On 24/12/1437 H. (25/9/2016 G.), the Ministry of Commerce and Investment ("MoCI") published the draft Bankruptcy Law ("Draft Bankruptcy Law") and a Clarification Guide (the "Clarification Guide"). The MoCI invited the public to submit comments on the Draft Bankruptcy Law by the end of 25/1/1438 H. (27/10/2016 G.). After this process is completed and the Bankruptcy Law is enacted, the MoCI must prepare implementing regulations with concerned Governmental authorities. These regulations must be issued with the approval of the Council of Ministers.
The Draft Bankruptcy Law was preceded by a policy paper (the "Policy Paper") that had previously been published by the MoCI for comments on 26/5/1436 H. (17/3/2015 G.). The Policy Paper described the main concepts that the legislator contemplated including in the Bankruptcy Law. The Draft Bankruptcy Law follows the broad lines of that paper.
The MoCI described the Draft Bankruptcy Law as a step taken towards the encouragement of economic activity and the implementation of the 2020 National Transformation Plan and Vision 2030.1 The MoCI stated that the Draft Bankruptcy Law follows best practices and the recommendations formulated on the subject by various international bodies such as the World Bank and the United Nations Commission on International Trade. The MoCI stated that the draft legislation also takes inspiration from the legislative frameworks and experiences in England and Wales, France, the United States, Germany, the Czech Republic, Singapore and Japan.
The Draft Bankruptcy Law contains a total of 320 provisions, revolving principally around three mechanisms: preventative settlement, financial restructuring, and liquidation. According to the MoCI, the Draft Bankruptcy Law's mechanisms attempt to protect the rights of creditors while safeguarding the continuation of economically viable businesses and minimizing the time and impact of business disruptions. According to MoCI, the Draft Bankruptcy Law attempts to palliate the typical challenges met by merchants and investors.
The Draft Bankruptcy Law also contains simplified processes for individuals and smaller entities with limited assets. The simplification aims at reducing the time and cost associated with the Draft Bankruptcy Law processes.
The Draft Bankruptcy Law applies to:
- Saudi individuals engaged in a commercial, professional, or lucrative activity in Saudi Arabia;
- Saudi registered legal entities; and
- Foreign investors (either individuals or companies) which/who own assets in Saudi Arabia or which/who conducts a commercial, professional or lucrative activity in Saudi Arabia.
Pursuant to the Policy Paper, it was intended that the Draft Bankruptcy Law would apply to all natural persons (Saudis and foreign residents), irrespective of whether or not they are practicing a commercial activity. It is notable that, in respect of natural persons, the scope of the Draft Bankruptcy Law is actually limited to 'merchants'. Arguably, this would create a vacuum regarding the regime and rules applicable to non-merchants.
The MoCI recognizes that although the Draft Bankruptcy Law is intended to provide a comprehensive framework governing insolvency, individual regulators (e.g. the Saudi Arabian Monetary Agency in the case of banks and insurance companies) may wish to supplement such framework with specific rules in respect of entities subjected to their jurisdictional sphere.
3. EXISTING LEGISLATIVE FRAMEWORK
At present, the legislative framework governing bankruptcy remains largely underdeveloped. It is constrained to very few provisions in the Commercial Court Law2, as well as to the Bankruptcy Preventative Settlement Law3.
The Commercial Court Law distinguishes between different types of bankruptcies.4 It spells out a brief process for the liquidation of the bankrupt's assets. It also prioritizes certain creditor claims over others. As for the Bankruptcy Preventative Settlement Law, it spells out a procedure for the settlement of creditor claims, but it apparently has not gained sufficient traction amongst practitioners.5
The Draft Bankruptcy Law, once enacted, would supersede the framework under both the Commercial Court Law and the Bankruptcy Preventative Settlement Law.
4. BANKRUPTCY COMMITTEE
Pursuant to the Draft Bankruptcy Law, a Bankruptcy Committee will be created by way of a decision of the Council of Ministers (the "Bankruptcy Committee"). The Bankruptcy Committee will be composed of five members or more and will be supervised by the MoCI. Amongst its most notable roles, the Bankruptcy Committee will be responsible for:
- the creation of a register of individuals and/or entities which have engaged any of the mechanisms described in Paragraph 6 below;
- the creation of a list of trustees and experts;
- the oversight of the effectiveness of the bankruptcy framework;
- raising public awareness regarding the bankruptcy framework and its mechanisms; and
- the preparation of templates for any documents or forms referred to the in the Draft Bankruptcy Law.
The Draft Bankruptcy Law defines 'debts' as contractual and non-contractual obligations. This includes pecuniary obligations and obligations to perform or abstain from performing certain actions.
The Draft Bankruptcy Law distinguishes between an 'insolvent' and a 'bankrupt'. According to the draft law the former is a person who has stopped paying his debts and the latter is a person who – in addition to having stopped paying his debts – has debts that exceed all of his assets.
6. MAIN MECHANISMS AVAILABLE UNDER THE DRAFT BANKRUPTCY LAW
6.1 Preventative Settlement
Preventative Settlement is one of the options available in the event of anticipated financial distress, insolvency or bankruptcy. It may be initiated by way of a Court order at the request of either the debtor or the regulatory authority vested with the oversight of the debtor's field of activity (the "Competent Authority").
This mechanism may not be engaged:
- if the debtor had already engaged it within the past six months
- if any other mechanism under the Draft Bankruptcy Law would be concurrently engaged; or
- without the approval of the Competent Authority, as applicable.
Upon its own initiative or at the request of the debtor or any of the creditors, the Court may require that the hearings be held confidentially. The Court may also decide to steer away from the preventative settlement route and rather engage the financial restructuring or the liquidation routes.
Under the preventative settlement route, the debtor is allowed to continue the day-to-day management of the business, without being put into administration.
Depending on the circumstances, the preventative settlement process may result in the suspension of creditor claims for up to 180 days. As an exception, the enforcement of pledges may be authorized in certain circumstances (e.g. where such enforcement would not lead to the failure of the mechanism or the discontinuation of the debtor's business or where non-enforcement would cause substantial harm to the secured creditor).
The Court may order the termination of any contractual arrangements that turn out to be excessively onerous on the debtor, provided that such termination does not result in excessive damage to the counterparties to such arrangements.
Interestingly, the Draft Bankruptcy Law states that the preventative settlement mechanism does not result in the acceleration of non-mature contractual debts of the debtor and that any contractual provision to the contrary is deemed null and void. If this new provision is adopted, it would imply the need to revisit many of the forms and templates typically utilized in the financing industry.
The settlement plan formulated under such mechanism may be imposed on dissenting creditors, subject to being approved by (i) at least two thirds of the creditors in each category of creditors, and (ii) by creditors representing over half of aggregate debts in each category. Creditors who are unaffected by the proposed plan have no voting rights.
The settlement plan must be validated by the Court, which will be bound to apply a fairness standard stipulated in the draft law. The Draft Bankruptcy Law is not clear regarding what would happen if the plan is approved by some, but not all, categories of creditors. Most probably, it would result in the plan having to be approved by all categories of creditors for it to be effective.
6.2 Financial Restructuring (Reorganization – Rehabilitation)
Financial restructuring is another option available in the event of anticipated financial distress, insolvency or bankruptcy.
Financial restructuring may be initiated by the Court, following the petition of either the debtor, a creditor or the Competent Authority. This mechanism may not be engaged:
- if the debtor had already engaged it within the past 12 months;
- if it would be concurrently engaged with any other mechanism already engaged under the Draft Bankruptcy Law; or
- without the approval of the Competent Authority, as applicable.
Once the restructuring process is engaged, the Court appoints a trustee to oversee it. The Court may also appoint experts to assist the trustee in his role. The trustee enjoys wide administration powers and may, for instance, sub-lease property leased by the debtor, even where this is not allowed under the lease agreement. The trustee also has the power to divide the creditors into voting categories depending on the similarity of their respective rights and any factors deemed relevant.
The trustee takes over the day-to-day management of the debtor's business during the process but may allow the debtor to undertake certain tasks under the trustee's supervision. The debtor may not sell any of its assets outside the ordinary course of business, except with the trustee's prior approval.
The trustee prepares a proposal for financial restructuring and submits it for voting by the creditors. The approval of the proposal requires the vote of at least two thirds of the creditors in each category of creditors. It must also be approved by creditors representing over half of aggregate debts in each category. The Court must validate the proposal if it is approved by at least one category of creditors and if it meets the fairness requirements stipulated in the draft law. The trustee oversees the implementation of the restructuring plan and must report to the Court any difficulties faced in this regard.
All creditor claims are suspended throughout the duration of the process. As an exception, and in the same way as under the preventative settlement mechanism, the enforcement of pledges may be authorized in certain circumstances (e.g. where such enforcement would not lead to the failure of the process or the discontinuation of the debtor's business or if non-enforcement would cause substantial harm to the secured creditor).
As under the preventative settlement mechanism, and with the exception of contracts made in the scope of the Government Tenders and Procurement Law, the Draft Bankruptcy Law states that the financial restructuring mechanism may not result in the acceleration of non-mature contractual debts of the debtor or the termination of any contracts to which the debtor is a party. Any contractual provision to the contrary is deemed null and void.
Also as under the preventative settlement mechanism, the Court may order the termination of any contractual arrangements that reveal to be excessively onerous onto the debtor, provided that such termination does not result in excessive damage to the counterparties to such arrangements.
Liquidation may be ordered by a Court on its own initiative, or by way of a petition by the debtor, a creditor, or the Competent Authority. Naturally, forced liquidation is an option of last resort, when the financial situation of the debtor cannot be rehabilitated. Most often, it is requested by the creditors.
Under the liquidation route, a trustee is appointed by the Court to:
- take over the day-to-day management of the business of the debtor;
- identify and fairly decide between the claims of the creditors; and
- identify and liquidate the assets of the debtor to satisfy creditor claims.
The trustee must announce the commencement of the liquidation process in one or more daily newspapers (and by any other means instructed by the Bankruptcy Committee). The announcement must invite creditors to submit their claims within a period to be specified in the announcement. The period must be between 14 to 90 days. Within 14 days from the end of this period, the trustee must present a list of all creditor claims and recommendations regarding whether or not to approve them or solicit the opinion of the expert. The trustee may present certain matters for the vote and approval of those creditors representing the majority of undisputed claims. The trustee must act transparently and report to creditors on steps taken.
The Court orders the sale of liquidation assets either by auction or based on a price and any conditions that it deems appropriate. The trustee proceeds with the liquidation of the assets and the distributions between the creditors based on the order described in the Paragraph 7 below. Non-matured debts are accelerated and considered due as from the commencement of the liquidation process.
The liquidation process does not normally discharge natural person debtors of their debts, unless otherwise approved by the creditors. The regulations to be issued in implementation of the Bankruptcy Law will specify the manner by which creditors may recover remaining debts from natural persons following the completion of the liquidation process.
The Draft Bankruptcy Law contains a mechanism for expedited and simplified liquidation (referred to in the Draft Bankruptcy Law as 'Administrative Liquidation'), in case it is clear from the outset that the proceeds would not suffice for distribution amongst the creditors or to cover the costs of the liquidation process.
7. PRIORITY RANKING FOR UNSECURED CREDITOR CLAIMS
The Draft Bankruptcy Law articulates the following priority ranking for unsecured creditor claims:
- one month salary for the debtor's employees;
- alimony for the debtor's spouse, children and/or relatives, as required by law or a court judgment;
- (i) fees, charges and disbursements for the provision of goods and services required for the debtor's business, provided that they became due following the commencement of the liquidation process; (ii) any dues owed by the debtor and tied to the obligations performed by this latter in his sphere of activity; and (iii) any dues owed by the debtor and tied to the assets under liquidation;
- ancillary disbursements and costs associated with any decision taken, following the commencement of the liquidation process, to continue the debtor's business;
- charges and disbursements associated with any of the Draft Bankruptcy Law mechanisms engaged, including the fees of the trustee and the fees for the preservation and liquidation of assets;
- any wages and other entitlements owed to the debtor's employees pursuant to the Labor Law6;
- any contributions (including late payment charges) due to the General Organization for Social Insurance;
- any customs due on merchandize;
- any other debts owed to governmental authorities;
- any creditors with prioritized rights under any legislation;
- any unsecured new financing obtained by the debtor pursuant to the Draft Bankruptcy Law.
- the generality of unsecured creditors;
- unsecured creditors who have contractually agreed to subordinate their rights to those of other unsecured creditors; and
- the shareholders of the debtor.
To the extent that the balance of the liquidation assets is insufficient to fully cover the claims of a particular category of creditors, such balance is distributed pro-rata amongst the creditors in that category.
8. NEW FINANCING
Subject generally to the Court's consent, the Draft Bankruptcy Law allows the debtor to seek new financing following the commencement of any of the Draft Bankruptcy Law processes. However, it is obviously difficult to obtain financing in such circumstances. For this reason, and as shown in Paragraph 7 above, the Draft Bankruptcy provides the lenders of any new financing with priority over the generality of unsecured creditors. New financing may even be secured by a pledge if this is justified in the circumstances and approved by the Court.
9. DEBTS IN FOREIGN CURRENCY
Debts in foreign currency are converted into their Saudi Riyal equivalent, according to the currency conversion rates applicable on the date of the commencement of the Draft Bankruptcy Law process in question.
10. PENALTIES AND SANCTIONS
The Draft Bankruptcy Law sets out penalties and sanctions for fraudulent actions that harm or compromise any of the processes specified in, or any of the objectives sought by, the Draft Bankruptcy Law. These actions include:
- the continuation of trading while there are no reasonable prospects of avoiding liquidation;
- the settlement of debts owed to a single creditor, in a manner that harms other creditors;
- the provision of false accounts or information on behalf of the debtor; and
- the provision of false or exaggerated creditor claims.
The Bureau of Investigation and Public Prosecution is responsible for the investigation of any allegations of such actions.
The overhaul of the Saudi Arabian bankruptcy regime has long been awaited and the publication of the Draft Bankruptcy Law is hence strongly welcomed.
The proposed legislative instrument attempts to encourage economic activity by promoting the survival of economically viable companies. As for inefficient companies that cannot be rehabilitated, the proposed legislative instrument seeks to expedite and maximize recoveries by creditors.
It is notable that the Draft Bankruptcy Law attributes various functions to the Court for each mechanism it regulates. The Court's involvement and discretion in determining when and how these mechanisms are employed should help make the Saudi Arabian bankruptcy regime transparent, predictable and efficient. The role of trustees under the Draft Bankruptcy Law should likewise participate in achieving this outcome.
Evidently, once the new law is enacted, market practitioners and the business community will need to be educated with the principles and mechanisms that it contains.
1 The core objectives of the 2020 National Transformation Plan and Vision 2030 include the diversification of the Saudi Arabian economy away from oil revenues and the strengthening of the capabilities and contribution of the private sector.
2 Articles 103 to 149 contained in Chapter 10 of Part 1 of the Commercial Court Law, issued by way of Order No. 32, dated 6/4/1350 H. (20/8/1931 G.).
3 issued by way of Royal Decree No. M/16 dated 4/9/1416 H. (25/1/1996 G.).
4 The Commercial Court distinguishes between real, negligent, and fraudulent bankruptcy.
5 Al Arabiya, 'A Lawyer: Three Important Steps in the Bankruptcy Law to Protect Companies', 28/5/1436 H. (18/3/2015 G.), http://www.alarabiya.net/ar/aswaq/special-interviews/2015/03/18/%D8%A7%D9%84%D8%AA%D8%AC%D8%A7%D8%B1%D8%A9-%D8%AA%D9%81%D8%AA%D8%AD-%D8%A8%D8%A7%D8%A8-%D8%A7%D9%84%D9%85%D9%82%D8%AA%D8%B1%D8%AD%D8%A7%D8%AA-%D9%84%D9%85%D8%B4%D8%B1%D9%88%D8%B9-%D9%86%D8%B8%D8%A7%D9%85-%D8%A7%D9%84%D8%A5%D9%81%D9%84%D8%A7%D8%B3-.html
6 Enacted pursuant to Royal Decree No. M/51 dated 23/8/1426 H. (27/9/2005 G.).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.