The New Saudi Civil Transactions Law and its Impact on Guarantees in the Banking Sector
Rafiq JafferPartner,Banking & Finance
Mohammed NegmSenior Counsel,Dispute Resolution
Rawan AlsawadTrainee Lawyer,Banking & Finance
The Kingdom of Saudi Arabia (KSA) has adhered to Shari’ah principles as the foundational framework for its legal system. The Shariah principles predominantly originate from the Holy Quran and have been implemented in a comprehensive and inclusive manner. In contrast to other legal systems in the Gulf countries, KSA lacked codification in relation to contractual matters.
In a significant recent development, KSA has introduced the Civil Transactions Law, formally enacted on 18 June 2023 through Royal Decree M/191 (the “Civil Code”). The enactment of this new legislation formalizes the regulations and fundamental principles that govern the process of contract formation, the consequences arising from the contract, and the procedures for contract termination. This achievement holds considerable importance, supported by the national initiative known as Vision 2030, which aims to enhance the economy and legal structure through modernization efforts and ensure alignment with international best practices. While the Civil Code addresses various aspects that were previously uncodified, this article will focus mainly on the legal framework governing guarantees under the Civil Code.
Guarantees form the backbone of many financial transactions and it is common in the banking and financial world for corporations and individuals to provide guarantees for third-party debts. The guarantees serve as a commitment to fulfill payment obligations in cases where the primary debtor has defaulted on its payment obligations. Both corporate and personal guarantees offer credit support to creditors and means of recourse to a third party when things go wrong.
Under the Civil Code, the guarantee is a legally binding agreement where the guarantor undertakes the responsibility to fulfill the debtor’s obligations towards the creditor in the event that the debtor fails to fulfill the said obligations. For a guarantee to be valid under the Civil Code, certain requirements must be met. We elaborate on the specific provisions for guarantees as detailed in the Civil Code:
As per the Civil Code, a guarantee refers to a legally enforceable arrangement entered into by a guarantor and a creditor. In the event that the offer of a guarantee is specifically addressed to the creditor, the absence of a response from the creditor may be construed as an indication of its acceptance of the guarantee. Importantly, the consent of the debtor is not a prerequisite for the guarantee, and it can be executed without the debtor's awareness or even in the face of its objection.
The guarantor must have full legal capacity to enter into the guarantee. Special limits are placed on guarantees made by terminally ill persons, restricting them to only one-third of the estate. Another key validity requirement is that the underlying liability that is being guaranteed must be true and legally enforceable.
The guarantee itself can take different forms as being absolute, conditional, temporary or deferred. Importantly, the Civil Code allows for guarantees to cover future and conditional debts, provided the amount of the liability is fixed and determined in advance. However, if the guarantee of the future debt does not specify a definite duration for the guarantee, the guarantor has the right to withdraw his/her guarantee, provided that the creditor is duly notified of the retraction before the debt reaches its maturity, allowing for a reasonable period of time.
Before the Civil Code, the practice of issuing "all monies" guarantees was prevalent. This type of guarantee essentially held the guarantor accountable for all liabilities the debtor had towards the creditor, irrespective of whether these debts were incurred before or after the guarantee's issuance. However, this approach encountered enforcement difficulties in KSA due to the fundamental principles of Shari'ah law that requires contracts to be devoid of uncertainty. Saudi courts typically insisted that guarantees should pertain to a clearly specified debt or an amount with certainty. They also favored guarantees to stipulate a maximum recoverable amount and a defined period of validity.
In the Civil Code, it is necessary for the terms of the guarantee to ensure that the guaranteed obligations will not exceed the underlying debt being guaranteed. In situations where the guarantee exceeds the debtor's outstanding balance and imposes stricter terms than the guaranteed obligations, its validity is limited to the extent of the debtor's outstanding balance and the corresponding terms. On the other hand, in situations where the guarantee is provided for a sum that is less than the debtor's unpaid obligations, it would still remain enforceable.
This approach in the Civil Code lies in its ability to strike a balance between the interests of the creditor and the guarantor, while also ensuring that guarantees are issued in accordance with the principles of Shari'ah. Creditors are currently obligated to ensure that guarantees are issued for a specific debt or a clearly defined amount, and that the value and conditions of the guarantees are in accordance with the corresponding debt being secured. By doing so, creditors can ensure that their guarantees are enforceable under the Civil Code.
One of the primary stipulations pertaining to the enforceability of guarantees is that in cases where the guarantor is not jointly liable with the debtor, the creditor may not pursue legal action against the guarantor solely unless all available avenues for recourse against the debtor have been exhausted. This means that the creditor is obligated to initially pursue the debtor prior to establishing the liability of the guarantor. Furthermore, the creditor lacks the ability to enforce against the guarantor's funds unless the debtor's assets have been fully exhausted. However, the Saudi courts will not dismiss the creditor’s claim against the guarantor in such cases unless the guarantor upholds his right.
From the creditor's perspective, this is a significant limitation necessitating the inclusion of suitable provisions in the guarantee to permit the creditor to take action against both the debtor and the guarantor simultaneously, and without the need to first take action against the debtor.
Another significant stipulation pertains to situations where the debt is backed by a security interest in a specific property either before or in conjunction with the guarantee. In such cases, the guarantor is not held jointly liable with the debtor. Prior to seizing the assets of the guarantor, there is a requirement to first take enforcement action against the secured assets. From the creditors' perspective, this limitation may not be acceptable. Accordingly, a provision in the guarantee that allows the creditor to take enforcement action against the secured assets, as well as the guarantor, may be included.
Additionally, we recommend that the demands under a guarantee must be made in writing. Where the primary obligor has defaulted on its obligations and the guarantor notifies (or warns) the creditor that such default has occurred, the creditor has six (6) months from the date of notification to commence enforcement proceedings.
Furthermore, the Civil Code states that where the guarantee is absolute, the liability of the guarantor is contingent upon the debtor's obligation, regardless of whether it is immediate or deferred. This implies that the guarantor bears responsibility for all obligations owed by the debtor to the creditor, irrespective of their timing. Nevertheless, the extent of this responsibility is restricted to the duration specified in the guarantee. The Civil Code further provides that the guarantee is classified as a deferred guarantee where it pertains to an existing debt. The guarantor's liability for the debt does not arise until the expiration of the agreed term, while the creditor retains the right to demand immediate payment from the debtor. This provision serves to shield the guarantor from being held responsible for debts that have not yet reached their maturity date, while also ensuring that the creditor is able to enforce the guarantee when required.
In the context of a temporary guaranteed contract, the guarantor assumes liability solely for the obligations that arise within the specified guarantee period. This provision serves to establish that the extent of the guarantor's responsibility is confined to the precise duration during which the guarantee remains valid.
The Civil Code covers several ways in which a guarantee may be terminated. If the underlying debtor is released from liability, then the guarantor is also discharged, with limited exceptions. If the creditor accepts some alternate performance or payment for the debt, this serves to release the guarantor from liability. Assignment or transfer of the debt itself by the debtor or creditor also ends the guarantee. Importantly, the guarantee continues to be binding even after the death of either party, with liability passing to the deceased person's estate.
In summary, the Civil Code is a positive step forward in clarifying issues surrounding guarantees. The codification will allow parties to clearly set out and understand their rights and obligations when granting or accepting guarantees. The Civil Code will certainly provide clarity and certainty serving to mitigate disputes and safeguard the rights of all relevant parties.
For further information,please contact Rafiq Jaffer, Mohammed Negm or Rawan Alsawad.
Published in August 2023