The Commercial Pledge Law was issued in April 2018. This step was taken in response to the long-awaited and highly pressing need to support the growth of financing options for Saudi Arabia’s business sector. The newly issued Commercial Pledge Law will be a catalyst for greater and sustained credit growth in the years ahead.
The Commercial Pledge Law has changed the landscape of creating security over ‘movables’ in Saudi Arabia. These changes will have an impact on the law and practice of banking in the Kingdom and will provide a wider variety of options when structuring lending transactions. Significantly, pledge agreements are required to comply with the Commercial Pledge Law within a six-month period from the effective date of the law. The law also specifies a comprehensive and complete procedure for expedited enforcement of security over movable assets. These procedures would reduce risks associated with debt collection and thereby encourage banks, financial institutions, and other lenders to participate with confidence in the credit markets.
This article will cover the key features of the Commercial Pledge Law and will explain the law and its Implementation Regulation. The article will also discuss how the Commercial Pledge Law will help in tackling various issues associated with enforcement relating to pledged properties.
Under earlier laws, it was possible to create security over movables that were in existence but it was largely the case that security could not be created over future movables. Therefore, where a movable asset was not in existence (e.g. machinery that was under-construction or future deposits in a bank account) it was not possible to create security.
The Commercial Pledge Law covers the creation of security over movable property, which includes present as well as assets that will come into existence in the future. For movables that will come into existence (e.g. machinery that is under-construction) the pledgor would have a contract for purchase or construction and should be able to describe the asset, its value and date of completion.
Future rights include debts that can be pledged or assigned by way of security. This would cover receivables under contracts or invoices.
Significantly, the Commercial Pledge Law applies to pledge contracts that secure ‘Commercial Debts’. A Commercial Debt is a debt that arises from business or professional activities. A loan to finance the purchase of a computer server by a company for storage of its files would be a Commercial Debt. A loan to finance the purchase of a computer server by an individual for storage of personal data would not be a Commercial Debt. The provisions of the Commercial Pledge Law would apply to the former scenario but not the latter scenario.
Registration of pledges (where applicable) under the Commercial Pledge Law are required to be registered at the Unified Register of Commercial Pledges or if there is a special register for a type of asset (e.g. vehicles, ships, aircraft) registration on the relevant special register would suffice. A pledge contract relating to movable property is valid as against third parties if it is registered or possession of the movable property is transferred to the pledgee or to a trustee. For inventory and raw material, a floating charge is required to be created (discussed below).
It is possible to create more than one pledge on the same pledged property. A registered pledgee will have priority over an unregistered pledgee in respect of the same pledged property. If there is more than one registered pledgee, the pledgee having the earlier date of registration will have priority. Unless otherwise agreed between the pledgees, a pledgee under a pledge contract shall have priority over a pledgee under a floating charge or a Pledge over Economic Enterprise.
The Ministry of Commerce and Investment has published the draft bill of the Commercial Pledges Unified Register Regulation, which aims to make the registration of pledges electronically, for the public to express opinion and feedback. The regulation is expected to be issued shortly.
The significant development under the Commercial Pledge Law when it comes to pledging deposits is that it is now possible to pledge both present and future deposits in the bank account. This is especially important where security is to be taken over deposits in current and operating accounts where deposits and withdrawals occur on a regular and on-going basis. Unless the pledgor and pledgee agree otherwise, the pledgor is not permitted to operate the bank account.
The Commercial Pledge Law defines a floating pledge or charge as a pledge created over movable property without determining the elements of the movable property. Effectively, the pledgor and the pledgee are not required to identify the specific assets that are subject to the pledge. Inventory and raw materials are covered under the scope of a floating charge. A floating charge must be registered in the Unified Register of Commercial Pledges in order for the security to be effective against third parties. The pledgor is required to provide monthly reports of the stock available and if the quantity is not permitted to fall below 50% of the required pledged property unless the parties have agreed otherwise.
The pledge over economic enterprise or pledge over commercial business enables the secured party to obtain security over an entity that carries out commercial or professional activities. The pledge over economic enterprise creates security over all elements of the commercial or professional business including its intangible elements (goodwill and customer database) and its tangible elements including its movable assets, rights (receivables and book debts) as well as the location where commercial activities are carried out. Inventory of products sold by the business would be excluded.
The Commercial Pledge Law excludes from its application shares of companies that are listed as well as shares of unlisted companies (being shares of Joint Stock Companies Closed). However, portions in entities (e.g. a portion or shares in a limited liability company) may fall under this Commercial Pledge Law and require registration at the Unified Register of Commercial Pledges. Other unlisted securities may also require registration unless they are governed by a special law governing perfection requirements.
The Commercial Pledge Law sets out the constituent elements of a pledge contract. The key elements include (a) where the pledged property is not in existence, the expected description, approximate date of existence and approximate value of the pledged property should be specified; (b) the general description, amount or maximum limit of the secured debt should be specified; and (c) the due date or expected due date of the secured debt should be specified.
The designation of an “Execution Agent” (he/she cannot be one of the parties involved in the pledge) is given to an individual licensed by the Ministry of Commerce and Investment (“MOCI”) for practicing the act of enforcing pledged properties if the pledgor defaults and there are multiple pledgees.
The Commercial Pledge Law, however, allows any individual (even if he or she does not have the license of the MOCI) to play the role of an Execution Agent if all the pledgees agree to allow him/her to be their representative when the enforcement procedures are underway.
Whatever might be the case, appointing an Execution Agent is a must whenever there are multiple pledgees. This is because the writ of execution (we have discussed it later in this article) is always issued under name of the concerned Execution Agent.
Under the Commercial Pledge Law, where the pledgee and pledgor agree, the pledgee may enforce the pledge directly without the requirement of a court order. The procedures that can be adopted for self-help enforcements are as follows:
It is important to mention that the self-help clause does not permit the inclusion of a provision in the agreement, which allows the pledgee to take direct ownership of the pledged property against secured debt in the event that the debtor fails to make payment of the debt. Such a provision would be void but would not impact the rest of the agreement.
The Commercial Pledge Law, however, has provided the pledgee (when an event demanding the execution of pledged property takes place) with the right of enjoying preference over other involved parties when it comes to buying the concerned pledged property. The price the pledgee would be required to pay for making the purchase would be same as that determined during the evaluation of the property unless another buyer offers a larger amount than the property’s assessment price.
When a financing contract is breached by the debtor in a manner that makes execution mandatory and the pledge agreement does not contain a self-help enforcement clause, the execution agent or pledgee would carry out the following steps for enforcement:
The pledged property’s value is determined by following the procedures and regulations agreed upon by the parties involved in the pledge agreement. In case there is no agreement between the pledgee and the pledgor, the assessment will be carried out by a professional (certified) assessor. Each party would have his/her own assessor; the final assessment price would be the average of the assessment prices put forward by the two assessors.
If any one of the two parties does not appoint their assessor within 10 business days from the date the other party appointed an assessor and notified his/her counterpart about the appointment, the appointed assessor’s assessment would automatically be approved.
The issuance of the new Commercial Pledge Law in April of this year, responded to a most pressing and long awaited requirement for supporting credit in the business sector in the Kingdom of Saudi Arabia. This Law sets out a complete and comprehensive mechanism for quick collection of debts secured by pledges and lessening risks implied therein; and thus encouraging banks, finance companies and others to engage in credit business with confidence. All existing pledge agreements should be brought in line with the Commercial Pledge Law within six months of the issuance of the law, that is, by the 3rd week of October 2018.