Investigating the Proposed Changes to Pakistan's Corporate Bankruptcy Code

Abstract

Over the last few years, firms in Pakistan have failed at an alarming rate, prompting some parties in the business community to call for government intervention, specifically by reforming insolvency law to make, inter alia, bad debt easier to cancel. The Securities and Exchange Commission of Pakistan has responded by proposing an amendment to Pakistan’s bankruptcy code, which it calls the draft Corporate Rehabilitation Act (CRA). In this working paper, we evaluate the proposed law from both an economic and a legal perspective. Conceptually, we describe the narrow confines in which economic theory supports bankruptcy, and argue that bankruptcy is poorly conceived as a tool to “rehabilitate” firms. We also argue that rehabilitation policies are, in the first place, an incorrect response to endemic firm closure since they systematically favor lossmaking firms, thereby setting up perverse incentives in the economy. Legally, we compare the CRA section by section to Title 11 of the United States Code on which it is based. While observing that the CRA’s authors have made a good first attempt at the limited goal of adapting Title 11, we argue that much remains to be done in this regard, given Pakistan’s weak institutional and political environment. We conclude that the proposed code deserves a complete review before being signed into law.