Applicability of the Karnataka Micro Loan and Small Loan (Prevention of Coercive Actions) Ordinance, 2025 to auto-finance and hire purchase.

S. Basavaraj, Senior Advocate, Bengaluru.

1. The Hon'ble Supreme Court of India Charanjit Singh Chadha v. Sudhir Mehra, (2001) 7 SCC 417 had an occasion to consider the issue as whether the hire-purchase amounts to money lending and the profit generated from the contract amounts to interest. 

2. In para 5 of its judgement, the Supreme Court analysed the issue that the “Hire-purchase agreements are executory contracts under which the goods are let on hire and the hirer has an option to purchase in accordance with the terms of the agreement. These types of agreements were originally entered into between the dealer and the customer and the dealer used to extend credit to the customer. But as hire-purchase scheme gained in popularity and in size, the dealers who were not endowed with liberal amount of working capital found it difficult to extend the scheme to many customers. Then the financiers came into the picture. The finance company would buy the goods from the dealer and let them to the customer under hire-purchase agreement. The dealer would deliver the goods to the customer who would then drop out of the transaction leaving the finance company to collect instalments directly from the customer. Under hire-purchase agreement, the hirer is simply paying for the use of the goods and for the option to purchase them. The finance charge, representing the difference between the cash price and the hire-purchase price, is not interest but represents a sum which the hirer has to pay for the privilege of being allowed to discharge the purchase price of goods by instalments.”

3. The Hire Purchase Act, 1972, was passed by Parliament; however, it has yet to be notified in the Official Gazette by the Central Government. Although an initial notification was issued, it was subsequently withdrawn. In the absence of statutory enforcement, the principles governing hire-purchase agreements have been shaped by judicial precedents. A series of rulings by this Court have elaborated on the nature of hire-purchase agreements, primarily in the context of determining whether such transactions constitute sales for the purpose of tax liability under the Sales Tax Act.

4. In Damodar Valley Corpn. v. State of Bihar [AIR 1961 SC 440] The Supreme Court has held that a mere contract of hiring, in itself, constitutes a form of bailment and does not confer title upon the bailee. However, over the past half-century, the law of hire purchase has undergone significant evolution, introducing various distinctions that make it increasingly complex to categorize specific agreements.

5. Ordinarily, a hire-purchase contract does not transfer ownership to the hirer but merely grants an option to purchase, contingent upon fulfilling certain conditions. Some agreements, however, incorporate a provision for deferred payments, wherein ownership remains with the lender until all installments are paid in full. Additionally, various other forms of hire-purchase contracts exist, depending on the specific terms negotiated by the parties.

6. Complications arise when third-party rights are introduced, either through contractual arrangements or by operation of law, necessitating an examination of the precise rights and obligations of the original contracting parties.

7. In K.L. Johar & Co. v. CTO AIR 1965 SC 1082, the Supreme Court recognized that a hire-purchase agreement consists of two distinct elements: (a) Bailment, wherein the hirer takes possession of the goods without acquiring ownership. (b) Sale, which is contingent on the hirer fulfilling the conditions of the agreement and exercising the option to purchase.

8. The element of sale materializes only when the hirer completes all contractual obligations and formally exercises the purchase option. At that point, the transaction transitions from mere hiring to an actual sale, transferring ownership of the goods that were previously held on hire.

9. The agreements in hire-purchase executed by the parties are to the effect that the hirer would not become the owner of the property until he pays the entire instalments. The agreements specifically state that the first party would be the absolute owner of the vehicle and the second party agreed to pay all the instalments punctually. The agreements also say that the hirer may, at any time before the final payment under the hire-purchase agreement falls due and after giving the owners not less than fourteen days' notice in writing of his intention to do so and redelivering the vehicle to the owners at their office, terminate the hire-purchase agreement. The clauses in the agreements give right to the owners to repossess the vehicle in case of default by the hirer. An irrevocable licence to enter any building, premises or place where the vehicle may be or is supposed to be for the purpose of inspection, repossession or attempt to repossess the vehicle and the owner of the vehicle will not be liable for any civil or criminal action at the instance of the hirer is also provided. The contracts make the hirers liable for all the expenses of the owner in obtaining repossession or attempting to obtain repossession of the vehicle.

10. The hire-purchase agreement in law is an executory contract of sale and confers no right in rem on the hirer until the conditions for transfer of the property to him have been fulfilled. Under the hire-purchase agreement, the owners continue to be the owners of the vehicle. 

11. In the light of the above settled legal position, the Karnataka Micro Loan and Small Loan (Prevention of Coercive Actions) Ordinance, 2025 cannot be made applicable to auto finance and vehicle purchase through hypothecation.

12. The following aspects also contribute to the above view. Auto Finance is a secured loan, not a micro loan. The Ordinance deals with small and micro loans, often unsecured, that are taken by economically vulnerable borrowers. Auto finance loans are secured loans where the vehicle itself serves as collateral. The risk is significantly lower for lenders in auto finance because the financed vehicle can be repossessed in case of default.

13. Why secured loans should be exempt: Hypothecated vehicles can be lawfully repossessed without coercion. Microfinance loans have no physical security, leading to the need for borrower protection. The hypothecation process is legally recognized and follows due process of law.

14. Why additional regulation under the Ordinance is unnecessary: Lenders already follow laws such as Contract Act and the terms and conditions under agreements in writing. The contracts provide lawful repossession mechanisms, eliminating coercion.

Microfinance sector issues (unethical recovery, overcharging) do not apply to auto finance. Auto Loans Are Not Given to "Vulnerable Sections" as Defined in Section 2(g). 

15. The ordinance focuses on protecting farmers, vendors, construction workers, and other economically weaker sections from loan sharks. Auto loans, however, are taken by individuals with stable incomes, often requiring credit checks, income verification, down payments, legal hypothecation agreements

16. Auto loan borrowers are different from microfinance borrowers. Auto loans involve formal contracts, legal hypothecation, and systematic recovery procedures where as microfinance targets vulnerable groups who may not have formal banking access. Auto finance borrowers have greater financial literacy and structured repayment options.

17. Hypothecation-based repossession is legal and not coercion. Section 8 of the Ordinance criminalizes "coercive recovery actions" such as intimidation, harassment, and undue pressure. Vehicle repossession under hypothecation is not coercion but a contractual remedy for default. Thus, including auto finance in the ordinance could make even lawful repossessions illegal.

18. Why hypothecation should be treated differently: The lender has legal ownership rights over the vehicle until full repayment. Repossession follows due process and does not involve unlawful coercion. Microfinance loans lack such legally enforceable security, leading to exploitative recovery practices.

19. Negative impact on the auto finance industry. If the Ordinance applies to vehicle loans, it would create legal uncertainty for auto finance lenders. Banks, NBFCs, and car dealerships that finance vehicles would hesitate to offer loans, fearing regulatory intervention. Repossessions and resale of hypothecated vehicles may face legal hurdles, increasing default risks.

20. Economic consequences of including auto finance:
Higher loan rejection rates for low-income buyers.
Increase in interest rates to cover the risk of default.
Slowdown in automobile sales, impacting employment in the industry. Auto finance and vehicle purchase through hypothecation should be excluded from the Ordinance because: It is already regulated by Contract Act and the agreements in writing. It involves secured loans, unlike microfinance. Borrowers are not part of the “vulnerable section” targeted by the Ordinance. Repossession through hypothecation is a legal remedy, not coercion.

In conclusion, applying the Ordinance to auto loans would disrupt vehicle financing and economic activity. 

S. Basavaraj 
Senior Advocate 
Bengaluru
raj@dakshalegal.com

Note: The author has used ChatGPT for the initial analysation of the Ordinance