Although several analysts had predicted that the global credit crunch would sail past several of the Middle Eastern jurisdictions including Kuwait, the bite of the global recession became evident in the final quarter of 2008. As a result of the global recession, several corporate entities in Kuwait defaulted on their facilities and it became increasingly difficult for such entities to meet their financial obligations as they fell due and payable. In such circumstances, creditors justifiably became concerned and started to consider the various options available to them.
Secured or not?
Are you a secured creditor? Resolving this question should be the first point of call given that secured creditors in Kuwait, as in many parts of the world, occupy a privileged position of priority with regards to the assets of an insolvent debtor. To a creditor who is obviously unsecured, the response to this question would be a no-brainer. However, resolving the question becomes more complex when one encounters creditors who believe they have valid security when they do not.
There are elaborate steps for the perfection of security in Kuwait. The procedures vary with the different forms of security available to a creditor. If these steps have not been followed, a creditor's security is likely to fail. For instance, it is quite common for lenders in Kuwait to require their debtors to enter deeds of assignment as security. By these assignments, the debtors assign by way of security the proceeds of certain contracts they have entered into with third parties. In order for such an assignment to be valid as perfected security, the third party must be duly and lawfully served with a notice of such assignment through a Kuwaiti court process server; alternatively an acknowledgment and consent to the assignment would need to be signed by the third party and the date of such acknowledgment and consent to the assignment must be certified by the Notary Public of the Ministry of Justice in Kuwait. In many cases these procedures are not fully complied with. At times the non-compliance is for justifiable reasons such as impracticality where a debtor purports to assign the proceeds of a large volume of consumer contracts. In certain cases the contracts in question may amount to hundreds. Notwithstanding the justification for non-compliance, the security would fail if not perfected.
Once a creditor realises that perhaps its security has not been perfected, it is not unusual for such a creditor to commence the perfection process in earnest. However, this effort may be defeated by Article 586(1) of the Kuwait Law of Commerce No 68 of 1980 (Law of Commerce) which may be interpreted by a Court as providing that the perfecting of any security, after the suspension of payments by the debtor (the suspect period) and after the lapse of 15 days from the date of creation of the security, is not effective against the creditors and is liable to be set aside by the court. The date of suspension of payments is determined by the Bankruptcy Court as a factual matter, subject to the requirement that the date may not be more than two years prior to the date of adjudication of bankruptcy.
While we have considered the position of a creditor who obtained security prior to the onset of the suspect period, the position of a creditor that obtains security during the suspect period is crystal clear, such security is automatically set aside by Article 584(1)(d) of the Law of Commerce.
The secured creditor will also need to be mindful of certain super-priority creditors that would rank ahead of secured creditors by law. The super-priority creditors are set out in Articles 1071-1079 of the Kuwait Civil Code Decree Law 67 of 1980 (Civil Code) and include: the cost of legal proceedings incurred for the preservation, sale and distribution of the property of the debtor including all costs relating to the preservation of the property (and not merely legal costs) provided that such preservation costs are necessary; amounts due to the state treasury for tax and other duties of any kind (limited to two years of taxes); and amounts due from the debtor to employees for wages and salaries of whatever kind that have fallen within a six month period prior to the insolvency of the debtor.
The truly secured creditors are at liberty to proceed with executing against their security notwithstanding pending bankruptcy proceedings against the debtor.
Swords and shields
In the face of a distressed debtor, the unsecured creditor occupies a rather precarious position. This body of creditors would certainly not be encouraged to note that the recovery rate for Kuwait has been recently estimated by the World Bank Group at 34.5 cents to the Dollar.
However, all is not lost to a creditor in this position as Kuwaiti laws include a reasonable arsenal of swords and shields that such creditors may deploy. The unsecured creditors will normally queue with all other unsecured creditors and obtain payment ratably from realised recoveries. This queue is not normally a tranquil orderly one; in Kuwait, many unsecured creditors attempt to get ahead of the others and sometimes undertake unscrupulous actions to achieve this.
Civil Code
Article 307 of the Civil Code clearly states that all property of the debtor constitutes security for the payment of his debts. It further states that all creditors are to be treated equally as much as regards the said security except those of them who have priority at law.
This provision provides some solace to the unsecured creditors and is the backbone along which further protective provisions have been woven in the Civil Code. Drawing from this basic principle, the ideal position is that no unsecured creditor is to obtain for himself a position of advantage relative to the other unsecured creditors.
However, it sometimes occurs that a debtor may be unwilling to take legal proceedings for protection of its assets. Such protective steps may be needed. This may occur in scenarios where unscrupulous creditors, third parties, or even shareholders are raiding assets of the debtor. The debtor may be unwilling or unable to bring actions to protect its assets. As such raids would diminish the pool of assets for unsecured creditors, Article 308 of the Civil Code permits a creditor (even when its right has not matured) to exercise all financial rights pertaining to the debtor, in the name of the debtor except such rights which are purely personal or not attachable, if the creditor proves that the debtor has failed to exercise such rights and such failure tends to cause or aggravate his insolvency. Under these provisions a creditor may bring a suit in the name of the debtor and will be deemed to be acting for such debtor. Through such an action, the creditor may level challenges against asset raids.
A creditor may also challenge a disposal made by the debtor if such is a fraudulent preference. According to Articles 310 and 311 of the Civil Code, any creditor whose claim has fallen due, and whose debtor has entered into an act of alienation prejudicial to the creditor, may demand that such an act be declared void so far as the creditor is concerned, if such act has either diminished the debtors rights or increased his obligations, and has in consequence resulted in, or increased, his insolvency. When the debtor's act is for valuable consideration, it can only be held void if made by the debtor with the intent to defraud and if the other party to the contract was aware of the fraud. The fraud of both the debtor and the other party is presumed if they were aware (or should have been aware on the date of the disposal) that the debtor is insolvent. The definition of insolvent is broad and would cover situations where the debtor is unable to pay, or has stopped paying, its debts. This provision would avail the unsecured creditors in circumstances whereby the debtor may be attempting to favour certain creditors that it prefers over others.
A creditor may of course bring a civil action for the recovery of the amounts owed to it by a distressed debtor. However, the final resolution of such a suit in Kuwait may take two to four years depending on the circumstances.
Attachment Order
A creditor may bring a suit against the debtor and seek to obtain an attachment order in advance, by virtue of Article 222 of the Kuwaiti Civil and Commercial Procedures Law, Decree Law 38 of 1980 (Civil and Commercial Procedures Law). Under this provision, where the creditor has a clearly evidenced liquidated claim, that creditor may file an ex parte application seeking provisional attachment of the movable properties and bank accounts of the debtor. If the order is granted by the judge, the creditor is required to perfect the attachment by filing a substantive case within eight days. In practice, Kuwaiti courts are reluctant to issue attachment orders against apparently well-established companies. However, where there is a reasonable belief that the claimant creditor would not be able to recover its funds (such as in circumstances where a debtor is disposing of its assets and/or has suspended payment of its debts), the court may grant the order.
Once the attachment order is issued, the property is attached in favour of the creditor. However execution cannot proceed until the attachment order is perfected as described above (i.e. by having a favourable enforceable judgment in the substantive case noted above). The conclusion of the substantive case may take two to four years depending on the circumstances, and accordingly while this remedy protects certain assets from disposal, it does not immediately place them at the disposal of the creditor bringing the action.
For so long as bankruptcy proceedings have not been commenced against the debtor, the creditor would have a form of priority over the attached assets and would have the priority to recover its dues from the attached assets ahead of other regular creditors. However, should bankruptcy proceedings be brought, that development would likely spell doom for the creditor as Article 597 of the Law of Commerce provides that the adjudication of bankruptcy entails the suspension of individual actions brought by the ordinary creditors. Accordingly, where a creditor has an attachment order in his favour, but execution has not yet occurred, such creditor will join the general pool of unsecured creditors of the bankrupt in the event of insolvency proceedings.
Injunctions
Where a valued asset of the debtor is under threat of being disposed of or being appropriated, the unsecured creditors may consider applying for an injunction to preserve such assets. The debtor may file a summary suit seeking the issuance of an injunction to prevent the disposal or appropriation of the valued asset. If the debtor is reluctant to bring such an action, or is delaying inordinately, the creditors may consider bringing the action themselves under Article 308 of the Civil Code (described above). In the recent few months, we have observed a few instances of such injunctions being granted by the Kuwaiti courts.
The Commercial Companies Law
Under Kuwait's Law of Commercial Companies, Law 15 of 1960 (Companies Law), particularly Article 148, it is provided that the chairman and members of the board are liable to the company, to shareholders, and to third parties for all acts of cheating (fraud) and abuse of authority, as well as for any violation of the law or of the articles of association and for fault in management. This provision highlights that directors may be liable to third parties such as creditors.
In the event that the directors of the debtor are not co-operating with creditors or if they are actively working against creditors during distressed times, the creditors may use the above provision and other provisions of the Companies Law such as Article 789 which provides for possible jail terms for directors for certain offences associated with the bankruptcy of a company. These provisions may be used to provide wake-up calls to directors reminding them that their acts may lead to loss of their personal assets and more importantly their liberty. Such techniques have at times been useful to creditors.
The Law of Commerce
The Law of Commerce provides for schemes of arrangement under Articles 743 to 800. These schemes are to an extent comparable to US Chapter 11 bankruptcy protection schemes. The scheme of arrangement will typically be preferred by creditors where they believe the debtor may survive if restructured appropriately. The scheme also allows creditors to have some control over the debtor's business which would give them more comfort and probably a higher chance of successfully recovering the amounts owed to them.
The debtor initiates the application for approval of a scheme of arrangement. A majority of the debtor's shareholders must pass a resolution at an ordinary meeting of the shareholders approving the submission of a petition for a scheme of arrangement. The petition is submitted to the President of the Al Kulliya Court which exercises bankruptcy jurisdiction. The petition should among other things, detail the causes of the disruption to the business of the debtor concerned and the proposals under the scheme. Such proposals would incorporate matters including restructuring and debt repayment strategies.
Once the petition is received at the court and accepted for filing, the court makes an order opening proceedings and appoints a scheme supervisor. At this stage there is an automatic stay of proceedings effective against creditors of the debtor, except secured creditors. Following the order opening proceedings, the debtor is permitted to continue managing its assets (including the disposal of the same in the ordinary course of business) and to conduct its business under the supervision of the scheme supervisor appointed by the court. The oversight of the scheme supervisor and the restrictions on trading enable objective management, preservation of assets, and may rule out collusion between the debtor and certain creditors or third parties.
The scheme of arrangement must then be approved at a creditors meeting by a majority of the creditors present or represented at the meeting, provided that such majority holds two-thirds of the debt after excluding the debts of the creditors who did not participate in the voting. A practical difficulty here is the identification of the debtor's creditors. This would be complicated in certain cases such as where a debtor has issued bonds and trade creditors whose supporting documentation may not immediately justify their positions. Every unsecured creditor is entitled to vote on the scheme for its entire debt. However, secured creditors are prohibited from voting on the scheme unless such secured creditors have relinquished their security prior to voting on the scheme. Part relinquishment of security may be made, provided that such part is not less than the equivalent of 50% of the debt.
During deliberations for the scheme, the creditors may require that one or more guarantors be procured to secure the enforcement of the terms of the scheme. If a debtor can avail such guarantors, it significantly assists in fortifying the position of the creditors. Such credit enhancement measures would greatly incentivise creditors to participate in a scheme.
Following approval by the creditors, the court may approve the scheme. When it does so, it appoints (from among the creditors of the debtor) one or more supervisors to enforce the terms of the scheme and to report any violations to the court. A summary of the judgement approving the scheme should be filed in the Real Estate Register and creates a mortgage on any real estate owned by the debtor (in the case of the Register of Commerce, a mortgage is created over the trading premises of the debtor) so as to secure the rights of the creditors who are bound by the scheme. Accordingly, unsecured creditors emerge from the scheme as secured creditors to this extent.
Following approval of the scheme, it is binding upon unsecured creditors and, in effect, the scheme of arrangement substitutes for any actions or proceedings of enforcement that they may have had against the debtor.
Bankruptcy
Creditors may submit a petition to the Kuwaiti courts applying for the debtor to be declared bankrupt. The bankruptcy provisions generally span from Article 555 to Article 742 of the Law of Commerce. This is normally viewed as a last resort, when all other options do not have reasonable chances of success. Bankruptcy proceedings in Kuwait can be time consuming, and the average time frame for conclusion of the same has been estimated by the World Bank Group at just over four years. Given the uncertain outcome of insolvency proceedings, this potentially long time frame would not encourage creditors to take this option.
However, the assets of the debtor are protected during bankruptcy proceedings. For instance, upon a petition for the bankruptcy of a debtor, the court appoints a bankruptcy manager and may order that measures be taken to safeguard the property of the trader pending a decision being made about whether the debtor is bankrupt. Further, once a trader has been judged bankrupt, the bankrupt is immediately banned from managing or disposing of its assets with certain exceptions. For example, there is an exception which permits the bankrupt to carry out such actions as are necessary to safeguard its rights. The ban on disposing of assets also does not apply to property which is not attachable under Kuwaiti laws, any rights relevant to his person or personal status, or compensation from certain insurance policies entered into prior to the date of adjudication of bankruptcy. The bankrupt is also not permitted to discharge any debts, or collect any debts.
Following an adjudication of bankruptcy, there is a suspension of individual actions brought by unsecured creditors and interest would cease to accrue on their facilities to the debtor. Further, the court may set a provisional date of suspension of the payment of debts of the bankrupt (thus establishing the suspect period discussed above). The suspect period is relevant to determining what, if any, disposals made by the insolvent company during the preference period leading up to the adjudication of bankruptcy will be set aside or may be set aside at the discretion of the court pursuant to Article 584 of the Law of Commerce. This would enable the creditors to unwind suspect transactions that were undertaken during the suspect period. To an extent this may assist the creditors in recovering certain assets to the state of the debtor and enhance their chances of recovery.
The creditors would then be required to prove their debts by submitting their supporting documents to the bankruptcy manager. The proven debts are confirmed by the court. At this stage the creditors with proven debts may execute against the debtors assets. The creditors may also be deemed to be in a state of union by operation of the law and in this regard have the power to require the court to substitute the bankruptcy manager for one of their choice and also have the power to determine whether the bankruptcy manager should continue operating the debtors business. The bankruptcy manager recommended by the union may also sell the bankrupts movables, real estate and trading premises.
Bailout law
In order to address the recent impact of the global financial crisis, the Kuwaiti government issued a new financial stimulus law to stabilise the financial sector as well as to support economic activity sectors so as to encourage the financing of such sectors by local banks (the Stability Law). The law was primarily designed to safeguard the financial system and stabilise the domestic economy by ensuring the stability of the banking sector and supporting local business activities. Under the Stability Law, creditors may not directly commence proceedings on behalf of or against a debtor. The procedure is driven by the debtor. However, all creditors may be bound by the outcome of a judicial scheme of arrangement undertaken under the Stability Law.
The Stability Law is essentially designed for solvent banks and investment companies which enjoy good creditworthiness but face financial difficulty which, if assisted by the government, would be able to continue with their business activities. Those that cannot be saved (i.e. that are not currently solvent) will not be assisted by the Stability Law. The Stability Law assesses solvency by measuring the company's net worth which is defined as the adequacy of the company's assets to meet its short or long term obligations, including future cash flows.
The Stability Law seeks to i) save Kuwaiti banks facing default and strengthen their balance sheets; ii) overcome shortage of cash in the market; iii) to increase liquidity; and iv) assist the government in implementing the Stability Law. These objectives in principle provide comfort to creditors. However, in practical terms, we are not aware of any debtor that has actively invoked the provisions of this law.
In order for a local investment company to obtain the benefits under the Stability Law, the applicable investment company would have to submit an application to the Central Bank of Kuwait (CBK), subsequent to which the CBK may assign a specialist party to assess the company's financial situation to determine whether or not the company qualifies for assistance under the Stability Law. If so, the CBK shall prescribe the relevant actions to be taken so as to assist the financial situation of the company.
The CBK will assign specialised parties to assess the situation of the investment company and if it qualifies under the Stability Law, will decide the appropriate actions to remedy the situation.
The form of assistance provided by the Stability Law to qualified investment companies includes:
- Providing loans from Kuwaiti banks and branches of foreign banks registered in Kuwait (which will be 50% guaranteed by the government) in 2009 and 2010 to be utilised for the settlement of any outstanding debts (as of December 31 2008) to any party (other than debts to Kuwaiti banks and branches of foreign banks registered in Kuwait) and 25% of any debt to foreign banks and financial institutions;
- Applications for loans or subordinated finance from its shareholders, the Kuwait Investment Authority (KIA), government and public institutions, to the extent permitted by law; and
- In the event that the CBK or the investment company considers seeking financial support from the debtor's shareholders, it may undertake procedures for capital increase facilitated by the CBK which may entail the purchase of unsubscribed securities issued by the investment companies by government entities, public institutions, or the KIA.
Under the Stability Law, any re-scheduling of an investment company's debts must be carried out as follows:
- Any proposed debt rescheduling must be submitted to the CBK for approval. The rescheduling plan will be managed and headed by a manager bank appointed by the CBK. The role of the manager bank includes coordination with other creditor banks and negotiations with foreign banks and financial institutions to determine and reschedule the investment company's debt.
- The prior approval of the general assembly of the investment company is required to execute the terms and actions prescribed by the CBK.
Chapter two of the Stability Law notes that in the event that an investment company encounters difficulty which may prevent it from fulfilling its obligations and/or from continuing with its activities, that investment company may apply to the special circuit of the Court of Appeal (the Special Circuit Court) to adopt the company restructuring procedures. This procedure is akin to a scheme of arrangement. The Special Circuit Court has been established, with exclusive jurisdiction, to urgently hear all restructuring applications under the Stability Law. We note that the CBK may also apply directly to the Special Circuit Court for such an order. The advantage of doing so is that all legal actions and executions against the investment company in question will then be stayed; we are of the view that this will also apply to a stay of all legal actions and executions which may have been instituted by the creditors of the investment company, whether secured or unsecured.
Creditors do not vote on the restructuring plan, and the plan can be imposed on them by the Special Circuit Court.
| Author biographies |
Ahmed Barakat
Al-Sarraf & Al-Ruwayeh
Ahmed Barakat is the Managing Partner at ASAR. He received his education at Cairo University, Egypt (Bachelor of Law with Honors, 1981) and at New York University, US (Masters of Law in International Law and Business Transactions, 1984). He is admitted to the New York and Egypt Bar.
Prior to joining ASAR, Barakat worked as a lead counsel at the Kuwaiti Authority for Assessment of Compensation Resulting from Iraqi Aggression and at Baker & Mckenzie in New York. He specialises in commercial, construction and tax litigation, as well as local and international arbitration. Barakat also advises clients on corporate and commercial matters, as well as Islamic banking and investment.
Barakat is fluent in English and Arabic.
Ezekiel Tuma
Al-Sarraf & Al-Ruwayeh
Ezekiel Tuma is of counsel to ASAR. He joined the firm in March 2008. He received his LLB from Makerere University Kampala, Uganda in 1997 and obtained a Master of Commercial Laws degree from the University of Cambridge, UK in 2000. Tuma was admitted to the Uganda Bar in 1999.
Tuma practiced with a leading law firm in Uganda from 1997 and became a partner at that firm in 2004. He has been recognised by Chambers and Partners Global and IFLR1000 as a leading lawyer in Uganda. Tuma also worked as a part-time lecturer at Makerere University, Kampala for eight years. He lectured on company law and trusts law and has published several articles in reputable law journals. He practices in the areas of banking and finance, commercial and corporate law, international transactions, securities, mergers and acquisitions, projects and privatisation law, and Islamic finance.
Tuma is fluent in English, French and Swahili. |