October 03 2001
Restructuring or Renewal of Finance
Restrictions on Asset Transfers
On August 30 2001 the president promulgated the Financial Institutions (Recovery of Finance) Ordinance 2001. The ordinance repeals the Banking Companies (Recovery of Loans, Advances, Credits and Finances) Act of 1997. This update examines some of the material differences between the 2001 ordinance and the 1997 act relating to corporate finance. A number of other differences, not discussed here, relate exclusively to banking law.
The 2001 ordinance includes an inclusive definition of the term 'obligation'. Section 2(e) states that an obligation includes:
"any agreement for the repayment or extension of time in repayment of a finance, or for its restructuring or renewal, or for payment or extension of time in payment of any other amounts relating to a finance or liquidated damages."
There was some doubt in cases instituted under the 1997 act as to whether finance could be 'restructured' or 'renewed'. This doubt has been removed by the new definition.
The question remains whether such restructuring or renewal can provide for additional mark-up by capitalizing previous amounts owed as mark-up without any fresh disbursement by the financial institution. As a matter of contract there would appear to be no conceptual difficulty with such an arrangement. A new mark-up agreement may be executed from the date of the restructuring. The sale price of the assets that are the subject of the new mark-up agreement can equal the amount of principal and mark-up due under the previous agreement. This sale price must be paid by the financial institution to the customer for the sale of the goods by the customer to the financial institution. The customer agrees to purchase the goods from the financial institution at the new restructured purchase price, payable in instalments. The customer and the financial institution may agree that rather than disburse the sale price, the obligations of the customer under the previous mark-up agreement will be deemed to be satisfied by entering into the new mark-up agreement. Therefore no new disbursement by the financial institution will take place. This is not a novation of the original mark-up agreement since the original liability is not extinguished. The parties merely agree that this liability will be deemed to be satisfied in a particular manner.
This situation is a case of two genuine trade transactions both supported by consideration with parties contractually agreeing to adjust outstanding dues under the respective contracts. On the face of it there is nothing unIslamic about these two transactions. No amounts in excess of the purchase price are being claimed, nor is there any mark-up on mark-up being claimed. This structure does not seek to do indirectly what is prohibited directly. If it is accepted that the two trade transactions are genuine (and if they are not then neither is valid and nothing can be recovered by the financial institution apart from the sale price disbursed) then no prohibited act is taking place either directly or indirectly.
Another mechanism for enabling restructuring or renewal that has been canvassed is novation of the existing mark-up agreement. There are difficulties with this concept in the context of Islamic finance. By novation is meant substitution of a new contract for an old one. The consideration is the mutual release of obligations under the old contract and the assumption of obligations under the new contract. For example, a financial institution and a customer might agree that rather than pay a set purchase price on a certain date for certain goods the customer will now pay more than the set purchase price after the agreed date for the same goods. This would be tantamount to charging mark-up on mark-up or interest beyond the stipulated contractual period in the guise of novation.
The 2001 ordinance restricts the disposal of assets by customers and judgment debtors. A customer or other defendant who has furnished security for finance cannot sell or otherwise transfer any charged asset after the publication of the summons under the 2001 ordinance. Any such sale or transfer shall be void and of no legal effect.
A judgment debtor cannot transfer or otherwise dispose of any of its assets (whether charged or not) without the prior permission of the Banking Court.
These restrictions were not contained in the 1997 act and should facilitate the execution of decrees obtained by financial institutions.
The 2001 Ordinance fills many of the holes contained in the 1997 act and is an attempt to expedite recovery of bank-provided finance. At the time of its promulgation the 1997 act was denounced as a draconian law. It was hoped it would ensure quick recovery of bank-provided finance. However, in practice the recovery procedure remained slow and cumbersome.
The 2001 ordinance does contain provisions that are harsh for corporations that obtain finance from banks. It constitutes another attempt to facilitate expeditious recovery of dues and, from the perspective of financial institutions, to address the deficiencies experienced in litigating under the 1997 act.
For further information on this topic please contact Ahsan Rizvi at Rizvi, Isa & Hosain by telephone (+92 21 587 2879) or by fax (+92 21 587 0014) or by email (firstname.lastname@example.org). The Rizvi, Isa & Hosain website can be accessed at www.rihlaw.com.
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