A recent article in The National Law Review says that the Kingdom of Saudi Arabia is about to change its restructuring law in a way that will likely make restructurings more common in that influential country.
One implication is that the change will provide alpha-seeking opportunities for investors and traders who aren’t afraid to dig into the recondite legal (and even theological) issues that will be involved in such a change.
Here’s a quick summary, drawing from the NLR article by Alex Gross and Christopher J. Smith. Saudi law on the subject is composed of one very old statute and one not-so-old decree. The old statute is the Commercial Court Law of 1931. This is supplemented by the Royal Decree of 1416 (which is the year in the Moslem calendar that corresponds to 1996 in the west).
Out with the old
According to the CCL, there are lots of expenses that are to be taken out of the estate of a bankrupt before any creditors have a crack at it – and none of these expenses is subject to any statutory cap or judicial review whatsoever.
The 1416/1996 decree allows for debtors, a class that includes corporations, to serve a request for “amicable resolution” of debts if insolvency is imminent. One key point here is that the privileged debts within the CCL remain privileged; they are not to be included in these talks. Another key: the request for resolution doesn’t create any binding moratorium on actions by those creditors who don’t agree to be “amicable” and engage in the talks.
The resulting system is quite awkward for all parties and resort to it is rare. But the new proposal may create a new workable system, and may introduce the world of distressed-assets speculation to the debtors’ paper. It can do so, though, only by stepping on some theological toes.
In with the new
The reform will enhance the protective settlement regime created by the 1996 Decree. In its new form, the regime will provide a moratorium from creditor action, allow for the identification of different classes of creditors, and bind dissenting secured creditors by a majority vote of other secured creditors of equal standing. It will also allow a Board of Grievance to impose a restructuring, and displace company management, as part of the project of bringing the insolvent company back to financial viability.
This all seems common sense enough in the West, but in the Middle Eastern context it risks a backlash. As Jason Kilborn observes in the excellent blog Credit Slips, some of the provisions of the proposed law seem to violate principles of Islamic law, Shariah, which are explicitly incorporated in Saudi Arabia’s “Basic Law of Governance.”
What does the Koran say? On the one hand, it does acknowledge the importance of the forgiveness of debts. Verse 2:280 reads, “If a person is in difficulties, let there be respite until a time of ease. And if you give freely, it would be better for you, if only you knew.”
The reference to “giving freely” in this context is generally understood as giving that “respite” referenced in the prior sentence.
On the other hand, the same holy book emphasizes the sacred obligation of the debtor. Verse 5:1, “O you who believe, you shall fulfill your covenants.”
These two contrary-seeming impulses are further complicated by the strict prohibition of riba, usury, sometimes interpreted to refer to any contracted-for interest payment.
But leaving riba out of it for now, there is a real concern among scholars in the field that any reorganization plan that includes across-the-board reduction of the amount due creditors, imposed upon dissenting creditors will violate verse 5:1.
If the Saudi state does push through a system that effectively breaks with this older understanding of Shariah, that may have consequences throughout the region. If the reform effort encounters a good deal of push back that, to, will be a development worth following.
Kilborn, whose portrait is above, serves as a law professor at The John Marshall Law School. He has long argued that westerners who want to take part in discussions with interlocutors in Moslem nations about the insolvency laws in the latter have to engage respectfully “with classical sources and methods, as opposed to advancing arguments based merely on Western views of economic expediency, efficiency, and experience.”
Those who want to seek alpha and who need to learn the lay of the land precisely as the land is being terraformed, might want to study up from such sources, too.