On Sept 12 the senate passed the Corporate Rehabilitation Bill, 2017, to provide an institutional arrangement and legal process for the revival and rehabilitation of distressed companies.

The legislation resembles American bankruptcy laws in terms of management arrangement, litigation during bankruptcy proceedings and access to fresh funds.

The rehabilitation of non-performing banking assets needs a regulatory framework more than a statutory intervention based on arbitration as the legislation leaves many primordial concerns unanswered.

A take on the 2017 Corporate Rehabilitation Act

Not surprisingly, the Pakistani banking sector has the highest infection ratio among comparable countries such as Bangladesh, India, Sri Lanka, Philippines and Malaysia. None of them cross the 10 per cent line except Pakistan.

The corporate sector is the front runner in advances, with a 14pc infection ratio. Given the 67pc allocation of advances granted by banks to the sector, the issue becomes more pressing.

Foretelling exactly how far a restructuring mechanism can go to prevent insolvency is like predicting the unpredictable. The restructuring plan, however, should be implemented for the right reasons, and is generally unique in nature to each creditor. A fit for all is not possible as warranted by the act.

Under the act, the draft of which is available on the SECP website, references before accountability courts under the accountability ordinance, 1999, or any other law on account of wilful default, will be suspended upon approval of a rehabilitation plan by the court.

On the basis of deductive argument one can presume that all distressed businesses are not mala fide and are due to genuine exogenous economic factors; therefore all proceedings under accountability ordinance are suspended.

Subjectivity associated with wilful default and financial distress remains unaddressed and is determined by informed creditors. Rehabilitation is the only viable course of action left on the discretion of creditors. In future the SECP may devise a procedure under the act in this regard.

The act provides 16 provisos ranging from fresh provision of funds to appointment of creditors’ representatives to the board of directors. These provisos are all in vogue and enforceable under the companies ordinance 1984.

A rehabilitation plan shall be drawn up based on desired business targets or goals and the duration; for example, regularity in debt servicing, imposed cash flow targets, and sale of noncore assets.

The State bank of Pakistan needs to collaborate with the SECP to devise prudential guidelines because each non-performing loan is viewed as a mirror of an ailing, unprofitable enterprise

Such milestones would get us away from having just one cut-off or decision point.

Though the act sets a limit of three years for further rehabilitation plans, a distressed company can be entertained after three years from the date of the plan’s termination for further planning and restructuring.

Not only may this lead to economic waste in terms of cleaning up the bank book, three years is also a very small timeframe to judge that the right medicine had been prescribed to the ailing business.

A rehabilitation plan shall be settled with the consent of the debtor and creditors through an arbitrator under the arbitration act 1940. An approved arbitrator nominated by the Chief Justice of Pakistan will determine the awarded liability of the applicant and the claim under Qanun-e-Shahadat Order, 1984.

It is imperative that before invoking arbitration the petitioner be willing to do everything necessary to achieve proper arbitration. Non-willingness on part of any party opens the process to many hiccups in a country where laws are pro-creditor.

In the present scenario, a statutory corporate rehabilitation process would make the recovery of distressed concerns even more difficult. Present laws do not differentiate between a wilful default and a circumstantial default.

Under National Accountability Ordinance, 1999 a person is said to commit a wilful default if he does not pay the amount on the date that it became due. On the other hand pure circumstantial defaults are due to unfavourable domestic or global circumstances that are beyond the borrower’s control. Many debtors are victims of this oversimplified interpretation of wilful default.

In an environment of imbalanced legal remedies available to rehabilitate debtors, the choices offered by the act are essentially same as offered in section 284 of the Companies Ordinance, 1984: if three-fourths in value of the creditors … as the case may be, agree to any arrangement it will be binding on all the creditors.

This provision has failed to deal with ascertaining the level and nature of the debtors’ distress.

For context, the Indian model of corporate debt restructuring mechanism has its genesis in the local regulatory framework under supervision of the central bank. The mechanism provides prudential guidelines on restructuring of loans.

The three tier mechanism utilises available contract act legislation to rehabilitate and restructure ailing loans. It steers, monitors and self-corrects the rehabilitation process under expert supervision.

The Corporate Rehabilitation Act, 2017, may be supplemented with prudential guidelines and correction in accountability laws to affix associated subjectivity and streamline the process.

The State bank of Pakistan needs to collaborate with the SECP to devise prudential guidelines because each non-performing loan in the financial sector is viewed as an obverse mirror image of an ailing unprofitable enterprise.

From this point of view, the eradication of non-performing loans is a necessary condition to improve economic status.

Published in Dawn, The Business and Finance Weekly, October 9th, 2017