The Kingdom of Saudi Arabia overhauled its corporate insolvency framework in 2018 with the introduction of a new bankruptcy law. In this client alert we examine the new Bankruptcy law in detail.
The bankruptcy law that came into effect in the Kingdom of Saudi Arabia in 2018 reshaped the legal landscape with regards to the restructuring and liquidation of companies in the Kingdom. It established the framework for the administration of restructuring and liquidation procedures in Saudi Arabia, through the Commercial Courts and a newly formed Bankruptcy Commission. In addition, it set out a number of clearly defined restructuring and liquidation procedures to which a company may be subject, depending on its circumstances, ranging from solvent restructurings to accelerated liquidation procedures, as well as clearly setting out the priority of debts on a liquidation. A number of companies have been restructured or are undergoing liquidation pursuant to the new bankruptcy law and important indicators of how the new law will be applied by the courts have become available. While it remains too early to form a definitive view as to the efficacy of the new bankruptcy law, it is hoped that (i) the new bankruptcy law will cause distressed businesses to view solvent restructurings as a generally viable option and (ii) competing creditors' claims will be effectively managed, particularly in complex restructurings.
The new Saudi bankruptcy law (the "Bankruptcy Law") came into force in February 2018, followed in September by a set of implementing regulations (the "Implementing Regulations"). Despite the connotations of the name used, the Bankruptcy Law is akin to an insolvency law in other jurisdictions.
The Pre-Existing Legal Framework
Prior to the introduction of the Bankruptcy Law the legal landscape in Saudi Arabia as it related to insolvency and bankruptcy was not particularly developed. A legal framework did not exist for restructuring companies facing financial difficulties to enable to them to emerge as a going concern. Courts were particularly hesitant to declare individuals bankrupt, there was no mechanism to organize creditor claims and a cohesive and detailed set of rules stipulating how insolvent companies would be liquidated (provisions around moratorium periods, for example) was missing.
Given the family owned nature of many, if not most, business in the Saudi Arabia, and their typical position as part of larger conglomerates, formal restructuring and insolvency proceedings have traditionally been eschewed in favor of other, perhaps less efficient, measures such as intra-company liquidity support. In addition, many creditors have in the past favored resolving payment disputes through direct negotiation instead of using the legal tools available to try and compel repayment. These factors, and others, mean that a voluminous precedent for liquidation and/or administration does not exist in Saudi Arabia, nor is there great precedent for creditors aggressively pursuing their claims against debtors through all available legal channels.
The Bankruptcy Law
The promulgation of the Bankruptcy Law was universally welcomed given the preceding paucity of regulation in this area. In particular, the breadth and depth of the Bankruptcy Law contrasted very positively with the pre-existing legal regime and reassured investors considering investing in the Kingdom of Saudi Arabia.
The stated objectives of the Bankruptcy Law include, most notably, permitting the reorganization and business continuity of debtors facing financial difficulties and ensuring the fair treatment of creditors.
The Bankruptcy Law provides for the Commercial to Courts administer the various restructuring and insolvency procedures established by the Bankruptcy Law. In addition, the Bankruptcy Law provides for the creation of a Bankruptcy Commission which is to issue regulatory instruments necessary for the application of the Bankruptcy Law (rules for creditor meetings, for example), license trustees (insolvency practitioners) and maintain a register of companies and individuals that have undergone one or more of the procedures set out in the Bankruptcy Law.
Restructuring and liquidation procedures
A protective settlement is best thought of as a debtor driven administration process. The debtor puts forwards a plan (which needs to be approved by the Commercial Courts) that would enable it to continue as a going concern and repay its creditors.
A debtor would be eligible to apply for a protective settlement if, for example, the debtor has been unable to pay its debts on their due dates or is otherwise insolvent. In order to approve the debtor's application the Commercial Courts will need to find that, amongst other things, the debtor's business can continue and that the debtor's creditors can be repaid within a reasonable period of time. The conduct of the Commercial Courts indicates that prior to approving an application they will undertake a fairly detailed analysis of the debtor's existing financial position so that they are reasonably satisfied as to the prospects of the debtor emerging as a going concern. Debtors will need to provide the Commercial Court with information sufficient for such an analysis, and we are aware of cases where an application was rejected on the basis of insufficient information having been presented.
Once the application for a protective settlement has been approved the debtor may apply to have a moratorium put into effect. The debtor's creditors will need to vote on the restructuring proposal for it to be approved and, once approved, then the creditors' vote will need to be ratified by the Commercial Court.
A financial restructuring is similar to an administration under common law; the business of the debtor is largely controlled by a registered insolvency practitioner as it is restructured to enable it to pay its creditors while continuing as a going concern.
While a protective settlement is applied for and driven by the debtor a financial restructuring is more prescriptive. Creditors of the debtor, in addition to the debtor itself, may apply to the Commercial Court to place the debtor into financial restructuring and a trustee is appointed to supervise the running and restructuring of the debtor's business.
An application to place the debtor in a financial restructuring procedure may be made if, amongst other things, the debtor has been unable to pay its debts on their due dates or is insolvent.
In order to approve an application to place a debtor into a protective settlement the Commercial Courts are required to find that the debtor is likely to be able to continue its business following the implementation of the financial restructuring procedure. Once the application is made a moratorium with respect to claims against the debtor comes into force, ending on the earlier of (i) the date on which the application is rejected, or (ii) if the application is accepted, the date on which the financial restructuring is completed.
Upon approving an application to place a debtor into a financial restructuring procedure the Commercial Courts will appoint a registered insolvency practitioner, referred to as a trustee, to manage a significant portion of the debtor's business and assist the debtor in preparing and implementing the restructuring proposal. The trustee is required to prepare a record of all of the debtor's assets, in addition to requesting that the debtor's creditors submit their claims against the debtor.
The debtor is required to prepare the restructuring proposal with the trustee's assistance prior to the trustee submitting the completed proposal to the Commercial Courts for approval. Once approved, the restructuring proposal will need to be voted upon by the debtor's creditors.
Two of Saudi Arabia's most famous and long-running corporate insolvency cases, that of the Saad Group and Ahmed Hamad Algosaibi and Brothers are presently being conducted pursuant to the financial restructuring chapter of the Bankruptcy Law, with creditors welcoming the greater clarity now associated with the proceedings. As with protective settlements, the Commercial Courts have been undertaking a detailed analysis of the viability of the financial restructuring prior to granting their approval to the same. Where the debtor is a regulated entity, the Commercial Courts have given weight to the views of the relevant regulating authority as to the viability of the restructuring proposal submitted as part of the financial restructuring application.
Liquidation is intended for those debtors who are unable to pay their creditors while continuing as a going concern. The aim is to maximize the value received from the disposal of the debtor's assets to ensure that as much as possible of the debtor's outstanding debt is paid.
The debtor or any of its creditors may apply to the Commercial Court to place the debtor into liquidation, provided the debtor is in default of its payment obligations. If the application is approved a moratorium will come into force from the date on which the application is made to the earlier to occur of (a) date on which the application is rejected, or (b) if the application is accepted, the date on which the liquidation is declared completed.
In a liquidation a trustee takes complete control of the debtor's business. Once the trustee has prepared an audit of the debtor's assets and creditors' claims the trustee will start selling the debtor's assets and distributing their proceeds to creditors.
Creditors retain a measure of control over the liquidation process given that the trustee is legally required to seek their approval before taking certain actions, such as selling assets above a certain value.
Administrative liquidations aims at liquidating the assets of the debtor as efficiently as possible where the proceeds of the disposal of the debtor's assets are not expected to cover the cost of the liquidation. Comparing administrative liquidation to a standard liquidation, it is worth noting that:
(a) the two procedures are run differently (a liquidation is supervised by the Commercial Court while an administrative liquidation is supervised by the Bankruptcy Commission); and
(b) creditors do not have a direct say in how an administrative liquidation is run while in a liquidation creditors would have voting rights in respect of certain matters.
Provided that, amongst other things, the debtor has defaulted on the repayment of its debts, then either the debtor or its regulating authority may submit a petition to the Commercial Court requesting that the debtor be placed into administrative liquidation. If the application is approved then the Bankruptcy Commission would run the debtor's business for the duration of the procedure and would start selling the assets of the debtor as soon as it is able to do so.
Existing precedent suggests that the Commercial Courts would be willing to unilaterally turn a liquidation petition to one for administrative liquidation should they find that the debtors' assets are unlikely to cover the costs of a liquidation.
The Bankruptcy Law includes sections dedicated to the application of the protective settlement, financial restructuring and liquidation procedures to 'small debtors', defined as of the date of this circular as being those debtors with debts not exceeding two million Saudi Riyals (SAR 2,000,000). The aim is to make those procedures simpler and less costly than they would be for debtors not classified as 'small debtors'.
While many of the details of each procedure apply equally to 'small debtors' and debtors not so classified, there are a number of differences; for example:
- in a protective settlement procedure applicable to 'small debtors' the 'small debtor' may place itself into a protective settlement by completing a form prepared by, and filing the same with, the Bankruptcy Commission, whereas typically an application for a protective settlement would be made to the Commercial Court; and
- voting thresholds for creditor approval differ in a financial restructuring of a small debtor as against the same procedure applied to debtors not so classified.
Priority of Debts
In setting out the priority of debts on a liquidation the Bankruptcy Law follows an approach similar to that in other jurisdictions. For example, the liquidation's expenses rank ahead of secured debt which, in turn, ranks ahead of unsecured debt. It is worth noting, however, that prior wages of the debtor's employees rank in priority to unsecured debts.
Debt finance and set-off
The Bankruptcy Law clearly sets out the types of finance that may be procured, and the types of set-off that may be performed, in each of the procedures set out therein. For example, debtors are generally prohibited from procured secured loans except with the leave of the Commercial Court and in the context of a protective settlement or financial restructuring procedure.
Liability of the debtor's management
The Bankruptcy Law sets out a number of actions that a company's management are prohibited from taking, such as continuing a company's business knowing that the company can no longer avoid insolvency. Management would only, however, be liable if, for instance, such actions led to the company being subject to, or were taken during, one of the restructuring or liquidation procedures contemplated by the Bankruptcy Law.
In addition, the Bankruptcy Law provides for the possibility of the Commercial Court clawing-back certain assets and transactions, including those assets disposed of, or those transactions entered into, by a debtor at an undervalue, subject to certain exceptions.
While the Bankruptcy Law came into force only relatively recently its regulating entities have already been established and companies have already been restructured and liquidated pursuant to its terms. Given the paucity of regulations around corporate insolvency prior to the issuance of the Bankruptcy Law there can be little doubt that the issuance of the Bankruptcy Law has caused a significant shift in the regulatory landscape applicable to distressed companies. Companies facing financial difficulties, as well as their creditors, now have a number of clearly defined procedures that they can choose from depending on the circumstances of the indebted company. Similarly to other jurisdictions, such as the United Arab Emirates, where the insolvency law has recently been overhauled, while the new laws are themselves relatively detailed it will take time for a substantive precedent of cases to accumulate such that we would be able to tell (a) precisely how the Bankruptcy Law is implemented practically, especially where the debtor is a large corporate entity with a large number of creditors and complex contractual arrangements and (b) whether the Bankruptcy Law, as implemented by the Commercial Court, the Bankruptcy Commission and trustees is effectively able to manage between the competing interests of (a) efficiency, (b) continuing the debtor's business (or maximizing the proceeds of the liquidation of the debtor's assets) and the (c) maximizing the recovery by creditors of outstanding debts.