Banking & Finance
The Saudi Arabian Monetary Authority (SAMA) is the central bank of Saudi Arabia and the regulator of the banking sector. The Banking Control Law 1966, together with its implementing regulations, constitutes the principal law governing banking activity in Saudi Arabia. The Banking Control Law defines ‘banking business’ as follows:
“The business of receiving money on current or fixed deposit account, opening of current accounts, opening of letters of credit, issuance of letters of guarantee, payment and collection of cheques, payment orders, promissory notes and similar other papers of value, discounting of bills, bills of exchange and other commercial papers, foreign exchange transactions and other banking business.”
This chapter is focused on banking business. Banking business should be distinguished from ‘securities-related business’, which is regulated by the Capital Markets Authority (CMA). The Securities Business Regulations issued by the Board of the CMA pursuant to its Resolution Number 2-83-2005 dated 21/05/1426H (28 June 2005) sets out the requirements for applying for a securities business authorisation from the CMA, in respect of the securities activities of dealing, arranging, managing, advising and custody.
According to the Basic Law of Governance, the Kingdom of Saudi Arabia is a fully sovereign Arab Islamic state. Its religion is Islam and its constitution is the Holy Qur'an and the Sunnah (traditions) of the Prophet Muhammad (PBUH). The Qur'an and the Sunnah form the Islamic Shari’ah, which is the primary foundation of all Saudi laws.
Shari’ah principles relating to contracts are not codified in Saudi Arabia. Accordingly, the broad and general nature of the Shari’ah means that Saudi courts can be expected to apply a combination of discretionary powers and established legal principles in the review and interpretation of contracts. Given this flexibility, Saudi law generally provides parties the freedom to negotiate the terms of their dealings, unless such dealings relate to activities prohibited under the Shari’ah.
Financing structures used in Saudi Arabia typically are structured using Islamic finance arrangements such as Ijara or Forward Ijara (similar to a finance lease), Mudaraba or Musharaka (similar to a joint venture or partnership), Murabaha, etc.
The Bankruptcy Law was issued on the 05/28/1439 AH corresponding to 02/14/2018 AD, this law works to regulate bankruptcy cases in Saudi Arabia. There are seven main procedures that are connected to different bankruptcy cases, and they have been implemented in Saudi Commercial Courts.
This Law aims to regulate the following bankruptcy procedures:
Protective settlement: The debtor may file a petition with the court to initiate a protective settlement procedure if he is: a) likely to suffer financial difficulties that may lead to distress. b) Distressed. c) Bankrupt.
Financial restructuring: The debtor, creditor, or competent authority may file a petition with the court for the initiation of a financial restructuring procedure if the debtor is distressed or bankrupt.
Liquidation: A procedure which aims to list the claims of creditors, sell the bankruptcy assets, and distribute the proceeds thereof among creditors under the supervision of the liquidation trustee.
protective settlement for Small debtors: The protective settlement procedure for small debtors aims to enable small debtors to reach an agreement with creditors to settle the debts within a reasonable time through simple, efficient, and low-cost procedures, allowing the debtor to continue management of his business. A debtor is considered small under the provisions of the Bankruptcy law and its implementing regulations if the total debts owed by him at the opening of the bankruptcy procedure do not exceed the amount of (2,000,000) two million Saudi Riyals according to the decision 0218/12 dated 07/11/2018 of the Bankruptcy Commission regarding the criteria for small debtors.
Financial restructuring for Small debtors: The small debtors' financial restructuring procedure aims to facilitate an agreement between the small debtor and his creditors in order to restructure his business within a reasonable period, through simple, low-cost, and efficient procedures and under the supervision of the trustee.
“liquidation for Small debtors: The small debtors' liquidation procedure aims to sell bankruptcy assets and distribute their proceeds to creditors within a reasonable period through simple, low-cost, and efficient procedures under the supervision of the trustee.
Administrative liquidation: A procedure which aims to sell bankruptcy assets whose sale proceeds are not expected to cover the charges of the liquidation procedure or the small debtors' liquidation procedure under the supervision of the Bankruptcy Committee.
Bankruptcy procedures shall aim to:
Enable a debtor who is bankrupt, distressed, or likely to suffer financial difficulties to benefit from the bankruptcy procedures, restructure his financial position, resume his business, and contribute to economic development.
Protect creditors’ rights in a manner that ensures fair treatment.
Maximize the value of bankruptcy assets, conduct proper procedures for the sale thereof, and ensure fair distribution of sale proceeds among creditors upon liquidation.
Reduce the costs and duration of procedures and increase their efficiency, especially in restructuring the financial position of small debtors, or the sale of bankruptcy assets, and the distribution of sale proceeds among creditors in a fair manner within a specified period.
Undertake administrative liquidation of a debtor whose assets are not expected to cover the costs of the liquidation procedure or the liquidation of small debtors.
Aside from what is mentioned above from the bankruptcy law and it’s implementing regulations, stated that the regulations shall specify the provisions relating to transborder bankruptcy procedures according to rules of Cross-border bankruptcy which is issued on the 14/05/1444 AH corresponding 08/12/2022 AD, the regulations included scope of application, jurisdiction of the court, powers of the trustee and the foreign trustee, general principles, limited jurisdiction, protection of creditors and interested parties, recognition of a foreign bankruptcy procedure, judicial assistance, notification of the foreign creditor, cooperation between the court and the foreign court, simultaneity between procedures. Bankruptcy, multiple foreign bankruptcy procedures,
The Bankruptcy Commission has also published several rules and regulations and established the most up-to-date Regulatory Documents for a smoother process as follows:
Code of Archiving and Managing Bankruptcy Register and Penalty Register.
Rules for Meetings Management in the Bankruptcy Procedures.
Rules of Nominating Officeholders and Experts.
Code of Professional Conduct for Officeholders and Experts.
Rules Governing Bankruptcy Procedures in Commercial Courts.
The Rules Organizing the Work of Officeholders and Experts.
Rules of Information and Documents Stipulated in the Bankruptcy Law and the Implementing Regulations Thereof.
Code of Licensing the Officeholders and Experts.
Rules of Inspection and Verification.
Rules for Officeholders and Experts Fees.
The Saudi Government has issued a package of laws to reform key areas of the finance industry.
Commercial Pledge Law: This law, issued in 2018, deals with the taking of security over movable assets, including future movables, and the creation of floating charges.
Real Estate Mortgage Law: This law provides for the registration of mortgages. It also facilitates a secondary mortgage market (and thereby enabling access to the capital markets for refinancing) by allowing mortgages to be transferred by the mortgagee. The law is intended to pave the way for the private sector to assume a greater role in housing finance, leading to reduced borrowing costs.
Real Estate Finance Law: This law requires real estate finance companies to be licensed by SAMA.
Law on Supervision of Finance Companies: This law provides for SAMA to be the regulator of licensed finance companies operating in Saudi Arabia.
Finance Lease Law: This law provides for the leasing of assets. The lessee has an obligation to use the leased asset for the agreed purpose and be responsible for the operational maintenance of the asset.
The Commercial Pledge Law has changed the landscape in relation to the creation of security over ‘movables’ in Saudi Arabia. These changes will have an impact on the law and practice of banking in the Kingdom and will provide a wider variety of options when structuring lending transactions.
Movables – current and future property and future rights: Previously, it was possible to create security over movables that were in existence, but it was generally not possible to create securities over future movables (e.g. machinery under-construction or future deposits in a bank account). The Commercial Pledge Law contemplates the creation of security over movable property, whether in existence already or yet to come into existence. For movables that will come into existence, the pledgor should have a contract for purchase or construction and should be able to describe the asset, its value and date of completion. Future rights include debts that can be pledged or assigned by way of security, and this would cover receivables under contracts or invoices.
Security for a commercial debt: Significantly, the Commercial Pledge Law applies to pledge contracts that secure ‘Commercial Debts’. A Commercial Debt is a debt that arises from business or professional activities.
Registered pledges, possessory pledges and priority: Where registration of pledges is applicable under the Commercial Pledge Law, pleadges are required to be registered at the Unified Register of Commercial Pledges. If there is a special register for a type of asset (e.g. vehicles, ships, aircraft), registration on the relevant special register would suffice. A pledge contract relating to movable property is valid as against third parties if it is registered, or if possession of the movable property is transferred to the pledgee or to a trustee. For inventory and raw material, a floating charge is required to be created (discussed below). It is possible to create more than one pledge on the same pledged property. A registered pledgee will have priority over an unregistered pledgee in respect of the same pledged property. If there is more than one registered pledgee, the pledgee having the earlier date of registration will have priority. Unless otherwise agreed between the pledgees, a pledgee under a pledge contract shall have priority over a pledgee under a floating charge or a pledge over economic enterprise. At the time of writing, the Ministry of Commerce & Investment has published a draft of the Commercial Pledges Unified Register Regulation, which aims to provide for the electronic registration of pledges.
Pledge over bank accounts: A significant development under the Commercial Pledge Law is that it is now possible to pledge both present and future deposits in a bank account. Under the Commercial Pledge Law, it is possible to take security both over the deposits standing to the credit of the bank account as at the date of the pledge, as well as future deposits. This is especially important where security is to be taken over deposits in current and operating accounts, where deposits and withdrawals occur on a regular and on-going basis. Unless the pledgor and pledgee agree otherwise, the pledgor is not permitted to operate the bank account.
Floating charge: The Commercial Pledge Law defines a floating pledge or floating charge as a pledge created over movable property, without determining the elements of the movable property. Effectively, the pledgor and the pledgee are not required to identify the specific assets that are subject to the pledge. Inventory and raw materials are covered under the scope of a floating charge. A floating charge must be registered in the Unified Register of Commercial Pledges in order for the security to be effective against third parties. The pledgor is required to provide monthly reports of the stock available, and the quantity is not permitted to fall below 50% of the required pledged property unless the parties have agreed otherwise.
Pledge over economic enterprise: The pledge over economic enterprise, or pledge over commercial business, enables the secured party to obtain security over an entity that carries out commercial or professional activities. The pledge over economic enterprise creates security over all elements of the commercial or professional business, including its intangible elements (goodwill and customer database) and its tangible elements including its movable assets, rights (receivables and book debts), as well as the location where commercial activities are carried out. Inventory of products sold by the business would be excluded.
Pledge over securities: The Commercial Pledge Law excludes from its application shares of companies that are listed as well as shares of unlisted companies (being shares of Joint Stock Companies Closed). However, portions in entities (e.g. a portion or shares in a limited liability company) may fall under this Commercial Pledge Law and require registration at the Unified Register of Commercial Pledges. Other unlisted securities may also require registration unless they are governed by a special law governing perfection requirements.
Pledge contract: The Commercial Pledge Law sets out the constituent elements of a pledge contract. The key elements include: (a) where the pledged property is not in existence, the expected description, approximate date of existence and approximate value of the pledged property should be specified; (b) the general description, amount or maximum limit of the secured debt should be specified; and (c) the due date or expected due date of the secured debt should be specified.
The Registered Real Estate Mortgage Law (the ‘Mortgage Law’), issued in 2012, was a significant step towards encouraging real estate finance in Saudi Arabia. Until recently, local banks typically took an outright conveyance of the title to real estate (Ifragh) to a nominee entity. The transfer of title structure involves the obligor transferring legal title to a special purpose company, set up by the bank providing the financing, for the duration of the financing. The title to the property would revert to the obligor once the financing is repaid.
The Mortgage Law has now paved the way for a traditional mortgage structure, whereby the title to the property would remain with the borrower and the bank would obtain a registered mortgage. Some of the key features of the Mortgage Law are as follows:
Once a mortgage over property is registered, the secured debt can be recovered from the sale of the property in priority to other creditors;
The mortgage should be created in respect of a specific debt, or future or contingent debt, provided that the amount of the secured debt or maximum limit of the debt is specified in the mortgage agreement;
The owner of the property (mortgagor) continues to receive the rentals and other proceeds being generated from the property;
The mortgagor and mortgagee may agree in the mortgage agreement that the receivables from the mortgage property will be used to pay the debt, in accordance with the amortisation schedule, and to service any other fees, charges, and profits;
A lease of more than five years will not be enforceable if the property has been mortgaged; and
A property may have more than one mortgagee, allowing for the creation of a succession of mortgages (e.g., first mortgage, second mortgage, and so on).
In May 2017, SAMA issued a circular urging banks and finance companies to: comply with the notarisation of real estate mortgages and to stop the process of transferring title to property rather than mortgaging the real estate; remedy the status of properties that are currently registered in their name within a three-year period, and inform their clients accordingly; and inform SAMA about the cases in which the notary public refrains from registering a mortgage. This circular, in-effect, restricts the outright transfer of title, and instead requires any security over real property to be registered as a mortgage under the Mortgage Law.
Importantly, following publication of SAMA’s circular, notaries have issued guidelines as to the information banks will be required to present in order to register mortgages. Most notably, banks are required to provide a letter confirming that the debt being secured by the mortgage relates to a Shari’ah compliant transaction (either a tawarruq or murabaha). Yet another recent development is the issuance by SAMA of standard form ijara and murabaha documentation to be used when providing real estate finance.
These legal and regulatory developments, coupled with government-sponsored housing schemes, are indications of further reform in the real estate and housing market in Saudi Arabia.
Guarantees are generally recognized under Saudi law, and are commonly provided by corporations and individuals for third party debts as an undertaking to make payment where the primary obligor has failed to make the payment. While both corporate and personal guarantees justifiably provide lenders with some comfort and recourse to the guarantor, there are various aspects a cautious lender must be aware of in respect of guarantees in Saudi Arabia.
Primary Obligations: The obligations of a guarantor under a guarantee are secondary to those of the primary obligor. Furthermore, if the creditor releases the principal obligor from any guaranteed obligation, the guarantor will also be released from such obligation. In the same vein, if the primary obligations are found to be void, the guarantee will also be void as a result. Lenders should also be aware that if the primary obligor’s obligations relate to a transaction that does not satisfy the primary objective of Islamic finance, there is a risk that the guarantee may not be enforceable. For instance, derivative contracts are generally not recognised as enforceable from a Shari’ah perspective. Therefore, if a guarantee was provided to secure such transactions, it is unclear whether it would be deemed enforceable if the underlying obligations are seen as too uncertain or speculative in nature.
Demands: Any demands under the guarantee contract should be in writing. Furthermore, in certain instances, Saudi courts and other judicial authorities have acted in a manner which suggests that no reliance may be placed on any notice given by facsimile, telex, bank wire or electronically. Accordingly, from an evidentiary perspective, lenders should ensure that all communications to guarantors, including demands, are delivered by way of hard copies.
Enforceability: Lenders should note that the Saudi courts and judicial committees are likely to interpret guarantees in favour of the guarantor; under Saudi law, gurantees are considered ‘voluntary’ obligations. By way of example, while Saudi law does not stipulate a time period or limitation period during which a demand must be made, the Banking Disputes Settlement Committee has found that any delays on the part of a lender to exercise its rights against a guarantor can be construed as a waiver of the lender’s rights against the guarantor.
All monies guarantees: The distinction between specific guarantees and all monies guarantees is an important one. Under an all monies guarantee, a guarantor guarantees any and all obligations from the principal debtor to the lender, whether existing at the time of the guarantee or arising in the future. Lenders should be aware that guarantees for ‘all monies’ may face issues upon enforcement in Saudi Arabia. A fundamental rule of Shari’ah is that contracts must be free from uncertainty. In applying this principle, Saudi courts generally require that guarantees are issued with respect to a specified debt or a thing certain in amount. Additionally, Saudi courts have shown a preference for guarantees to include a maximum amount recoverable and to have a fixed period of validity.
Promissory notes: Lenders should also note the importance of promissory notes, a form of quasi-security in Saudi Arabia. Promissory Notes fall within the definition of commercial papers as provided for in the Law of Commercial Papers 1964 and are commonly used in Saudi Arabia as they are generally quick to enforce. Any claims under a promissory note can be filed directly with the Execution Court, which would generally not examine the underlying transaction to which the promissory note relates (as promissory notes are treated as independent of their underlying agreements). A promissory note can be enforced in a few months (in contrast with a guarantee, for which enforcement can take up to two years or longer). For this reason, a market practice has developed wherein promissory notes are taken for financings from both borrowers and guarantors. Provisions for the granting and reissuance of promissory notes can be built into the guarantee, providing the lender a more efficient avenue for enforcement. Promissory notes may also be enforced by a foreign lender not licensed in Saudi Arabia, although successful enforcement would be subject to the liquidity of the borrower.
Upstream guarantees: With regard to upstream guarantees (i.e. guarantees provided by subsidiaries for the benefit of their shareholders), and the extent to which these are permitted, this is a somewhat controversial issue under Saudi law. In particular, there are differing views as to whether Article 10 of the KSA Law No. 999 of 2015 (the ‘Companies Law’), which states that only profits from distributable profits may be distributed to the shareholders, applies to guarantees. Lenders should be aware that there are two views on this. The more restrictive view considers that where payments under guarantees are not made out of net profits, this would constitute a prohibited distribution of dividends. The alternative view is that payments under guarantees do not constitute a prohibited distribution where made for a proper purpose and there is demonstrable corporate benefit for the guaranteeing subsidiary. As this is a grey area, lenders should consider the impact of including an upstream guarantee in a security package. Additionally, Article 10 of the Companies Law is not thought to prohibit cross-stream guarantees (i.e. guarantees provided to affiliated companies), although it is generally necessary to demonstrate corporate benefit for this. Similarly, downstream guarantees (i.e. guarantees from parents to their subsidiaries) are not affected by this provision.
