SECURED VS UNSECURED BUSINESS LOANS IN INDIA: A LEGAL PERSPECTIVE
Indian firms rely on access to credit; how loans are formulated, however, can matter for the law. It wasn’t just matters of money to decide upon but also legal considerations – secured business loan or unsecured business loan. Before taking a bet on one or the other, entrepreneurs need to understand what they mean under Indian laws, regulations and contracts.
Legal Framework: Secured Business Loans
A secured business loan is a loan in which the borrower offers security to secure the loans; this could be property like land, machinery, fixed deposit, or stock. The lending party thus stands to gain a legal entitlement over the asset till the time the loan is liquidated. Important Legal Issues:
1. Charge Creation
The Indian Contract Act, 1872 and the Transfer of Property Act, 1882 allow creation of security in form of mortgage, pledge or hypothecation. On the part of the companies, charges will have to be filed under the Companies Act, 2013 before the Registrar of Companies (ROC).
2. Enforcement
Where there is default, the lender can enforce his security. The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002, allows the secured creditors (primarily, the banks and financial institutions) to take the collateral under its control and sell it without the involvement of the court.
3. Precedence of Claims
In the insolvency procedures under the Insolvency and Bankruptcy Code (IBC), 2016, secured lenders have a privilege to receive the proceeds ahead of unsecured lenders.
Borrowers Will Benefit Through:
● Lower interest rate because of less legal risk.
● Increase in loan limits as the position of the lender is safeguarded.
Borrowers’ Risks:
● Loss of assets by law in case of default.
● Procedures of documentation, valuation and registration that are lengthy.
Unsecured Business Loans: Legality
Unsecured business loans are given without collateral. Banks base their lending on the financial stability of the lender, his credit worthiness, and his invoice management.
Important Legal Issues:
- ● Contractual Obligation These are loans upon which only the loan agreement is the deciding factor as per Indian Contract Act, 1872. The borrower has to observe repayment schedules and terms.
● Recovery in Default - Lack of Collateral Lenders, therefore, use:
• Instituting recovery under recovery suits in civil courts, under the Code of Civil Procedure (CPC).
• In case of the company being the borrower then initiating proceedings under IBC, 2016.
• With the help of arbitration clauses (in the event of their presence in the loan agreements).
• Debt Collection Regulation – The RBI rules govern the recovery process and recovery agents are not allowed to use threat or even harassment practices.
Borrower Benefits:
● No pledge of assets needed and thus business ownership remains.
● Quicker release and easier records.
Borrowers’ Risks:
● Increased interest rates to cover the legal risk of a lender.
● Less loan amounts, which are not always adequate to large expansion.
● Harsh dependency on credit rating and finance past.
Conclusion
From a legal perspective, the differences between secured and unsecured business loans in India is due to the character of rights and remedies that lenders have the opportunity to exercise. Under SARFAESI and IBC, lenders have the legal authority to test and enforce secured loans against collateral that has been ratified while the loan is still immature. However, when derivative contracts are executed, lending has no effect through contractual remedies or the legal system. To the entrepreneur, this translates to a calculation not only of the cost of borrowing but also the legal risk in the instance of default. Whereas the secured loans involve risk of loss of assets, the unsecured loans lead businesses to lawsuits and increased interest rates. The careful borrower should approach loan agreements critically, be aware of rights and duties as defined under Indian laws, and consult with professional legal counsel when the need arises, prior to signing on the dotted line.
