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October 20, 2019

KSA Bankruptcy Law (the Law) - Advance Payment Bonds


HYPOTHETICAL SCENARIO

Party A (contractor) entered into a construction contract (the EPC Contract) with Party B (employer).

Party B made an advance payment under the EPC Contract and Party A procured an Advance Payment Bond (the Bond) from a bank (the Bank) was issued in favour of Party B.

Party A has filed a petition to enter into a Financial Reorganisation Proceeding (FRP) (Article 42, Chapter 4 of the Law).

Party B has made a demand under the Bond.

QUESTION

Does Article 46 of the Law (Suspension of Claims) suspend the right of Party B to make a demand under the Bond and therefore provide the Bank with a defence to paying out Party B under the Bond?

ANALYSIS

Provisions of the Law

Article 46 of the Law, provides, “The filing of an application for the commencement of Financial Restructuring Proceedings or the commencement of such proceedings shall result in a Moratorium until such date when the commencement application is rejected, or when the court ratifies the Proposal or the termination of the proceedings is ordered at a prior date.”

“Moratorium” is defined in Article 1 of the Law as “The suspension of the right to take or continue any procedure or action or file a claim against the Debtor, its assets or against the guarantor of the Debtor’s Debts during a specific period under the provisions of the Law.”

If the court determines that the Bond is the equivalent of a guarantee of the debtor’s debts, which is a possibility, then the Moratorium would in theory bar Party B from pursuing recovery under the Bond during the period of the Moratorium.

An issue which arises under Chapter Four of the Law (Financial Reorganisation Proceeding) is that the terms of Article 46 of the Law do not expressly give the court the power to modify the Moratorium for specific claims, such as guarantee or bond claims. The Bankruptcy Law Implementing Regulations do not address this, either. This apparent inflexibility is different from the provisions of a Moratorium under Chapter 3 (Protective Settlement Procedure) and Chapter Five (Liquidation Procedure) of the Law, both of which contain provisions whereby the court can make exceptions (see Articles 20(1)(b), 20(1)(c) and 97(5) of the Law).

Other Provisions

In the “Information and Documentation Rules provided for in the Bankruptcy Law and the Implementing Regulations thereof,” (the Rules) which form part of the “Documents of Bankruptcy Law” there are two implementing provisions that regulate the right of creditors to ask for a court-approved exception to the general prohibition on bringing claims against a debtor or any guarantor of the debtor’s claims:

Requesting the Execution against any Bankruptcy Assets or the Assets of the Guarantor of the Debtor's Debt

Article 13 of the Rules

The request of execution, filed by the creditor, against any of the bankruptcy assets or against the assets of the guarantor of the debtor's assets during moratorium period must be accompanied by:

  1. the data of the asset against which execution is requested and a copy of its documentation;
  2. the amount of the secured debt and evidence that such debt is secured by the asset against which execution is requested.
REQUESTING TO SUSPEND MORATORIUM ON CERTAIN CLAIMS

Article 14 of the Rules

The request, filed by any stakeholder, to suspend the moratorium on certain claims must be accompanied by a statement of the procedure applied before the enforcement of the moratorium, and evidence that suspending the moratorium on such claims will be in the interest of the debtor and the majority of creditors.

Application of Article 13 and 14 of the Rules in a FRP

It is not clear that Articles 13 and 14 of the Rules would apply in FRPs, as opposed to other forms (Protective Settlement, Liquidation, etc.). The Bank might argue that Articles 13 and 14 of the Rules only implement requests for execution or suspension where the Law provides for such modification, and Article 46 of the Law does not provide this.

Party B could argue that the court has the power to grant modifications and exceptions to the Moratorium in a FRP under Articles 13 and 14 of Rules, as well as Article 6 of the Law, which states, “The Court shall issue the necessary judgment and decisions to implement the procedures provided for under this Law, oversee the implementation thereof, hear all disputes arising therefrom and impose the penalties and sanctions provided for under the Law.” (Article 6 of the Law is similar to the U.S. Bankruptcy Code section 105(a), a catch-all provision to give the bankruptcy court broad authority, which US courts apply liberally). The language “provided for under this Law” may limit the use of Articles 13 and 14 of the Rules.

The policy argument that may persuade the Court to find in favour of Party B

The provisions of Chapter Four of the Law are designed to give the stakeholders the highest level of flexibility of any bankruptcy Chapter. For instance, Article 61 allows the Bankruptcy Trustee to evaluate and terminate contracts; Article 69(1) of the Law provides that “the Debtor shall continue to manage its business and activities” during the procedure; Article 70 of the Law gives the Bankruptcy Trustee the right to approve many types of business activities, including requesting funding, repayment of “due or outstanding debts,” retaining counsel, transferring assets outside the normal course of business, etc.; and Article 75 of the Law provides for flexibility in reorganization proposals (including the sale of secured assets under Article 82 of the Law). Article 16 of the Bankruptcy Law Implementing Regulations also provides for flexibility in reorganization proposals. Article 5(b) of the Law provides that the aim of the Bankruptcy Procedures is, among other things, to “consider the Creditors’ rights in a fair manner and to ensure a fair treatment among the Creditors.” One such creditor’s right would be the right for Party B to make demand against the Bond. Given these objectives, it would make sense for FRPs to have at least the same option to request court-approved relief from the Moratorium as provided for in Chapter 3 (Protective Settlements) and Chapter 5 (Liquidations) of the Law.

Other factors to consider

The Bond, like a letter of credit, falls within a category of instruments known as “demand instruments”. The beneficiary of a demand instrument is able to obtain payment based simply on written demand, transferring the risk of non-recovery from the beneficiary of the demand instrument (i.e. Party B) to the issuer of the demand instrument (i.e. the Bank). The beneficiary of the demand instrument (Party B) collects from the issuer (Bank) and then the issuer (Bank) will have to recover from its customer (Party A). The aforementioned arrangement consists of two separate contracts, one between the Bank and Party A and one between the Bank and Party B.

If the Bank is a Saudi Bank, Party A is established in Saudi Arabia, Party B is established in the UK and the Bond is governed by English law with the English courts having jurisdiction, would an English court issue a judgement in favour of Party B in the event that the Bank refused to pay out under the Bond on the grounds that such payment would not be in compliance with Article 46 of the Law? The answer is that an English court would almost certainly issue a judgement in favour of Party B requiring the Bank to pay out under the Bond (the general position under English law with respect to demand instruments is that, absent fraud, the issuer of a demand instrument must satisfy a written demand for payment from the beneficiary of that instrument).

Alternatively if the Bank is a Saudi Bank and Party A is established in Saudi Arabia but Party B is also established in Saudi Arabia and the Bond is governed by Saudi law with the Saudi courts having jurisdiction, would a Saudi court issue a judgement in favour of Party B in the event that the Bank refused to pay out under the Bond on the grounds such payment would not be in compliance with Article 46 of the Law? From a business perspective, the answer should be that the Saudi court would also issue a judgement in favour of Party B requiring the Bank to pay out under the Bond.

However, because all of the relevant parties are established in Saudi Arabia and the Bond is governed by Saudi law the issue becomes more complicated. An interested party (e.g. Party A or the Bank) could apply to the Saudi court claiming the demand by Party B and/or the Bank paying out under the Bond would be a breach of Article 46 of the Law on the grounds that the Bond is an action against “the guarantor of the Debtor’s debts”. That would in our view be the wrong result, the right result in our view would be for the Bank to pay out under the Bond (i.e. the contract between the Bank and Party B). The Bank should then look to recover from Party A (i.e. the contract between the Bank and Party A). If that were not the case, the purpose of demand instruments (viewed as cash equivalents with Party B taking the credit risk against the Bank and not Party A) would be undermined.

SUMMARY

The Bond falls within a category of instruments known as “demand instruments”. The grounds upon which an issuer can refuse to honour a written demand for payment are very limited (typically fraud). Because of the special characteristics of demand instruments in our view they should not be categorized as a guarantee of the debtor’s debts and therefore should not be subject to the Moratorium under Article 46 of the Law.

Party B should be entitled to make a written demand under the Bond. The Bank should then satisfy that demand. The amount paid out by the Bank to Party B under the Bond will then become a debt owed to the Bank by Party A. The Bank will then submit a creditor claim (in the amount it paid out under the Bond) in the FRP.