SECURING BANKING TRANSACTIONS

LIST OF NOTIFICATIONS REPRODUCED IN THE <!--[if gte mso 9]> SECURING BANKING TRANSACTIONS Mortgage by Entry in the Record-of-Rights By Syed Ahmad Hassan Shah and Faisal Fazli, Advocates, Islamabad I. Introduction This paper examines the law relating to the creation of a mortgage by deposit of title deed in the Punjab. The law regulating the creation of mortgages in Pakistan is embodied in the Transfer of Property Act, 1882 (the "TPA"). Although the TPA is a central statute, it extends only to a Province of Pakistan that adopts the statute, in whole or in part, through notification in its respective Provincial Gazette. Section 58 of the TPA, which identifies various types of mortgage and sets out the alternative manners of creation, has not been adopted in the Punjab. Historically, the Lahore High Court has applied the non-notified provisions of the TPA to the extent they embody general principles consistent with justice, equity, and good conscience, but has not been bound by its technical or procedural rules. Section 58(f) provides that a mortgage by deposit of title deed is created where a person delivers documents of title to immovable property to a creditor, with intent to create a security thereon. Although Pakistan does not recognize the distinction between legal and equitable title, a mortgage by deposit of title deed is referred to colloquially as an `equitable mortgage' due to its origin, in the English law of equity. The advantage of an equitable mortgage is, it is not required to be effected through a written instrument and is therefore not subject to the three percent combined stamp duty/registration fee leviable on a mortgage created by a written instrument (which is referred to as a `registered mortgage').1 In 1986, a proviso was added to section 58(f) providing that a mortgage by deposit of title deed in favour of a bank may also be created by an entry in the Record-of-Rights, reflecting the bank's charge. However, lawyers are divided on the issue of the proviso's enforceability because of a lack of judicial authority on point, and out of abundant caution, banks are advised to prefer other forms of mortgage. The problem is, it is not clear what constitutes a general principle or what the measure of consistency with justice, equity, and good conscience in the context of the TPA is. Defining these elements is central to making a determination on the validity of the TPA's non-notified provisions. This paper first defines these standards, and on the basis thereof, establishes that the proviso is enforceable to the Punjab under the general rule stated above. II. Section 58(f) Section 58(f) reads as follows: "Where a person delivers to a creditor or his agent documents of title to immovable property, with intent to create a security thereon, the transaction is called a mortgage by deposit of title-deed: [the "Operative Part"] Provided that, where a mortgage by deposit of title deeds is to be created in favour of a banking company as defined in the Banking Tribunals Ordinance, 1984 (LVI of 1984)2, the same may also be created by an entry in the Record-of-Rights against the entry relating to such immovable property [the "Proviso"]." Emphasis added 1. Section 59 of the TPA requires all mortgages, other than a mortgage by deposit of title deed under section 58(f) of the TPA, securing an amount in excess of Rs. 100, to be effected by a written instrument (the "mortgage deed"). The mortgage by deposit of title deed is effected by delivery of title deeds to the mortgagee. Although no written instrument is required, it has become standard commercial practice to record delivery of the title deed' by a memorandum of deposit of title deed ("MODTD"), which acknowledges a past transaction rather than effecting an in praesenti delivery of the title deed. 2. The Banking Tribunals Ordinance, 1984 was repealed by the Banking Companies (Recovery of Loans, Advances, Credits and Finances) Act, 1997, which in turn was repealed by the Financial Institutions (Recovery of Finances) Ordinance, 2001. The concept of a 'banking company' has been replaced in the 2001 Ordinance by the expression 'financial institution', which will be read in place of 'banking company' where mentioned in the TPA. III. The General Rule A long line of judicial decisions has established that the general principles of the TPA consistent with justice, equity, and good conscience are enforceable in Provinces where TPA provisions have not been extended by notification in their respective Provincial Gazettes; however, its procedural or technical provisions are not obligatory.3 To avoid repetition, we refer to this as the General Rule. 3. See 6 PR 1912 Rev. AIR 1919 PC 1; AIR 1924 Lah.707; AIR 1924 Lah.281; AIR 1924 Lah. 282(2); AIR 1925 Lah. 575; AIR 1925 Lah. 92; AIR 1925 Lah. 676; AIR 1928 Lah. 148; AIR 1930 Lah. 620; AIR 1933 Lah. 151; AIR 1934 Pesh. 17; AIR 1934 Pesh.101; AIR 1935 Lah. 350; AIR 1936 Pesh. 43; AIR 1936 Pesh. 158; AIR 1939 Lah. 330; AIR 1940 Lah. 291; AIR 1942 Pesh. 80; PLD 1952 Lah.36; PLD 1955 FC 1; PLD 1975 Quetta 22; 1981 SCMR 1200.; PLD 1995 Lah.124; 2003 YLR 495. The General Rule is in essence a two-pronged test: if a provision is, first, consistent with justice, equity, and good conscience and, second, a general principle rather than a procedural or technical rule, it is enforceable. The position of this paper is: (i) the expression, justice, equity, and good conscience functions as residuary law, and means in the context of contemporary Pakistani jurisprudence, the principles of Islamic law; (ii) the expression, general principle means a substantive, as opposed to procedural, provision of law. Each is discussed below. Justice, Equity, and Good Conscience: Origin of the Expression The terms, `equity' and `good conscience', in the Sub-Continental context, have their origins in the royal instructions to the East India Company. Upon the British Government's assumption of control of the colony from the Company, it, through_ the Letters of Patent of the newly established High Courts,4 provided for the exercise of their jurisdiction in accordance with equity and good conscience. In the Punjab, Section 6 of the Punjab Laws Act, 1872 (the "Punjab Laws Act"),5 required that "in cases not otherwise provided for, the Judges shall decide according to justice, equity, and good conscience".6 4. Through the Indian High Courts Act, 1861. 5. The statute that restates and consolidates the legal framework of the Punjab. 6. Section 6, Punjab Laws Act (IV of 1872). Most of the early 20th Century cases on point stress that the expression, justice, equity, and good conscience, meant English law to the extent that it was appropriate to Indian circumstances, rather than binding without exception.7 It func tioned as a guiding principle rather than a strict rule, as Wort, J, describes in J. H. Pattinson and Others v. Bindhya Debi,8: "[T]here is no doubt that the expression "equity" has been often used in a loose sense in Indian cases as has been the expression "equity, justice, and good conscience." Courts in this country are enjoined to apply the rule of equity, justice and good conscience where there is no rule of law applicable to the facts but that is far from saying that or meaning that each Judge may decide a case as he thinks fit and is bound by no rules, but there must be rules and the decision of the case cannot depend upon caprice. Often the rule of .the Common Law of England or rules of equity not as binding upon Indian Courts, but as guidance in determining matters which came before them in which there is no rule of Indian Law."9 This excerpt recognizes the expression as a residuary or catchall principle of law, in saying that it is applicable only where there is no rule of law on point. Moreover, it demonstrates the expression had no precise meaning. It was applied in a manner that gave English precedents strong persuasive value in British India, but not binding force, and Courts did depart from English law where common notions of justice and fairness militated towards the departure.10 7. (1887) 14 I A 89; (1903) 26 Mad. 686; AIR 1914 Mad. 587; AIR 1915 Mad. 1206; (1908) 35 Cal. 34; (1909) 36 Cal. 193. 8. AIR 1933 Pat. 196. 9. At p. 202. 10. In the case of Moolchand v. P. Alwar Chetty (AIR 1915 Mad. 934), Sadasiva Aiyar, J. says in concurrence: "[if it is the position] that the High Court on its original side is bound to decide questions like the one in controversy on the basis of English precedents and English common law procedure, even though the following of such precedents and procedure may be against "justice and right" or the "justice, equity and good conscience" which are the true guides to be followed according to the Charter Acts, I respectfully differ." AT. P. 936. Justice, Equity, and Good Conscience: Today Following Independence, Courts continued to use this expression as a legal standard in the context of the TPA. However, the meaning of the expression has changed: In Nizam Khan v. District Judge, Lyallpur,11 Muhammad Afzal Zullah, J., writing for the Lahore High Court held, "Wherever the expression "justice, equity and good conscience" occurs in the law, it shall be interpreted in accordance with Islamic law and principles" and that Courts may not "follow any other law including English law in preference to the above-stated Islamic law."12 This conclusion follows from the Court's premise that "[A]11 aspects of law which are not covered by territorial or other enforceable law or usage are to be governed in Pakistan by the Muslim Law."13 In A.M. Qureshi v. Union of Soviet Socialist Republics,14 Muhammad Afzal Zullah, J., now writing for the Supreme Court, reiterated his view as follows: "it is no longer good law to interpret [the expression] "justice, equity and good conscience" to mean rules of English law, as in any way applicable to Pakistan." Ajmal Mian, C.J., writing for the Supreme Court in Hitachi v. Rupali Polyester,15 explains the change in the meaning of the expression in the Constitutional context: 11. PLD 1976 Lah. 930. 12. At p. 1012. 13. At p. 970. This was upheld by the Supreme Court Muhammad Yousaf v. Ghayyur Hussain Shah (1993 SCMR 1185): "[A]11 residuary law in Pakistan to be applied in fields other than those occupied by existing statutory law has to be Muslim Law and jurisprudence and philosophy underlying the same." At p. 1188. 14. PLD 1981 SC 377, at p. 425. 15. 1998 SCMR 1618. "The Principles of common law or equity and good conscience cannot confer jurisdiction on the Courts in Pakistan which has not been vested in them by law. In this regard reference may be made to Clause (2) of Article 175 of the Constitution of Pakistan, which provides that no Court shall have any jurisdiction save as is or may be conferred on it by the Constitution or by or under any law. [...] In view of the above Constitutional provision and the case-law the principles of English common law or equity or good conscience cannot be pressed into service in Pakistan".16 As far as the non-notified provisions of the TPA are concerned, these cases have effected a fundamental shift in the TPA's jurisprudential underpinning. To be enforceable, a non-notified provision of the TPA must be both (a) a general principle, and (b) consistent with Islamic law. General Principles TPA cases use the term `general principle' liberally, but do not define or clarify it. The insight into its meaning is given by its usage, which is in contradistinction to procedural or technical rules. This is analogous to the dichotomy between substantive and procedural law and the position of this paper is that where TPA cases use the term general principles, they mean substantive principles of law, as opposed to procedural ones. The distinction between substantive law and procedural law remains an especially problematic question of juris prudence. Generally, procedural law has to do with the form and course of legal proceedings, and procedural laws and rights relate to the method of enforcement of substantive rights. The case of Adnan Afzal v. Capt. Sheh Afzal17 describes procedural law as follows: "It is obvious that matters relating to the remedy, mode of trial, the manner of taking evidence and forms of action are all matters relating to procedure. Crawford too takes the view that questions relating to jurisdiction over a cause of action, venue[,] parties' pleading[s] and rules of evidence also pertain to procedure. Crawford too takes the view that questions relating to jurisdiction, over a cause of action, venue, parties pleadings and rules of evidence also pertain to procedure".18 16. At p. 1645. 17. PLD 1969 SC 187. See also: PLD 2001 SC 482, PLD 1998 SC 1 and 1999 SCMR 92. 18. PLD 1969 SC 187, at p. 192. The above view has consistently been upheld by the Supreme Court as the meaning of the expression "procedure" in Pakistan. Everything else is substantive law, and relates to the nature and existence of legal rights, powers and duties.19 IV. The Proviso as a Substantive Provision Substantive or Procedural? The mechanics of making entries in the Record-of-Rights are as follows: the parties approach the relevant Circle Patwari (custodian of land records) with a letter describing the properties to be mortgaged and the amount secured. The Patwari then records the charge in favour of the mortgagee in red ink, completing the transaction. This procedure is not controlled by the TPA; it is prescribed by land revenue legislation and custom. Prima facie, the Proviso cannot be said to embody a rule of procedure because it does not describe the procedural aspects of making an entry in the Record-of-Rights. The Proviso recognizes an action (entry in the Record-of-Rights) as resulting in a legal relationship consisting of mutual rights and obligations (a mortgage). By operation of the Proviso, a party (the mortgagee) acquires an interest or a right in immovable property, and notwithstanding ambiguity in the distinction between substantive and procedural law, a right or interest in real property is generally recognized as substantive.20 If we admit that a right in real property is substantive, the next question is, whether a purely procedural or technical rule can operate to create a substantive right. The answer is in the negative. Procedures can confer rights but those rights relate to the course of legal proceedings. By its definition, no procedural rule can give rise to a substantive cause of action. 19. For a full discussion, see W. W. Cook, `Substance' and `Procedure' in the Conflicts of Laws (42 Yale L.J. 333); P.J. Fitzgerald, Salmond on Jurisprudence, 12th Edition, Sweet & Maxwell (London: 1966); Halsbury's Laws of England. 20. "Whether I have the right to recover certain property is a question of substantive law". P.J. Fitzgrald, Salmond on Jurisprudence, Sweet & Maxwell (London: 1966), p. 462. Comparison with Operative Part As a second argument for the position that the Proviso is a substantive provision, we consider its similarity with the Operative Part. Both prescribe what action is required to create a mortgage by deposit of title deeds: the Operative Part prescribes delivery of title deeds to the mortgagee; the Proviso prescribes entry in the Record-of-Rights. The Operative Part of Section 58(f) has long been recognized as a general principle of the TPA and not merely a technical or procedural rule.21 The Operative Part in essence says, if you do X, you will have created a mortgage by deposit of title deed; the Proviso in essence says, if you do Y, you will have created a mortgage by deposit of title deed, where X and Y are, delivery of title deeds with intent to create a security, and entry in the Record-of-Rights with intent to create a security, respectively. Therefore, if delivery with intent to create a security is a substantive provision, entry in the Record-of-Rights with intent to create a security must also be substantive. They are perfectly analogous. Moreover, every other type of mortgage enumerated in Section 58 has also been held to be a principle of the TPA22 and they all also follow the same form: If you do X you will have created a Y type of mortgage. 21. 2002 CLD 606. 22. 2001 YLR 2634. Doctrine of Retroactive Operation As a third argument, we consider the substantive law/rights versus procedural law/rights dichotomy in the context of the retroactive application of laws. The principle is, that a change in procedural law will apply to cases where the cause of action accrued prior to the change in law. However, a change in substantive law will only apply to causes of action that arise subsequent to the change in law (unless given express retroactive effect by the Legislature). The rationale, as laid down by Colonial Sugar Refining Company Limited v. Irving23 and upheld by the Pakistani Supreme Court,24 is that applying the new procedural law will not prejudice parties' substantive rights. The Supreme Court quoted the English case in observing that ""if the matter in question be a matter of procedure only", the provisions would be retroactive. "On the other hand, if it be more than a matter of procedure, if it touches some right in existence at the passing of the Act, [it will not be given retroactive effect]." 23. 1905 AC 369. 24. PLD 1969 SC 187. Ad arguendo, let us assume the Proviso is extended to the Punjab but, some time later, replaced with a provision saying a mortgage created by entry in the Record-of-Rights will not be considered valid. The question is, whether the replacement will have retroactive effect (as it would if it were procedural). If A mortgages his property to B pursuant to the Proviso whilst it is .in force, can he later, when the Proviso has been replaced, deny that a mortgage exists. The answer is in the negative. The reason is, the change in law would affect some substantive right in existence at the passing of the new legislation: Specifically, B's security interest in A's mortgaged property. Distinguishable from Proviso to 58(c) As a fourth argument, we distinguish between the Proviso and the proviso to Section 58(c) of the TPA (mortgage by conditional sale). . Section 58(c) provides that where the mortgagor ostensibly sells the mortgaged property on condition that (i) on default of payment the sale shall become absolute, (ii) on payment of the mortgage money, the sale shall become void, (iii) on payment of the mortgage money, mortgagee shall transfer the property to the mortgagor, the transaction shall be called a mortgage by conditional sale. A proviso was added to section 58(c) requiring the condition for retransfer to be embodied in the document of sale. This proviso was held in Muhammad Kazam through Legal Heirs v. Mst. Janat Bibi25 to be a procedural rule and therefore inapplicable. 25. PLD 1985 Lah. 637. The rationale of the Lahore High Court in Muhammad Kazam's case was, that since the proviso to section 58(c) relates to proof' of the existence of a mortgage, it is not a substantive provision. The purpose of this proviso is to prevent fraud. It is an evidentiary rule in the sense it requires a formality (for the provision of retransfer to be embodied in the instrument of sale) before the Court will take cognizance of the mortgage. As noted above, laws pertaining to evidence are procedural laws because they relate to the form of legal proceedings. The proviso to Section 58(c) is distinguishable' from the Proviso because the former relates to the proof of mortgage (a procedural issue), whereas the latter is a mechanism for the creation of a mortgage, which is a substantive operation. Confusion caused by Reliance on Indian Interpretations In Namdeo Lokman Lodhi v. Narmadabai,26 the Indian Supreme Court held that in determining whether a provision of the TPA is a principle of justice, equity, and good conscience, "it has to be seen whether the particular provision of the Act relied upon restates a known rule of equity or whether it is merely a new rule laid down by the Legislature".27 The view that the Proviso is not enforceable is premised, inter alia, on this judgment to argue that since the Proviso is a recent introduction that does not restate a known rule of equity, it cannot be said to embody a rule consistent with equity, justice, and good conscience. Reliance on Indian case law does not appreciate the shift in meaning of the expression justice, equity, and good conscience, as described above. Following Nizam Khan's case and its progeny, it no longer matters that a provision of the TPA restates a known rule of English equity because that is no longer the reference point for the expression. The Indian case implies that a "new rule laid down by the Legislature" cannot be consistent with justice, equity, and good conscience. In Pakistan, this is not the case: recent amendments embodying novel principles are enforceable provided they are not inconsistent with Islamic law. 26. AIR 1953 SC 228. 27. At p. 231. As an example of how the law is different in Pakistan, if for instance, a provision relating to the inheritance of immovable property were incorporated into the TPA and that provisions were contrary to Islamic principles of inheritance, it would not be enforceable under the General Rule, even if it were found to be a general principle and found to restate a known rule of equity. V. Consistency with Islamic Law In Arshad Aziz, Managing Director, Imran Corporation (Pvt.) Ltd. v. Bank of Oman Ltd.28 the petitioner denied the existence of an equitable mortgage on the basis that it was un-Islamic. The authority for this position came from Bank of Oman Ltd. v. East Trading Company Ltd.,29 in which Tanzil-ur-Rehman, J., notes his conclusion (which he admits to be contrary to the Federal Shariat Court's view30) that section 58(f) of the TPA is un-Islamic. The Arshad Aziz case, after quoting the Karachi case, points out that the Federal Shariat Court subsequently re-examined the TPA in an unreported judgment dated May 5, 1988, and found "most of provisions of Transfer of Property Act as not being repugnant to Injunctions of Islam [and] that equitable mortgage was not repugnant to Injunctions of Islam [sic]."31 28. PLD 1995 Lah. 6. 29. PLD 1987 Kar. 404. 30. He suggests the FSC reconsider the issue. 31. PLD 1995 Lah. 6, at pp. 9-10. The Federal Shariat Court's unreported judgment, decided two years after the Proviso's introduction, is dispositive of the issue: The Proviso is consistent with Islam. VI. Support from other Laws There are two possible scenarios in which a mortgage made by entry in the Record-of-Rights could be contested: first, where the mortgagor denies the mortgage's validity; and second, where a subsequent transferee or mortgagee denies its validity, or claims priority of interest over the mortgage created pursuant to the Proviso. Under existing laws, including common notions of justice and fairness and Islamic law, it is not plausible that any Court would find in favour of either the mortgagor or subsequent transferee. In the first scenario, the mortgagor would, inter alia, be estopped from denying the existence and validity of the mortgage under Article 114 of the Qanun-e-Shahadat Order, 1984 ("Qanun-e-Shahadat"),32 which provides that where a person intentionally causes another to believe a certain thing is true, he cannot later deny the truth of that thing. The mortgagor in the first scenario would be precluded from denying the existence of the mortgage created pursuant to the Proviso under this rule. 32. Law of Evidence. In the second scenario, where a mortgagor executes a subsequent mortgage on a property encumbered pursuant to the Proviso, the principle of notice would militate in favour of the prior mortgagee. In balancing the interests of prior and subsequent transferees, the law places a burden of diligence on the parties, such that they must take reasonable measures to discover encumbrances. The law only gives preference to the subsequent transferee where he is a bona fide transferee for consideration, and without notice of the earlier transfer. In the second scenario, the subsequent transferee cannot claim to be a bona fide transferee without notice because the particulars of the mortgage would be entered in the Record-of-Rights, and the subsequent transferee will be deemed notified. In the case of corporate mortgagors, such discovery may' additionally be made through inspection of the register of charges kept by the Company Registration Office. Therefore, if a mortgagor does effect an entry in the Record-of-Rights with intent to create a mortgage in favour of a bank, the bank may enforce its mortgage both against the mortgagor and against third parties claiming an interest, without invoking the Proviso. VII. Conclusion Our thesis that the Proviso is enforceable in the Punjab is built upon the following premises: (a) Section 58 of the TPA is not in force in the Punjab; (b) the TPA's non-notified provisions are enforced by Courts through the General Rule; (c) the General Rule requires provisions to be (i) general principles (ii) consistent with justice, equity, and good conscience; (d) `general principles' are substantive provisions of law; (e) the expression justice, equity, and good conscience refers to Islamic law; (f) the Proviso is both a substantive provision of law and consistent with Islamic law. Alternatively, we have argued that a mortgage created through entry in the Record-of-Rights is enforceable independently of the Proviso (through the principles of estoppel and notice). The final consideration militating towards accepting the Proviso is its desirability. The Proviso provides an important alternative to the mortgage created pursuant to the Operative Part in the context of second mortgages. Without the Proviso, where a mortgagor has already created a mortgage through delivery of title deed, he cannot create a second mortgage thereon without recourse to a registered mortgage (as he no longer has possession of the title deed). In today's banking practice, where there are often multiple tiers of financings and corresponding security interests, it appears unfair to burden subordinate security interests with the high costs of registered mortgages. The Proviso offers mortgagors another means of creating a mortgage without incurring the high costs associated with a registered mortgage. The combined stamp duty and registration fee applicable on any mortgage other than by deposit of title deed is three percent of the amount secured. This effectively raises the cost of credit on a one-year finance facility by three percent, and by even more on facilities having a shorter term. A recent law reform report by the Asian Development Bank ("ADB") makes the point that "as developing countries adopt market oriented economic policies, :the need to establish sustainable market-based incentive systems for the provision of credit by the private sector [...] is greater than ever before."1 The incidence of registration fees and stamp duties to mortgages is antithetical to a market-driven system of credit. The thesis of the ADB report is that the law in developing countries should evolve to facilitate the creation, perfection, and enforcement of security interests. Acceptance of the mortgage created pursuant to the Proviso would significantly facilitate the creation of mortgages in the Punjab. In the larger context, we hope this paper has identified the issues relevant to determinations of the TPA's non-notified - provisions.