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TalkingPoint : Restructuring Challenges In Islamic Financing « Back
November 2010
FW moderates a discussion between Hani Bishara at Ernst & Young and Christopher W. Langdon at Latham & Watkins LLP, on the restructuring challenges surrounding Islamic finance. >>

FW: How would you describe the state of the local bank debt finance market and the outlook for Q3 2010 into 2011?

Bishara: Many companies in the region continue to face challenges in obtaining new – or even extending existing – credit facilities. Lenders are increasingly becoming more demanding of their corporate clients, expecting more transparency and more diligence into the affairs of businesses. The existence of multiple bilateral lenders for individual corporations has exasperated this issue as lenders face concerns of at least perception of inequity between lenders. This generally translates to increasing pressures on debtors and demands for payment, equity injection or increased security. The imbalance on many regional balance sheets with short-term financing utilised for long-term and now devalued (and illiquid) investments also adds to the complex situation as repayment is seemingly always pushed into the future with mounting accumulated interest expense providing no source of relief on businesses cash-flows already affected by lower volumes. This environment will continue to put pressure on liquidity for many corporates well into 2011, as many companies will look to reschedule their debts and seek sources of refinancing in a region with relatively few options.

Langdon: On the heels of the 2008 global financial crisis, Saudi Arabian (and GCC) credit growth fell sharply in 2009 as liquidity tightened and banks became increasingly risk averse in the face of rising non-performing loans and deflated asset prices. A number of restructurings and workouts are still playing out in the Kingdom which were precipitated in late 2008 and early to mid 2009 due to the tightening of credit markets and many borrowers’ cash flows being affected by a reduction of commodity prices. In 2010, dollar new money deals have remained sluggish, but Saudi Riyal new money deals, along with refinancings, seem to be enjoying greater liquidity and activity. Many banks have now provisioned and put the worst of the last 18 months behind them, and are well capitalised to provide a sound basis for growth into 2011.

FW: In the context of a default by a debtor, what typical enforcement options would a creditor have?

Langdon: As an Islamic state, it must always be kept in mind that the law of the Kingdom of Saudi Arabia is based on the Shariah, with the Quaran and Sunnah as principle sources of law. Given that interest is ‘riba’ or forbidden under Islamic law, for example, there are obvious tensions between the basic Saudi Arabian legal environment and the interests of typical bank creditors. Nonetheless, creditors do have a number of enforcement options. Firstly, a creditor may make application to the Negotiable Instruments Committee under the Ministry of Commerce and Industry for recourse in respect of promissory notes or the like, provided such notes are in the appropriate form. Another route is the Banking Disputes Settlement Committee, or SAMA Committee, formed under the Saudi Arabian Monetary Agency, which has jurisdiction over all disputes involving banks and their customers, excluding negotiable instruments. Often colloquially referred to as a ‘court’, in fact the SAMA Committee has jurisdiction to orchestrate a ‘settlement’ between parties. Any process before the SAMA Committee may take up to two years or more and there is currently some debate in the Kingdom as to whether settlements can be appealed to the Board of Grievances. If the SAMA Committee cannot or does not take jurisdiction, or if creditors are seeking to enforce security, the dispute will fall to Board of Grievances’ jurisdiction. The timing in this regard is very open ended – a case may take up to several years to hear. And, given that the judges sitting at the Board of Grievances are also Shariah court judges, there is an element of uncertainty in results, including a stricter application of Shariah principles, meaning that interest is almost certainly not recoverable and any interest paid to date may be deducted from outstanding principle.

Bishara: While there are a range of technical enforcement options, they still remain fairly untested and therefore not desirable due to the lack of certainty on outcome. Many regional lenders still rely heavily on guarantees provided by either large sponsors or key shareholders.
FW: Is the local bankruptcy and insolvency regime in your region a viable solution for creditors?

The Kingdom has a Bankruptcy Code and a number of pieces of legislation that provide a framework for bankruptcy and insolvency. The Bankruptcy Code is fairly archaic, though, and was originally drafted to apply to individuals. It is largely untested in respect of large or complex corporate bankruptcies and the Board of Grievances, which has jurisdiction, has limited experience in applying it to companies. Basic principles seen in Western legislation is evident in the Code, including hardening periods, ranking of creditors and schemes of arrangement – and these principles are helpful in having a base line position at law – but in our experience creditors are quite hesitant to commence bankruptcy proceedings since they may take several years to play out. It’s worth noting that Saudi legislation includes bankruptcy avoidance regimes – ‘amicable conciliation’ sought by a debtor from its creditors under supervision of a committee formed by the Ministry of Commerce to avoid bankruptcy. Debtors may also apply to the Board of Grievances to convene ‘settlement procedures’ with creditors to avoid bankruptcy.
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