Before studying the special conditions governing a bank's advances on the security of merchandise, etc., it is necessary to grasp thoroly the difference between security afforded by warehouse receipts under Section 86 and the security on a loan given under Section 88 of the Bank Act. The main difference is one of the possession of the goods, namely, constructive and actual possession of the security, respectively.
Advances on a warehouse receipt or bill of lading can be made to any person, and the continued existence of the security depends upon the reliability of an independent party, the warehouseman or carrier, production and surrender of the warehouse receipt being necessary to obtain the goods. Loans of this kind are reasonably safe, and the conditions governing them are very simple.
In the case of advances made under Section 88, however, the conditions are much more complicated, as advances under this section can only be made to manufacturers and wholesalers dealing in certain classes of goods, the continued existence of the security depending entirely upon the probity and the ability of the pledger, who retains possession and control of the goods himself. Consequently, a bank never lends money under Section 88 unless it is absolutely certain of the honesty and experience of the customer. Even then, loans of this class are not very desirable, owing to the technical detail and work involved in their operation. There is always a latent risk. Men who have had no previous experience in this kind of business, no matter how competent in other lines, are not good credit risks for this kind of loan. They should furnish good indorsements or other security in addition, until they have shown by actual experience that their operations are successful.
Sections 86-90, which give the bank special privileges to take such security, are based on the principle that the security must be taken and bear the same date as the advances, for which it is taken, thus insuring that the assets of the borrower will be increased concurrently, and therefore the act will not in any way operate to the injustice of any creditor. Consequently, if there is any discrepancy between the date of the advances and the date of the taking of the security, the legality of the latter is voided unless, prior to the advance, the bank holds a written promise that the security would be given.
It must always be borne in mind that banks alone are permitted to take this kind of security. For that reason, it is necessary when making advances to follow strictly the letter as well as the spirit of the law.
Otherwise the courts, if called upon to adjudicate, would no doubt render judgment against a bank. The whole of this system is more or less a novelty in business practice, and in some respects may act contrary to established business customs. The fact, however, that there have been so few lawsuits arising out of such transactions goes to show that the system works well in practice, and that no interests have suffered, notwithstanding the enormous volume of business transacted. The conditions governing the classes of loans under Section 88 are varied and more or less technical, and the following brief description is intended only as a general, rather than a specific, explanation of some of the more important features.