

V. OBLIGATIONS UNDER RBI COLLATERAL FRAMEWORK

1. Valuation Obligation: At current market price only, by approved valuer under Wealth Tax Act Sec 34AB. Fresh valuation if >6 months.
2. LTV Maintenance: Ongoing. For broker lending from 1 April 2026, 100% collateral cover mandatory with prescribed haircuts. Cash, securities, receivables, immovable property eligible; short-tenor CP/NCD not eligible.
3. Custody & Insurance: Bank liable for deterioration, theft during custody (Canara Bank case).
4. No Collateral Mandate: Upto Rs 2 lakh KCC - must waive collateral, cannot demand. Upto Rs 20 lakh MSE - must not accept collateral.
5. Return within 7 days: RBI Gold Loan Directions 2025 - return collateral within 7 days of repayment, else penalty Rs 5,000/day.

VI. OBLIGATIONS OF HYPOTHECATION BORROWER - NOT TO SELL

Borrower must not sell hypothecated stock without bank consent, but breach is civil, not criminal breach of trust unless dishonest intention proved - CBI vs Duncan Agro Industries.

Summary Checklist for a Legally Compliant Collateral Manager

For Lender:

•  Separate tagged storage + insurance + CCTV
•  Two valuation reports + photograph
•  Explicit Clause 11 type authorization if you want general lien
•  Sec 176 notice by registered post + email + 15 days minimum
•  Never sale to self, only via auction/e-market to third party
•  Return surplus + making charges if lost
•  Return within 7 days of closure

For Borrower:

•  Redeem before actual sale, pay extra expenses
•  If sale without notice, file Sec 17 DRT or suit for redemption + damages
•  If gold lost, claim making charges + stone value + interest (rely on Canara Bank 2026)