In light of the recent global financial crisis, it is imperative for Kuwaiti investment companies that are likely to default on their debt obligations to adopt restructuring measures to rectify their financial situation and treat their financial problems, particularly by rescheduling their liabilities and refinancing their debts. Creditor banks stand a greater chance of recovering loans by working with such troubled debtors who are prepared and equipped to restructure their debt. Moreover, such move sends a positive signal to creditor banks that the debtor is committed to meeting its outstanding debt obligations. Cash generated through restructuring initiatives is used to repay selected debt obligations. As a result, a creditor bank is likely to be more willing to re-negotiate the terms of the debt with the debtor.

Recent Impact On Kuwaiti Banking And Investment Sector

The global economic downturn has spared only a few investment firms in Kuwait. The impact has been especially acute because the country has approximately one hundred registered investment companies and several other industrial and real estate companies with large investment portfolios. Listed investment companies alone constituted about twenty (20%) percent of the total market capitalisation of Kuwaiti listed companies at the end of the third quarter in 2008 and about fifteen (15%) percent in 2009, a higher share than in most other industrialised economies.

As in much of the rest of the world, the crises among Kuwait's investment companies stemmed from a misplaced belief in perpetual growth driven by unlimited access to liquidity. In this context, investment companies invested opportunistically in a large number of portfolio companies, often in minority shares of private companies.

The Kuwait banking industry is facing serious financial crisis with some of the largest and well-known players in the investment company sector who have either defaulted or have asked to reschedule their debts.

Various Restructuring Alternatives

By re-negotiating their debt obligations with existing creditors, investment companies can give the creditors greater confidence evidencing their ability to repay their obligations and defining a clear roadmap to improve their cash position. Under a restructuring, creditors gain greater insight into the debtor's ability to repay by being able to closely track their cash movements. Moreover, unsecured creditors can benefit from procuring collateral under the terms of the restructuring and thereby assume the position of secured creditors to such extent. We have identified three alternatives available to creditors to restructure the debts due from Kuwaiti investment companies. 

Private Restructuring

Private Restructuring basically means devising a plan for restructuring and refinancing the debt obligations of the debtor in accordance with the plan, on a private basis. The creditors and the troubled debtor are the only parties involved. As almost all investment companies have multiple creditors (including foreign creditors), there is a need to have consensus among the same so as to secure their individual interest. The advantage of a private restructuring is that there is no involvement or interference of any judge or other governmental authority. The private restructuring plan can describe the terms of repayment of the outstanding debt and can also provide for necessary collateral/ security arrangements.

Phases and Relevant Aspects of a Private Restructuring Plan

As an initial step, the creditors and the debtor will enter into a standstill agreement whereby the creditors agree not to bring any legal action for any breaches by the debtor in consideration for the debtor pledging not to dissipate any of its assets to third parties pending the attempt to put forth and implement a restructuring plan. While none of these standstill agreements have yet been tested in a Kuwaiti Court, we believe that they would be enforceable in accordance with the terms and conditions of the Kuwait Civil Code. Upon the execution of the standstill agreement, the parties can then discuss ways of restructuring their debt.

In Kuwait, we have been bifurcating conventional and Sharia-compliant debt into different tranches (and sometimes foreign debt and Kuwaiti debt as well). These various tranches are then brought together through the use of an intercreditor agreement. Given the uncertainty of the ability to repay, all of these restructurings are now secured with most of the assets of the investment company debtor. Typically, the majority of the assets of these investment companies are either securities or real estate. With respect to securities, Kuwait has very well developed custodian portfolio laws that allow debtors to put their assets into custodianship with other Kuwaiti banks and/or investment banks. The parties can then have the debtor pledge the custodian portfolio itself against its obligations. With respect to real estate, Kuwait also has very long established mortgage laws that allow for the placement of mortgages that may be held by either Kuwaiti or foreign mortgagees. The only issue that is a bit tricky under Kuwaiti law with respect to securing assets for a group of creditors is the fact that Kuwait does not have any trustee laws whereby the creditors can appoint a trustee to hold these assets in accordance with said laws. Instead, we use an agency concept whereby the creditors appoint a "security agent" which enters into the security agreements under a parallel debt theory.  While this theory has not yet been tested in Kuwait Courts, the practice over the last several restructurings in Kuwait has been to use the same.

Court-Ordered Restructuring (By Way of a Scheme of Arrangement)

In the event that the parties cannot agree to a private restructuring plan, then they may want to seek court or other governmental assistance.  For example, the Commercial Law No. 68 of 1980 ("Commercial Law") provides for the procedure for implementing a restructuring pursuant to a scheme of arrangement with the Kuwaiti Court whereby the debtor continues to manage its assets under the administration of a supervisor and carries out ordinary disposals as may be required for its commercial activity.

Corporate Action

The scheme of arrangement has to be approved by the shareholders of the debtor by passing a resolution at an ordinary general assembly meeting of its shareholders.

Process

A petition in respect of the scheme of arrangement is submitted to the Chairman of the Court of First Instance which exercises bankruptcy jurisdiction. If the petition is accepted for filing, the Court makes an order for commencement of proceedings and appoints a scheme supervisor ("Commencement Order").

The Commencement Order also designates a date for a meeting of the creditors to be held within Thirty (30) days from the pronouncement of the Commencement Order. The scheme of arrangement has to be approved at the 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 do not participate in the voting. Every unsecured creditor is entitled to vote for its entire debt.

Stay of Proceedings

Once the Commencement Order is pronounced, there is an automatic stay of proceedings effective against creditors and all actions/proceedings of enforcement against the debtor cease.

Dealings with Properties

The debtor is allowed to manage its properties under the control of the scheme supervisor and is able to perform all ordinary procedures required for its commercial business. The debtor is however precluded from alienating in any manner, any of its properties without the permission of the Court. Any violation of this requirement may compel the Court from declaring the debtor as bankrupt.

Authenticating the Scheme of Arrangement

After granting an opportunity of hearing the non-participating creditors, if the Court decides to authenticate the scheme of arrangement, then the Court appoints from among the creditors, one or more supervisor to observe and enforce the terms of the scheme of arrangement and to report any violations to the Court.

The judgment approving the scheme of arrangement is then proclaimed and published in the Official Gazette. Under Article 779 of the Commercial Law, a summary of the judgment is filed with the Commercial Register Office (Real Estate Register) which creates a mortgage on any real estate owned by the debtor so as to secure the rights of the creditors who are bound by and who have signed and participated in the scheme of arrangement. Accordingly, unsecured creditors emerge from the scheme as secured creditors to this extent.

Effect

Authentication of a scheme of arrangement makes it valid in respect of all creditors, regardless of whether they participated in it or not.

Article 770 of the Commercial Law is wide enough to prevent secured parties from realising on any security that they may hold. With respect to unsecured creditors, the scheme of arrangement once approved is binding upon them. In effect, the scheme of arrangement substitutes for any actions or proceedings of enforcement that they may have had against the debtor. 

Restructuring Under the Financial Stability Law Program

The Central Bank of Kuwait ("CBK") is taking a number of measures to resolve the negative impact of the global financial crisis and particularly its impact on the banking sector in the State of Kuwait in general. In protecting the banking sector and keeping it away from any further crisis in order to maintain the financial stability in Kuwait, the Financial Stability Law No. 2 of 2009 of Kuwait ("Stability Law") was passed in the Parliament. The Stability Law aims at enhancing financial stability in the State of Kuwait thereby ensuring stability in the banking sector, supporting the economic activity sectors in Kuwait as well as encouraging the banking sector to finance these sectors.

Applicability

The Stability Law applies to investment companies, Kuwaiti banks and branches of foreign banks in Kuwait, each of which is registered with the CBK. An investment company generally having good credit worthiness and facing financial problems is likely to qualify to seek assistance under the Stability Law.

Nature of Financial Assistance

CBK selects a suitable approach out of the following to be applied for a qualifying investment company:

  • Issuing a guarantee by CBK on behalf of the State of Kuwait of fifty percent (50%) of the new finance extended by local banks, within 2009 and 2010, to be utilised for the purpose of settlement of outstanding liabilities as of 31st December 2008 to all local parties other than local banks, and rescheduling its debts to foreign banks and financial institutions, provided that the cash settlement shall not exceed twenty five percent (25%) of the debt, and the remainder to be rescheduled for a suitable period upon a technical analysis and report to be submitted in this regard.

The investment company is however required to create a portfolio of its assets sufficient to cover the debts to local and foreign banks which are outstanding prior to obtaining any assistance under Stability Law.

  • Providing financial support to the investment company if it is unable to obtain finance from its shareholders or from other parties in accordance with the Kuwaiti laws or by means of loans or subordinated finance, then the Kuwait Investment Authority and other government and public institutions may assist the investment company which is unable to increase its capital, by:
    • Purchasing unsubscribed convertible bonds which are convertible into shares issued by the investment company;
    • 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

    • Subscribing for unsubscribed Islamic financial instruments.

Corporate Action

The investment company is required to obtain the prior approval of its general assembly with respect to its restructuring plans for the execution of the actions and terms prescribed by the CBK under the Stability Law.

Overview of Process

An application along with the prescribed supporting documents is submitted to CBK. A detailed report containing the financial status of the investment company, its current obligations against other local and foreign entities, the problems and difficulties it is currently facing, its intention to pay off its obligations and the steps taken in this regard, is also required to be submitted.

A specialist party appointed by CBK then studies the application and provides a report to CBK stating the financial position of the investment company, identifying the basis and reasons of the financial problems, estimating the required funds to resolve the situation, identifying the assets which the investment company may use as security; and other recommendations and treatment to be adopted for the investment company.

If the investment company qualifies, CBK prescribes the necessary remedial actions to be taken to assist the financial position of the investment company.

Enforcement of Restructuring by Courts of Kuwait

Besides the relief which is offered to investment companies as set out above, the Stability Law also provides 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 with its restructuring activities. If the investment company deems necessary, it may apply to the special circuit of the Court of Appeal to formally adopt the restructuring provisions. Moreover, 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 are stayed.

Comparative Analysis

The private restructuring option appears to be a preferred route from the standpoint of both the debtor and the creditor since they are able to jointly implement the agreed terms in a mutually agreed manner and more importantly within a mutually agreed time.

A scheme of arrangement can be tailoured to include specific terms of repayment of the debt by the investment company, terms of release from part of the debt, etc. Since the scheme of arrangement once approved by the majority creditors is binding on all the creditors, difficulties that may be posed by small groups of non-co-operative creditors automatically get eliminated. The main disadvantage here is that due to the intervention and supervision of the Courts of Kuwait, both the creditor and debtor have limited control over the process and pace of the process.

While the Stability Law appears to be a pragmatic route, the drawback is that there is no tested precedent under the Stability Law so far and therefore involves an element of uncertainty. To our knowledge, there is only one Kuwaiti investment company which has sought recourse under the Stability Law since its implementation last year.

Conclusion

If the troubled investment company is reluctant to adopt restructuring, the creditor would be compelled to look at liquidation or bankruptcy proceedings being initiated which would not only be long drawn and time-consuming, but the outcome would also be fairly uncertain.

Given the uncertainties involved with the Courts under a scheme of arrangement and with CBK under the Stability Law, private restructuring seems to be the most practicable alternative from the perspective of the creditors. Firstly, the assets of the investment company are secured on behalf of the creditors. Secondly, there is no interference by the Court which can impose its own thoughts on the restructuring plan or at least significantly slow down the pace of the restructuring. Lastly, upon closing of the restructuring transaction, it is likely that creditors may get paid relatively quicker than through the sale of assets later on.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.