Difference Between Lien and Pledge

Lien vs Pledge
 

Companies frequently borrow funds for investment, expansion, business development and operational requirements. In order for banks and financial institutions to grant funds to borrowers, there needs to be some form of assurance that the borrowed funds will be repaid to the lender. This assurance is obtained when borrowers offer an asset (as collateral) of equivalent or higher value to the lender. In the event that the borrower fails, the lender then has means to recover any losses. There are a number of security interests that are used by lenders which include mortgage, lien, pledge and charge. The following article takes a closer look at two such security interests, lien and pledge, and highlights their similarities and differences.

Lien

A lien is a claim on an asset such as property or machinery that is used as collateral against funds borrowed or for the payment of obligations, or performance of services to another party. The lien will provide the lender the right to detain the borrower’s assets, property or goods to secure payment over obligations. The lender can only detain the property/assets/goods until payments are made, and do not have the right to sell any such assets unless explicitly stated in the lien contract. Nevertheless, the lender should be cautious when selling off assets to safeguard against any charges of liability. There are instances in which financial institutions, individuals or entities that are owed money use legal avenues to impose a lien on the borrower’s assets; thereby securing against default. In such instances, the lender does not have any right to sell off the borrower’s assets. There are different types of liens such as construction/mechanic’s liens that are placed on house owners who owe funds to construction and repair workers who provide services for property improvement. Other liens include agriculture liens, maritime liens and tax liens. Liens are also imposed for receivable rent, unpaid premiums, or fees.

Pledge

A pledge is a contract between the borrower (or party/individual that owes funds or services) and lender (party or entity to which the funds or services are owed) in which the borrower offers an asset (pledges an asset) as a security to the lender. In a pledge, the assets will have to be delivered by the pledger (borrower) to the pledgee (lender). The lender will have limited interest with regard to the pledged asset. However, the possession of the pledged asset will give the lender legal title to the asset and the lender has the right to sell the asset in the event that the borrower is unable to meet his obligation. If the assets are sold off, the surplus funds remaining (once the due amount is recovered) needs to be returned back to the pledger. Pledges are frequently used in trade finance, commodity trading and in the pawning industry.

Lien vs Pledge

Liens are pledges are quite similar in that they are both security interest options that are used for the same purpose; that is to ensure that funds are repaid, obligations are met and services are performed. A lien can be formed by agreement between the two parties, or can be imposed by law. A pledge, on the other hand, can only be created by contract. The other major difference between the two is that a lien is the right to detain the assets/property but the lender has no right to sell the assets unless stated in the contract. As for a pledge, the lender retains title to the asset until the obligation is met; and in the event of default, the lender has the right to sell the assets and recover losses. Furthermore, pledges are made on assets that can be physically delivered, whereas liens can be on property or assets.

Summary:

Difference Between Lien and Pledge

• Liens are pledges are quite similar in that they are both security interest options that are used for the same purpose; that is to ensure that funds are repaid, obligations are met and services are performed.

• In a lien, the lender can only detain the property/assets/goods until payments are made, and do not have the right to sell any such assets unless explicitly stated in the lien contract.

• In a pledge, the assets will have to be delivered by the pledger (borrower) to the pledgee (lender). The pledgee will have the legal title to the asset and has the right to sell the asset in the event that the borrower is unable to meet his obligations.

  • Adam F

    ‘As for a pledge, the lender retains title to the asset until the obligation is met; and in the event of default, the lender has the right to sell the assets and recover losses.'; ‘The pledgee will have the legal title to the asset and has the right to sell the asset in the event that the borrower is unable to meet his obligations.’ I’m not sure which jurisdiction this is written in relation to, but under English law, the above statements are not correct. Neither a lien nor a pledge confer legal title: they are both possessory forms of security by which the borrower will retain ownership and the lender will gain possession until the discharge of the debt (a mortgage by contrast does confer title on the lender, but not possession).

    A good example of the contrast between a pledge and a lien is:

    1. Pawning a bracelet at a pawnbrokers (pledge relationship); and
    2. a mechanic fixing a customer’s car when payment has not yet been made (lien relationship).

    In both situations possession of the assets (bracelet and car) is with the party benefiting from the security (mechanic and pawnbroker), but ownership remains with their respective customers. In both situations, once the customers have fulfilled their obligations by way of payment, the pledge/lien relationship will end and possession of the assets will be returned to them. The key difference is that the pawnbroker has the implied right to sell the bracelet in the event of default, whereas the mechanic merely has the right to retain possession of the car. An additional difference, is that the pledge will have arisen by contract between the customer and the pawnbroker, whereas the lien (a common law lien in this case) will have arisen by the automatic operation of English law.

    Your point about pledges requiring physical delivery of assets and it being possible for liens to be granted over assets not capable of delivery is partly true. Pledges do require physical delivery. However, it is only an equitable lien that does not require possession of property to which it attaches (e.g. land). Under common law and statutory liens, actual possession will still be required.