Legal Issues Relating to Banking Credit

1. Legal Issues Relating to Banking Credit AHMED & QAZI Advocates & Legal Consultants

2. HISTORICAL BACKGROUND • Human History • Emergence of Civilization • Need to control collective human behavior • Emergence of (criminal) law and law enforcement agencies • Emergence of Courts

3. Industrial Revolution and development of commerce and trade • Emergence of Commercial Law such as contract, negotiable instruments etc. • Law and morality / religion

4. Legal Systems – Three main groups in the world • United Kingdom, United States of America, Canada, Australia, New Zealand, India, Pakistan, Bangladesh etc. • France, Germany, Italy, etc. • Middle East, China, Iran, Afghanistan etc. • Legal and juristic persons • Juristic persons – companies – societies - trusts etc.

5. Pakistan has a Federal system of government– Constitution divides: • Legislative Powers Legislative Powers between Federal Parliament (NA + Senate) and Provincial Assemblies in four Provinces (Article 142 of the Constitution) Examples - Federal - Foreign Policy, Defence, Monetary Policy etc. Provincial – Subjects dealt by provincial assemblies are Stamp-Registration-Police

6. Executive Powers Between Federal Government and Provincial Governments. • Hierarchy of legislation in Pakistan • Constitution • Federal Act/Ordinance • Provincial Act/Ordinance • Sub Ordinate Legislation through Rules & Regulations notified/issued under powers granted by Act or Ordinance

7. Licensed Activities • Driving • Hunting • Insurance • Flying aero planes • Deposit taking from public (i.e. Banking)

8. BANKS • Banks are juristic person that in Pakistan are licensed by State Bank of Pakistan under Banking Companies Ordinance 1962 to engage in the licensed activity of banking. • As companies, they are subject to Companies Ordinance 1984 and as such are regulated by Securities and Exchange Commission of Pakistan. • With regard to their business of banking, they are subject to regulations of SBP under BCO and under hundreds of Rules and Regulations issued by SBP under the authority given to it by BCO

9. Most Legal disputes and issues that banks have to face are not related to deposit taking but to the extension of finance facilities (banking credit) • Banks are engaged in the business of financial intermediation (i.e. deposit taking, extension of finance facilities) and thereby seeking to generate profit from the difference between Mark-up rates between the two

10. SBP requires banks not to extend any unsecured facility over 0.5 M (R-4) • All facilities above Rs. 0.5 M have to be secured in accordance with the applicable Prudential Regulations

11. COLLATERAL/SECURITY

12. LAW OF PROPERTY • What is property – It has not been defined in any statute. • Movable and immovable property • Intangible assets and tangible assets • Fixed Assets and Current Assets and Receivables–Accounting terms–Not legal terms

13. OWNERSHIP OF MOVABLE PROPERTY • Mostly no record is kept of ownership –In some cases, record is maintained, e.g. cars etc.

14. OWNERSHIP OF IMMOVABLE PROPERTY • How ownership of immovable property is determined • The Transfer of Property Act (IV of 1882) • Sale – Lease – Assignment

15. The Registration Act (XVI of 1908) • System of registrars of documents in all four provinces • S. 17 gives list of documents that are compulsorily required to be registered (i.e. any document relating to transfer of or affecting any right in immovable property) • All sale deeds and mortgage deeds are compulsorily registered

16. S. 18 makes the registration of all other documents at the option of parties (e.g. Service Contract) • Effect of non registration of a document that is to be registered compulsorily – S. 49

17. Registrar of documents – One Registrar in Karachi under whom there are 24 Sub-Registrars each dealing with specific area. • Process of registration of a document–3% registration fee and 1% stamp duty– Normal (takes more than one year) Urgent (takes about 45 days)

18. STAMP DUTY • What is stamp duty? Stamp Act - Provincial Statute • Stamp duty is payable on document not transaction • Stamp Duty on banking documents – Article 19 of the Schedule of Stamp Act • Sindh Board of Revenue – its powers and functions–All registrars function under this Board – Board is responsible for collection of registration fee and stamp duty

19. CHARGE • What is the purpose of obtaining a Charge? • Charges Over Movable Properties • Pledge • Hypothecation

20. CHARGES OVER IMMOVABLE PROPERTIES • Two Main Types of Mortgages • Legal/Simple Mortgage (S. 58(b) TPA) Owner or his registered attorney signs a formal document expressly creating mortgage rights in favor of another party. This document is normally called Mortgage Deed and needs to be registered compulsorily.

21. Both registration fee and stamp duty are payable at the time of registration of Mortgage Deed. • The above amounts are payable advalorem (percentage) of the amount of Mortgage and NOT the value of property.

22. Advantages • Universal Notice • Owner may not deal with the property or sell it. Disadvantage • It involves expense and hassle of time and effort

23. Equitable Mortgage (S. 58 (f) of TPA) • This mortgage is created by mere act of depositing original documents of property by the owner or his agent with the mortgagee or mortgagee’s agent • MODT – Purpose Advantages • No document is required to be signed for creation of this mortgage • No need to go to registrar • No Stamp Duty – No Registration Fee

24. Disadvantage of Equitable Mortgage • Being a silent mortgage, third parties have no knowledge of it and owners often obtain CTCs and then sell those properties or get mortgage deed registered in favor of third parties. Although such subsequent dealings are subordinate to earlier Equitable Mortgage, having such subsequent dealings set aside is always a big practical problem for equitable mortgagees

25. Prudent Practice of Banks In removing the problem, the banks have rightly developed the practice of obtaining 1% Token Registered Mortgage

26. Important Clarification • How can a large company create equitable mortgage in favor of more than one banks. Title deeds are deposited with one mortgagee bank which confirms to other subsequent equitable mortgagees that it is holding the said title deed on its own behalf as well as on behalf of other bank. Such confirmation meets the requirement of S. 58(f) of TPA

27. COMPANY LAW • Charge on the assets of a company – Creation of charge – S. 121 of Companies Ordinance 1984 (CO), requires that every charge created over the assets of the company should be reported/notified with SECP within 21 days of its creation – Charge created stands perfected upon registration

28. Important Clarification • Charges and mortgages over movable and immovable properties of companies are not created under CO. They are created in accordance with other provisions of law (i.e. TPA). S. 121 of CO only requires that the charges once created should be reported/notified with SECP.

29. A major error that bank officials often commit is to assume that just by obtaining a document from a company confirming creation of charge over all its “Fixed Assets, Land and Building, Plant and Machinery” and having that document duly registered through “Form-10” with SECP, the bank has also obtained charge over immovable property (Land and Building). This is incorrect. Charge on immovable properties can only be created under S 58 of TPA

30. Law provides for automatic ranking of charge (i.e. there is automatic queue of charge holders in accordance with date of reporting of their charge) • Practical and commercial consequences of ranking of charges (i.e. 1st charge holder, 2nd charge holder etc.) • The queue of charge holders can be broken if the charge holder standing ahead in the queue consents to junior charge holder enjoying the same rank of charge as that of its own. Such consent is normally given by senior charge holder issuing NOC to junior charge holder for pari passu ranking of charge

31. Practical Advantage For Junior Charge Holders in obtaining pari passu ranking of its charge is equal but proportionate sharing with senior charge holders of the sale proceeds of the assets of the company/borrower

32. What an NOC should contain: • We have no objection to your charge upto an amount of Rs. _____ ranking pari passu to the charge that our bank is holding over ________ (assets of the company)

33. Important Clarification When obtaining NOC from a senior creditor for pari passu charge, in case such senior charge holder is also holding title document of the company, then you must ensure that such senior creditor either in the same NOC letter or in separate letter, clearly confirms to you that it is holding title deeds on your behalf also. Without this confirmation, there will be no equitable mortgage in your favor

34. Partnership as Bank’s Customer • Agency – Agent and Principal • Partnership Firms – partnership is not a separate legal entity • Relation Between Partners • Joint And Several Liability of Partners

35. Why partnerships should be avoided as customers – potential for dispute – modification/termination of partnership deed – inheritance dispute • Partner as agent of the Firm

36. Murabaha financing • Execution of IB documents – blanks – witnesses – dates • No markup on markup

37. Financial Institutions (Recovery of Finance) Ordinance, 2001 – Basic outlines of procedure, requirement and remedies available • Banking Courts – Five Banking Courts in Karachi – If recovery amount is above Rs. 50 M than High Court has the jurisdiction

38. The above Recoveries Ordinance provides the best possible mechanism for banks to obtain speedy remedies. There is need for banks to supervise and monitor the performance of their counsels. Except in rare cases, there is no reason why, at least interim decree, may not be obtained within 6 months to one year

39. Mandatory requirement to file Leave to Defend in 30 days • Mandatory requirement for customers to comply with S. 10(4) of the ordinance. If they failed to comply, the Ordinance require the court to reject Leave to Defend and proceed to pass decree in favor of banks

40. And if customers comply with (S. 10 (4)) in Leave to Defend, then court must pass interim decree for at least the undisputed amount

41. Considering all the ground and practical realities, we think it is banks’ interest to pay their counsels good professional fees and monitor their performance and instruct them not to obtain any adjournment or give consent to seeking adjournments by other sides without the consent of the bank’s dealing officer

42. END OF FIRST SESSION

43. START OF SECOND SESSION

44. Particular Day To Day Issues & Queries Raised By Banks • What are Title Deeds • Types of properties in Karachi – KMC properties – lease hold – Land Utilization properties – residential – commercial – industrial – amenity plots • What are main leasing authorities in Karachi – KDA (CDGK) – DHA – PECHS – SITE • Mukhtiarkars

45. Documents involved in different types of properties in Karachi. • CDGK: Allotment/Transfer order- Possession order- Acknowledgment of Possession Lease Deed • PECHS/DHA: Allotment/Transfer Order- Form A Sub-Lease, Form B Lease

46. Search Certificate. What is a Search Certificate – Its purpose • How to confirm genuineness of a title document – modes – central record – micro filming – leasing authority – duration

47. Certified True Copies (CTC) – Whether CTC is a title document – Whether a CTC may be accepted for the purpose of mortgage • PTM/NOC/NEC • What is chain of documents