The Organisation for Economic Cooperation and Development (OECD) announced in a report released on June 8 2009 that the pace of economic deterioration is slowing in its member countries. This may in part be due to many governments across the world implementing measures to stimulate growth in their economies to prevent their decay. In this regard, Kuwait is no exception. In March 2009, the legislature passed Law Decree No 2 of 2009, known as the financial stability law.
The law was promulgated to promote confidence in the business and banking sector of Kuwait and to stimulate the economy by implementing measures targeting entities which, if assisted during these tumultuous times, will be able to continue doing business. The entities which are to be assisted include banks (both local banks and local branches of foreign banks), investment companies, and certain other qualified companies which conduct business in specified sectors of commerce.
Supporting banks and local companies
The assistance for banks can be divided into four different categories: guaranteeing deficits for specific bad debt provisions, providing guarantees to cover a drop in value of financial and real estate investment portfolios, guaranteeing 50% of the value of new loans being granted, and purchasing unsubscribed new securities.
The assistance provided by the state to guarantee deficits relating to specific bad debt provisions is restricted to Kuwaiti banks. This guarantee is provided for a 15-year period in respect of deficits as of December 31 2008. The guarantee is calculated according to the difference between the amount charged to Kuwaiti banks to meet the risk of non-collection of debts and the provision for bad debts required by the Central Bank of Kuwait.
The CBK's regulations, its categorisation of credit facilities and financial transactions, as well as its calculations of the bank's assets and liabilities, will affect the guarantee to be provided. The amount that may be covered by a government-guaranteed deficit will be regularly amended between 2009 and 2011, based on the changes to the amount of the deficit, but may not be increased from January 1 2012 until the expiry of the guarantee. These banks will be under a continuous obligation to follow up on the collection of credit facilities and finance, even if such facilities have been written off, in order to reduce the size of the deficit and thereby reduce the value of the guarantee.
Secondly, the state provides a 15-year guarantee against any drop which may occur between 2009 and 2012 in the value of a Kuwaiti bank's financial and real estate investment portfolios (calculated as of December 31 2008). The amount of the guarantee will be amended periodically during the years 2009 to 2011 according to the impairment of the financial and real estate investments, and shall be reduced in proportion to the profit realised in the event of a sale of any components of the portfolios during the guarantee period. As in the case of guarantees provided for deficits relating to bad debt provisions, the Kuwaiti banks will also have to abide by the CBK's regulations in respect of disposing of the assets in the portfolios which are subject to this guarantee.
Thirdly, guarantees are also issued with respect to 50% of the value of new loans granted by Kuwaiti banks or local branches of foreign banks to qualified investment companies and certain local clients during 2009 and 2010 to promote and facilitate the lending of money in the local market. Investment companies must be registered with the CBK, whereas eligible clients are those productive local businesses which operate in a specified sector (such sectors include, but are not limited to, the oil and gas sector, the agriculture and fisheries sector, the construction sector and the telecommunications sector).
From the client's and investment company's point of view, this benefit is indirect in nature because although the assistance is provided to Kuwaiti banks and local branches of foreign banks, the benefits of such assistance are experienced by clients and investment companies who receive loans granted as a result of the guarantee. The assistance which may be provided to investment companies is more comprehensive that that available to clients due to the significance of this sector to the Kuwaiti economy.
As mentioned above, various restrictions are imposed by the law on the granting of loans to clients. The special requirements of parties receiving the loans, as well as their financial position, would also influence the conditions under which such loans would be granted. The total value of the guarantee being provided by the state in this regard is KD4 billion. This equates to approximately $14 billion. This amount will be allocated to the various banks based on the relevant bank's market share (calculated as a ratio of the bank's total assets in relation the total assets of the local banking sector); the average growth rate in the credit facilities and finance portfolio of the relevant bank over the previous five years; and the relevant bank's projections of the expected growth of its credit facilities and finance portfolio for 2009 and 2010.
Proceeds of any such loans must be used locally and may not be used for the purposes of speculation, trading in real estate or securities or for the repayment of the client's debt outstanding at the time of the promulgation of the law. Should the client default on its obligations regarding the guaranteed loan, the guarantee would cover up to half of the shortfall on the loan, less the value of collateral provided and the interest and returns retained by the relevant bank.
In order for a bank to obtain and rely on the guarantees provided, the relevant bank must comply with the following:
- the CBK's instructions on rationalisation and organisation of credit and finance policies at the bank;
- when granting the loan, the bank must obtain sufficient collateral and verify title and value of such collateral with periodic assessments which must be submitted to the CBK in quarterly audited reports;
- ensure that finance granted is used for the purpose for which it was granted;
- the term of such finance may not exceed five years; and
- the repayment of such finance (including interest and other returns) shall be made in installments during the finance period, as opposed to a balloon repayment at end of finance term.
Lastly, where Kuwaiti banks struggle to raise additional capital, the law provides that the Kuwait Investment Authority (KIA) may purchase certain issued securities which have not been subscribed for. In this regard, the KIA is authorised to subscribe for unsubscribed convertible bonds (bonds convertible into shares issued by Kuwaiti banks), preferred shares and other Islamic financial instruments such as sukuk.
However, in issuing these securities, priority is given to the relevant bank's shareholders to subscribe to these newly issued securities. The approval of the general assembly of the relevant bank must also be obtained regarding the terms of the convertible bonds or preferred shares and, if allowed by the CBK, the banks may issue convertible bonds for values exceeding the bank's capital. When pursuing such measures, the articles of association of the relevant bank may have to be amended to allow the bank to issue the convertible bonds or to reflect the terms of the preferred shares.
In respect of guarantees provided for deficits of specific bad debt provisions and the drop in value of certain portfolios (as referred to above), banks are required to take all necessary steps to ensure the decrease of the guaranteed amount by at least 8% annually, commencing December 31 2008. The banks will also be required to pay an annual guarantee premium or commission not exceeding 1% per annum in respect of the amount guaranteed each year. The guarantees may be cancelled if the CBK decides that they are no longer required.
Kuwaiti banks and branches of foreign banks registered in Kuwait must implement effective internal controls to comply with the above which will be subject to audit. They will have to supply reports to the CBK at the end of each financial year throughout the restructuring process and while the above guarantees are in place.
Supporting investment companies
Assistance is provided to investment companies with good credit worthiness that are facing financial problems but may continue to comply with their obligations if assisted by the state. The law assesses the solvency of the investment company by examining the relevant company's net worth. This entails an analysis of the adequacy of the investment company's assets to meet its short and/or long term obligations, and its cash flows.
Should an investment company require the support provided in the law, it must submit an application to the CBK. A specialist party will then be appointed, either by the CBK or the investment company itself, to assess the investment company's financial situation and determine whether it qualifies for assistance.
If the investment company qualifies, the CBK will prescribe the proper actions to be taken to assist the financial situation of the investment company. This is a fluid process, tailored to the exact needs of the investment company. Provision is made in the law for the state, acting through its various organs, such as the KIA, to provide administrative and technical support on obtaining financial assistance.
Secondly, the state may, as mentioned above, provide a guarantee in favour of Kuwaiti banks and branches of foreign banks in respect of 50% of new financing provided to the investment company during 2009 and 2010 if it is to be used for the following purposes:
a) settlement of the investment company's obligations outstanding as of December 31 2008 to all local parties, other than Kuwaiti banks and branches of foreign banks; or
b) cash payments of no more than 25% of the investment company's debts to foreign banks and financial institutions.
When obtaining this financing, investment companies must provide collateral in the form of a portfolio of assets sufficient to cover all outstanding debt to local and foreign banks prior to the promulgation of the law, as well as for any new loans obtained pursuant to the guarantee provided. Furthermore, the investment company may not dispose of or sell any part of the assets provided as collateral without the approval of the manager bank.
The manager bank is appointed to manage the rescheduling of the company's debts and will either be the bank to which the largest portion of the investment company's debt is owed or any other bank as designated by the CBK. The manager bank will coordinate with the creditor banks to specify the size of finance required for the company from local banks as well as the collateral which may be provided. The manager bank will also take part in the negotiations conducted with the investment company's creditors, which may include foreign banks and other financial institutions, so as to negotiate and agree on the rescheduling of the investment company's debts. The CBK's prior approval is required before the proposed debt rescheduling can be finalised.
Thirdly, if the CBK deems there is need for a capital increase, the investment company must take action to obtain such capital which is facilitated by CBK within a specified timeframe. The procedures for the capital increase must be carried out in accordance with the provisions of the existing Commercial Companies Law (Law No. 15 of 1960 as amended).
As with assistance to Kuwaiti banks, if the investment company is unable to obtain finance from its shareholders, from other parties in accordance with the Commercial Companies Law or by means of loans or subordinated finance, then the KIA and other government and public institutions may assist the investment company which is unable to increase its capital by:
a) purchasing unsubscribed convertible bonds which are convertible into shares issued by the investment company;
b) subscribing for unsubscribed preferred shares, convertible into ordinary shares, issued by the investment company (such preferred shares may give priority to the investment company's profits or assets or voting rights); and
c) subscribing for unsubscribed Islamic financial instruments.
Even though these proceedings may have been entered into, the investment company and its shareholders do not abdicate their responsibilities to the state. In fact, the investment company and its shareholders remain in control and are intimately involved in just about every aspect of this process. In this regard, the law specifically provides that the investment company shall obtain the prior approval of its general assembly in respect of the following aspects regarding the investment company's restructuring plans:
a) the execution of the actions and terms prescribed by the CBK to remedy the investment company's situation;
b) the reduction of the expenses of the investment company such as reducing the allocations to top management, remuneration and bonuses;
c) effecting changes to the technical and administrative structures of the investment company; and
d) any merger of the investment company with another entity.
Court imposed settlement with respect to investment companies
Besides the relief which is offered to investment companies as set out above, provision is also made for an order of the court to enforce the restructuring provisions of the investment company against third parties. This is because an investment company may encounter difficulty preventing it from giving effect to, or continuing with, its restructuring activities. Should the investment company deem this necessary; the company may apply to the special circuit of the Court of Appeal to formally adopt the company's restructuring provisions. The law also provides that the CBK may similarly apply directly to the court for such relief. The advantage of applying to the court for such relief is that all legal actions and executions against the investment company will then be stayed.
These proceedings can be initiated by submitting an application to the court to hear the restructuring request on a summary basis. Pending the court approving or rejecting the restructuring plan, the court will make an interim order to indefinitely suspend all litigation and execution procedures related to the investment company's debt and obligations. Notice of this application is then provided to all parties of interest, which include the investment company's creditors. These interested parties may then submit a grievance against this stay of proceedings within 15 days of receiving the notification. Any such grievance submitted by an interested party must also set out the reasons for such grievance.
The CBK will then investigate and submit a report with its findings on the restructuring plan of the investment company to the court within four months of the initial acceptance by the court of the application for restructuring. This four-month period may be extended depending on the circumstances and the needs of the CBK. In investigating and compiling its report, the CBK may be assisted and advised by specialised consulting firms which will study the status of the investment company and identify its restructuring requirements. After the submission of the CBK's report to the court, a hearing will be convened to argue the merits of the application. Notice of this hearing must again be provided to all creditors of the investment company.
If the court approves the debt restructuring plan, the CBK will monitor its execution. However, if the court rejects the debt restructuring plan, the stay of proceedings will be lifted and legal proceedings against the investment company may then continue. The court's judgment shall be considered as final and unchallengeable. If the investment company fails to comply with the execution of the restructuring plan, or its specified timeframe, the CBK may refer the matter to the court to declare the restructuring plan null and void and consequently revoke the stay of proceedings.
General
Failure to comply with any of the provisions of the law will disqualify the companies, Kuwaiti banks and branches of foreign banks from benefiting from the law. The law also provides for sanctions against any fraudulent or dishonest behaviour by individuals who seek to unlawfully benefit from the law.
| Author biographies |
Rob Little
Al-Sarraf & Al-Ruwayeh
Rob Little is a partner with ASAR, Kuwait. He was born in 1963 and received his education at the University of Saskatchewan in Canada. He was admitted to both the Law Society of Upper Canada (Ontario) and the Law Society of Saskatchewan in 1993.
Prior to joining ASAR, Little practiced law in Canada. While in Canada, he lectured at the Bar Admission Course and published papers on various aspects of commercial law. Rob specialises in general corporate/commercial work, capital markets, project work and financial transactions and regularly advises both banks and other financial institutions on both a conventional and shariah compliance basis.
Luis Cunha
Al-Sarraf & Al-Ruwayeh
Luis Cunha is an associate with ASAR, Kuwait. He was born in 1978 and received his B Proc in 1999 and LLB in 2000 from the University of the Free State, Bloemfontein, South Africa. He received his LLM in 2001 from the University of Cape Town, South Africa.
Cunha is a qualified attorney in the High Court of South Africa and a solicitor in the High Court of England and Wales. Cunha was admitted as a South African attorney in 2004 and practiced as such in Johannesburg, South Africa, where he primarily focused on corporate and commercial matters. At ASAR, Cunha practices in the areas of commercial and corporate law with a strong emphasis on M&A.
Cunha is trilingual, fluent in English, Portuguese and Afrikaans. |