Legal Issues Relating to Banking Credit

AHMED & QAZIAdvocates & Legal Consultants

HISTORICAL BACKGROUND

1. Human History2. Emergence of Civilization3. Need to control collective human

behavior 4. Emergence of (criminal) law and

law enforcement agencies5. Emergence of Courts

6. Industrial Revolution and development of commerce and trade

7. Emergence of Commercial Law such as contract, negotiable instruments etc.

8. Law and morality / religion

9. 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.

10. Legal and juristic persons11. Juristic persons – companies –

societies - trusts etc.

12. Pakistan has a Federal system of government– Constitution divides:a. 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

b. Executive PowersBetween Federal Government and Provincial Governments.

13. Hierarchy of legislation in Pakistani. Constitutionii. Federal Act/Ordinanceiii. Provincial Act/Ordinanceiv. Sub Ordinate Legislation through Rules

& Regulations notified/issued under powers granted by Act or Ordinance

14. Licensed Activities Driving Hunting Insurance Flying aero planes Deposit taking from public (i.e.

Banking)

BANKS15. 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.

16. As companies, they are subject to Companies Ordinance 1984 and as such are regulated by Securities and Exchange Commission of Pakistan.

17. 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

18. 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)

19. 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

20. SBP requires banks not to extend any unsecured facility over 0.5 M (R-4)

21. All facilities above Rs. 0.5 M have to be secured in accordance with the applicable Prudential Regulations

COLLATERAL/SECURITY

LAW OF PROPERTY

22. What is property – It has not been defined in any statute.

23. Movable and immovable property

24. Intangible assets and tangible assets

25. Fixed Assets and Current Assets and Receivables–Accounting terms–Not legal terms

OWNERSHIP OF MOVABLE PROPERTY

26. Mostly no record is kept of ownership –In some cases, record is maintained, e.g. cars etc.

OWNERSHIP OF IMMOVABLE PROPERTY

27. How ownership of immovable property is determined

28. The Transfer of Property Act (IV of 1882)

29. Sale – Lease – Assignment

30. 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

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

31. Registrar of documents – One Registrar in Karachi under whom there are 24 Sub-Registrars each dealing with specific area.

32. Process of registration of a document–3% registration fee and 1% stamp duty– Normal (takes more than one year) Urgent (takes about 45 days)

STAMP DUTY

33. What is stamp duty? Stamp Act - Provincial Statute

34. Stamp duty is payable on document not transaction

35. Stamp Duty on banking documents – Article 19 of the Schedule of Stamp Act

36. 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

CHARGE

37. What is the purpose of obtaining a Charge?

38. Charges Over Movable Properties Pledge Hypothecation

CHARGES OVER IMMOVABLE PROPERTIES

39. 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.

Both registration fee and stamp duty are payable at the time of

registration of Mortgage Deed. The above amounts are payable ad valorem (percentage) of the amount of Mortgage and NOT the value of property.

Advantages Universal Notice Owner may not deal with the

property or sell it.

Disadvantage It involves expense and hassle of

time and effort

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

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

Prudent Practice of BanksIn removing the problem, the banks have rightly developed the practice of obtaining 1% Token Registered Mortgage

Important Clarification

40. 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

COMPANY LAW

41. 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

Important Clarification

42. 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.

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

43. 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)

44. Practical and commercial consequences of ranking of charges (i.e. 1st charge holder, 2nd charge holder etc.)

45. 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

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

46. 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)

47. Important ClarificationWhen 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

Partnership as Bank’s Customer

48. Agency – Agent and Principal

49. Partnership Firms – partnership is not a separate legal entity

50. Relation Between Partners

51. Joint And Several Liability of Partners

52. Why partnerships should be avoided as customers – potential for dispute – modification/termination of partnership deed – inheritance dispute

53. Partner as agent of the Firm

54. Murabaha financing

55. Execution of IB documents – blanks – witnesses – dates

56. No markup on markup

57. Financial Institutions (Recovery of Finance) Ordinance, 2001 – Basic outlines of procedure, requirement and remedies available

58. Banking Courts – Five Banking Courts in Karachi – If recovery amount is above Rs. 50 M than High Court has the jurisdiction

59. 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

60. Mandatory requirement to file Leave to Defend in 30 days

61. 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

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

63. 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

END OF FIRST SESSION

START OF SECOND SESSION

Particular Day To Day Issues & Queries Raised By Banks

64. What are Title Deeds

65. Types of properties in Karachi – KMC properties – lease hold – Land Utilization properties – residential – commercial – industrial – amenity plots

66. What are main leasing authorities in Karachi – KDA (CDGK) – DHA – PECHS – SITE

67. Mukhtiarkars

68. 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

69. Search Certificate. What is a Search Certificate – Its purpose

70. How to confirm genuineness of a title document – modes – central record – micro filming – leasing authority – duration

71. Certified True Copies (CTC) – Whether CTC is a title document – Whether a CTC may be accepted for the purpose of mortgage

72. PTM/NOC/NEC73. What is chain of documents