Vol 9 (2012) - Issue 5

Article preview

Insolvency Laws in Saudi Arabia: Time for Change?

1. Introduction
It is a long standing assumption that for a functioning economy to promote the inflow of money and investment, businesses should have the same ease to exit the market in their time of need as they are given to enter. Since the oil boom in the 1970s, the Middle-East has experienced a period of sustainable growth in most sectors. The region did not invest in the toxic assets that started the financial crisis because of the strong growth, profitable domestic markets, insignificant stock of securitised products, growing importance of Shari’a compliant finance and ample liquidity from capital inflows and oil exports. These factors have all provided a cushion against external shocks and most countries in the region are undertaking structural reforms aiming at building new international finance hubs, improving housing, infrastructure, business development and transport.
Despite this marked growth, the region was not immune to the effects of the crisis as the real economy felt the spill-over over the past few years. Since the high profile default of Dubai World in 2009 and the consequent defaults of major other Middle-Eastern conglomerates, there has been increased attention on the lack of efficient insolvency frameworks in the Middle-East. As this paper collectively assesses the impact of the financial crisis on the region, it will suggest ways to move away from a crisis control mode towards a rehabilitation mode. Although the focus of this paper will be on the Kingdom of Saudi Arabia (the 'Kingdom'), the insolvency frameworks of other countries in the region, such as the United Arab Emirates (UAE) and the United Kingdom (UK), will be referred to give a comparative outlook of the future of legal form in the region.
The current and very basic nature of the insolvency regime in Saudi Arabia fails to deal with the complexities of today’s financial transactions. Most of the insolvency frameworks in the Middle-East focus on the dissolution and liquidation of companies as a result of insolvency placing harsh and sometimes criminal penalties on the insolvent individual or company. Despite the economic boom in the Kingdom and the increased government spending in the last few years, companies were not exempt from running into debt problems. The inadequacies of the law have forced these companies out of business as the ‘rescue culture’, promoted both in the US and the UK, is almost absent from most of the region’s legal systems. This explains the poor track record of debt restructurings in the region. The paper will examine the current insolvency system in the Kingdom and suggest ways in which this could be updated to be more in line with the necessities of today’s financial and economic world. It will stress the importance of insolvency regimes based on an underlying philosophy of rescue and rehabilitation, both in the context of conventional and Islamic financings.

2. Economic climate in the ME – legal context
2.1 General overview
The current economic climate imposes on law makers in the Middle-East the need to consider the current insolvency laws. To date, the outdated laws have been a barrier to the growth of entrepreneurship. Bankruptcy protection is needed for innovation, growth and risk taking in any successful business model. The difficulty (and in most cases inability) for creditors to restructure a company’s debt portfolio has been disconcerting for lenders, especially if involved in mutli-million dollar facilities.
Additionally, the absence of a rescue culture within most frameworks has placed both lenders and borrowers under enormous pressures to meet debt obligations. Running into financial difficulties may mean an immediate liquidation in the Middle-East, giving borrowers no option but to declare bankruptcy. For example, Article 180 of the Companies Regulation in Saudi Arabia provides that if a limited liability company incurs losses amounting to 50% or more of its share capital, the shareholders must resolve either to continue the company on the basis that they will be responsible for its debts or liquidate the company, otherwise the protection afforded by limited liability status will be lost.