Pitfall for the Unwary Lender – circumstances where a lender’s collateral security may not be readily enforceable.
It is common practice for lenders in the Kingdom of Saudi Arabia (KSA) to include, in the security package to be provided in support of the repayment obligations of the borrower, third party personal guarantees and/or (on demand) promissory notes in respect of the obligations of the borrower.
Standard practice in KSA (as in other jurisdictions) would see personal guarantees drafted in such a way as to reference the fact that the personal guarantee is being provided in support of the obligations of the borrower.
By contrast, promissory notes (which must follow the format specified in the Commercial Papers Law (promulgated by Royal Decree No M/37 dated 11/10/1383H (corresponding to 25/2/1964G)) do not make any reference to the fact that the promissory note is being provided as collateral security for the obligations of the borrower. It should be noted that promissory notes are attractive to lenders due to the fact that they can be enforced directly through the Enforcement Court in KSA without any requirement to obtain a court or other judgment against the issuer.
As in many other jurisdictions, on an application being registered for the liquidation of a company or when a company enters into insolvency, under Article 97 of the Bankruptcy Law (promulgated by Royal Decree No. M/50 dated 28/5/1439H (corresponding to 14 February 2018G)), a moratorium against enforcement of claims against the insolvent company comes into effect, which lasts until either the application is rejected or the procedure is terminated by the court.
Further, Article 98 of the Bankruptcy Law states as follows:
Only the Court shall be entitled to take legal action during a moratorium against any guarantor of the Debtor who has provided a personal or in-kind guarantee to secure the Debtor's obligations.
Whilst in most common law jurisdictions, a lender would expect to be able to enforce repayment of loans granted by the insolvent company under either third party personal guarantees or promissory notes, irrespective of whether the issuer of such personal guarantees or promissory notes is connected to the borrower and/or the loan facilities granted to the borrower, this is not the position in KSA.
In the case of a personal guarantee, if the personal guarantee on the face of the document specifically states that the guarantee is being provided as security for repayment of the underlying loan by the borrower, then enforcement of the personal guarantee will not be permitted except with the consent of the bankruptcy court. The Law Firm of Salah Al-Hejailan LLC has recent experience supporting this position.
In the case of a promissory note, despite the fact that promissory notes do not reference the underlying loan advanced to the borrower or the fact the promissory note is being given as collateral third party security for repayment of the loan, the enforcement court has suspended enforcement of a promissory note where the borrower has been placed in liquidation. Again, The Law Firm of Salah Al-Hejailan LLC has recent experience supporting this position.
It may be possible to circumvent the impact of Article 98 with regard to a third--arty personal guarantee by ensuring that the text of the personal guarantee makes no reference to the underlying loan repayment obligation in respect of which the personal guarantee has been provided. However, given that the KSA courts have applied Article 98 to promissory notes, which make no reference to the underlying loan repayment obligation, it is open to question as to whether a personal guarantee drafted in this way would avoid suspension of enforcement.
Equally, attempting to rely on any indemnity wording contained in the personal guarantee does not, in our view, avoid the Article 98 problem as the KSA court is likely to take the view that, in economic substance, the indemnity is still a “guarantee” irrespective of what it is called.
The justification for this approach to the enforcement of third-party collateral security in the context of a liquidation would appear to be to prevent the creditor from obtaining double recovery of the underlying debt.
Rodger Murray & Alastair Drummond are Senior Legal Counsel at The Law Firm of Salah Al-Hejailan, with extensive experience in banking and finance transactions in KSA and would be happy to provide advice on this issue.