Hypothecation

Hypothecation is a form of security interest over movable property in which the borrower keeps possession and use of the asset while the lender holds a charge over it as security for a loan. If the borrower defaults, the lender (a secured creditor) can take possession of the hypothecated asset and sell it to recover the outstanding dues. It differs from a pledge, where the lender physically holds the goods, and from a mortgage, which applies to immovable property.

Legal basis

Hypothecation is defined in Section 2(1)(n) of the SARFAESI Act, 2002 as "a charge in or upon any movable property, existing or future, created by a borrower in favour of a secured creditor without delivery of possession," and it expressly includes a floating charge that later crystallises into a fixed charge. Banks and NBFCs enforce hypothecated security under the SARFAESI Act, often without court intervention.

How it works in practice

• Vehicle loans: the lender's charge is recorded in the Registration Certificate under the Motor Vehicles Act, 1988; it is removed via Form 35 once the loan is cleared.
• Working-capital / inventory finance: stock, receivables and other current assets are hypothecated as a floating charge.
• Company borrowers: the charge must be registered with the Registrar of Companies within 30 days in Form CHG-1 under Section 77 of the Companies Act, 2013; satisfaction is filed in Form CHG-4.

Why it is used

Hypothecation suits assets a business needs to keep operating, letting the borrower run vehicles or trade in stock while the lender retains enforceable security.