Financial institutions in the UAE may need to re-assess their loan books in response to two recent banking law amendments.
The amendment to Article 121 was introduced to mitigate the uptick in defaults among individuals and sole proprietorships in the UAE, by requiring financial institutions to obtain ‘sufficient’ security from these entities for loans.
Article 409(2) of the New Commercial Law similarly requires that banks must have ‘sufficient’ securities against loans they provide.
The legislative changes re-emphasise the importance of responsible lending, particularly if lending is to individuals or sole proprietorships, or being guaranteed by those entities. The changes also perhaps signal a move away from the practice of ‘name-only’ lending, as well as a reduction in reliance on personal guarantees exclusively as a form of security.
This move is a reminder to financial institutions to conduct thorough financial due diligence as part of any credit assessment. This can only have positive implications given what the UAE restructuring and insolvency community witnessed as a result of the collapse of NMC Health plc and related group companies, in addition to the financial fallout from the COVID-19 pandemic.
While the legislative changes are commendable from a policy perspective, they do not yet offer a definition or provide guidance on what is considered ‘sufficient’ in terms of securities. This has led the Abu Dhabi Courts in recent reported cases to apply its interpretation. In these cases, enforcement proceedings on guarantees taken by the financial institutions have been struck out on the grounds that the financial institutions were, in some cases, over-collateralised and, in other cases, under-collateralised.
The requirement for financial institutions to obtain sufficient guarantees and securities on loans has significant implications in respect of ongoing situations of financial distress, new credit transactions, and existing loan books as a whole. We consider each of these in turn.
Impact on situations of financial distress
There is optimism that more detailed guidance on what amounts to sufficient will be forthcoming from the UAE legislature. In the meantime, financial institutions should proceed with caution before taking action against debtors.
Financial institutions should therefore consider whether there is scope to take action in courts of other emirates where the courts may apply a different interpretation. And whether there is an ability to recalibrate the financial institution's guarantee or security position with the relevant customer prior to action being taken.
Impact on new credit transactions
Similarly, relationship teams within UAE financial institutions will be left scratching their heads when writing credit papers for new transactions. What now amounts to sufficient guarantees and security?
It is unlikely that the purpose of the legislation is to curb investment grade lending in the UAE, and financial institutions can take some comfort from the fact that borrowers of this nature do not often default.
For all other lending activities, there is no doubt that financial institutions will have to carefully consider the security and guarantee pool the borrower is proposing. In terms of practical guidance, we would suggest financial institutions consider the implications of the new legislation at the credit stage.
Create an audit trail for evidentiary purposes; and record any decisions taken in the relevant credit papers that the security and guarantees proposed are, in the bank's view, ‘sufficient’. Financial institutions should also consider conferring jurisdiction on courts that may take a more liberal approach to the interpretation of Article 121 (such as the DIFC Courts in Dubai).
Impact on existing loan books
Given the retrospective nature of Article 121, and the jurisprudence arising from the Abu Dhabi Courts, banks may benefit from conducting a thorough assessment of each of their existing UAE loan books to determine whether security or guarantees taken would likely fall foul of any of the new legislation.
A loan book review of this nature would be no small undertaking on the part of financial institutions. Perhaps, the prudent steps would be to ensure such a review takes place when loans are passed to the restructuring and non-performing teams within the institutions themselves. And to conduct the thorough assessment at this stage, including an assessment as to whether the financial institution would have the ability to recalibrate its secured position.
We do recommend that financial institutions follow the practical steps outlined above to mitigate the potential impacts of the legislation as far as possible.
