Saudi Arabia to Introduce Revolutionary New Insolvency Law in 2016
Saudi insolvency law has for some time been something of an unknown quantity for non-Saudis. A wide-ranging reform is due to take effect in 2016, which will express elements of the rescue culture and is likely to make restructurings more common. Increased certainty in the outcome of insolvencies will benefit both Saudi businesses and domestic and foreign creditors alike.
Critics of Saudi insolvency law have pointed out the current failures to distinguish between personal and corporate insolvency, or to provide a moratorium on creditor action and other rescue procedures. Generally, the cost of closing a Saudi business is far higher and the recovery rate, far lower. Historically, settlements may have more commonly proceeded outside the court system because of its inherent uncertainty. More recently, it is thought that restructurings which reflect the Shar’ia principle of “equanimity between creditors” are more likely to be endorsed by the Saudi Board of Grievances (the “BoG“) and certainly looked on more favourably than individual creditor action.
Existing Saudi Insolvency Law
Saudi insolvency law currently comprises two statutory provisions: chapter 10 of the Commercial Court Law 32/1350 (1931) (the “CCL“) and Royal Decree M/16 of 1416 (1996) giving effect to the Law of Settlement Preventing Bankruptcy (the“Preventive Settlement Law“), as supplemented.
The practical application of these provisions is heavily dependent on the discretion of the individual judge dealing with any particular matter. The judiciary does not have specialist insolvency expertise. There is no system of judicial precedent. Very little information is available to assess the approach of Saudi courts to the legislation in force.
The CCL provides a detailed code for bankruptcy, although its relationship to corporate insolvency is unclear.
There is an order of priority for payments out of the insolvent estate. For all but “fraudulent” bankrupts, both “his expenses and the expenses of his dependents” and “the rents for his residence and his business premises, the wages of his servants and clerks and the dowry of his wife” shall be deemed to be “Privileged Debts” and shall have priority over all creditors. None of these is subject to a cap, assessment scale or review. Special rules apply to deposits, mortgages and pledges.
From the rump of the estate, unsecured creditors receive an equal distribution, reflecting the Shari’ah principle of “equanimity between creditors”.
The concept of equal distribution also has echoes of the principle of pari passudistribution in English law. The radical difference comes from what is taken out of the insolvent estate first.
(b) The Preventive Settlement Law
Unlike the CCL, the Preventive Settlement Law applies to “every trader, person or company” who fears the imminence of insolvency on what appears to be a cash flow basis. The debtor may serve a request for an “amicable resolution with his creditors”, to be considered by creditor committees and, potentially, ordered by the BoG.
Critically, certain debts, including once again the wide ranging and potentially valuable Privileged Debts identified in the CCL (together with subsequent debts), are not comprised within the settlement.
Any creditor who does not participate may remain outside the settlement and the debt owed to it will mature at the closure of the settlement proceedings. In this sense there is a temporary prohibition on dissenting creditor action. However, aside from these points, there is again no general stay or moratorium on creditor action. There is no way to bind dissenting creditors. No distinction is drawn between different classes of creditors.
In May 2015 the Ministry of Commerce and Industry published a policy paper on the reform of insolvency law in the Kingdom of Saudi Arabia. It follows a comparative analysis of insolvency law in benchmark jurisdictions. The enactment of reforms is anticipated during the course of 2016.
As regards individuals, it appears as if the concept will not be retained in its current form. However, priority will be accorded to amounts owed to the Saudi Government, as well as liquid assets supplied to the estate during the conciliation period. Additionally, the court will be granted discretion to exclude certain ‘personal property’ and ‘resources required to meet personal needs’ from forming part of the bankrupt or insolvent estate. Depending on how this discretion is exercised, aspects of the Privileged Debts concept may, in practice, be retained.
What is clear is that the proposals are to apply to companies and other economic entities as well as individuals. They feature three procedures:
Conciliation: an enhanced version of the protective settlement regime akin to “conciliation” will be introduced. This will enable debtors to propose compositions that bind creditors and provide a moratorium from creditor action before or after entry into a formal insolvency process. It is envisaged that classes of creditors will be identified, with an analysis of the fairness of the proposed restructuring and an opportunity for creditors to challenge it in court. Dissenting secured creditors may be bound by a majority vote of secured creditors of equal standing.
Rehabilitation: a new rehabilitation procedure will also be introduced for companies where a return to financial health is possible, with some features in common with English administration. It will allow the cancellation of debt, debt for equity swaps, disposal of assets and the rescheduling of debts. Restructuring plans will be permitted. The BoG will be able to impose a restructuring on creditors, subject to certain provisos including fairness to the dissentient class, recognizing its relative priority. The management of the company will be displaced by the office-holder, subject to the court’s supervision.
In both Conciliation and Rehabilitation, it will be possible for debtors to receive new injections of capital and give priority to the funders over non-preferential unsecured creditors.
Liquidation: reforms will include a stay against creditor claims and the adjudication of those claims within the liquidation, rather than by the BoG, as now, save where issues of law or fact require judicial determination. A cash-flow test of insolvency is to be adopted.
Other key features of the new regime applicable to all three procedures will be:
Small Entities: streamlined procedures available for small entities falling below particular financial thresholds.
Moratorium: the right to apply for a moratorium, binding on all creditors.
Jurisdiction: jurisdiction rules based on connections with the Kingdom of Saudi Arabia.