05 Oct 2009

A NEW AGE FOR NAME LENDING DAWNS IN THE UAE

Authored by:

A NEW AGE FOR NAME LENDING DAWNS IN THE UAE

Although recent global economic indicators suggest various countries are slowly, but surely, emerging from recession, the eyes of the business world remain firmly fixed on the banks. "When will they return to lending as normal?" "Have they made sufficient provisions?" “Would a closer analysis of their loan portfolios reveal a yet deeper malaise?"
 
 
In brief:

  • Our legal due diligence experience in respect of UAE lending practices and procedures suggests there are “gaps” in the enforceability of the guarantees and security given to support the borrower.
  • If UAE banks are to safeguard their regulatory capital and limit the additional amount of economic capital they need, then lending practices and procedures will need to change.
  • Strong relationships with customers remain the key to successful contractual lending and borrowing arrangements. However, lending on the strength of relationship (or name) alone is not economically viable or justified.

In the UAE, the risk management activities inherent in running a corporate or investment banking business remain of crucial importance, not least because of the strong local characteristic of "name lending", by which is meant lending or providing other banking facilities to family or other private businesses, primarily on the strength of the "name" or "names" of the proprietors standing behind the business, rather than on the strength of the asset quality and underlying credit of the particular business. Of course, in practice, there is commercial overlap between the proprietors and the companies which they own, but the credit analysis can break down where poor banking practices and procedures result in poorly constructed legal documentation and gaps in guarantee and security support documents.
 
Recent UAE news has highlighted the distinction between "regulatory capital" and "economic capital". Whereas regulatory capital is essentially the capital which a bank is required to maintain by its regulator as a measure of capital adequacy, economic capital represents a deeper cushion of capital more accurately measuring the risks in the assets of the particular bank.
 
For UAE banks, this concept of economic capital providing a more effective measure of risk, than mere capital adequacy, will be the more significant, if any closer examination of a particular bank's lending and supporting documentation were to reveal "gaps" in enforceability of the guarantees and security given to support the borrower. Our legal due diligence experience in respect of UAE lending practices and procedures suggests there are indeed such “gaps”. If a bank’s credit/risk management committee has approved a loan on the basis that it is a secured loan, it would indeed be a concern, and increase the bank’s economic risk, if the security turned out to be defective as a matter of law.
 
Let us assume the family business consists of a holding company or other legal entity (e.g. partnership) and many trading subsidiaries doing business across a broad range of different business sectors.


If UAE banks are to safeguard their regulatory capital and limit the additional amount of economic capital they need, then lending practices and procedures will need to change. The rating agencies that rate UAE and other GCC government and corporate bonds will no doubt have a big influence in acting as a catalyst for change in improved operational quality. So too will the banks' shareholders; and also will the individual bank's credit/risk management committees, which now wield significant power and authority within their bank.
 
Many “what if” questions need to be adequately and satisfactorily answered in the affirmative and not left to doubt and/or subsequent action. For example:
 
Management and Corporate Governance

  • Is it clear who are the management members of each company?
  • Has their identity been fully validated?
  • Is there a board of directors additional to the general manager(s) of the company?
  • Is it clear from the company's memorandum and articles of incorporation what the management can and cannot do?
  • Does the bank have a clear audit trail of documentation identifying who were the directors and managers of the company during particular periods of time during the contractual period of the banking relationship and, therefore, who approved versions of which particular documents and who authorised which transactions?
  • Where a person (as would be usual in a family group of companies) is a director or manager of many companies, is he acting for the benefit of one company when he undertakes certain actions for another company, e.g. giving a cross company corporate guarantee?

Legal Documentation

  • Is there a good commercial reason to choose English law to govern the facility agreement for facilities to be made available to a UAE group of companies, when any security interests given over UAE assets will necessarily need to be governed by UAE laws?

Corporate and Personal Guarantees

  • Are the guarantees unequivocal in their terms?
  • Are they guarantees or merely sureties?
  • Do they have monetary limits?
  • Are they dated and correctly executed?
  • Are later-in-time entered standard form guarantee documents in conflict with earlier-in-time entered standard form guarantee documents?
  • Where there are personal guarantors, have they given security to support their otherwise unsecured obligations?
  • What credit analysis has been carried out in respect of particular individuals, who may have given personal guarantees in respect of many companies, not just to the particular bank, but many other banks as well?
  • What risk scenario analysis has been done to test how creditworthy are the personal guarantors were some or all of their personal guarantees to be called (e.g. what if a personal guarantor became bankrupt)?

Security

  • Have all the steps required as a matter of UAE law to perfect the particular security interest been effected?
  • Has a particular class of assets been given as security to another bank at an earlier point in time?
  • Is the borrower or other obligor in breach of any contractual lending documentation with another bank by giving security to the particular bank?
  • Does a fall in loan-to-value ratios require the provision of additional security and has such additional security been obtained?
  • Readers may also wish to refer to our What is Effective Security article for a more detailed discussion.

Priorities of debts and ranking of security between banks

  • In short, are the priorities and ranking clear as a matter of UAE law?
  • Has pre-drawdown due diligence been carried out to verify the true situation vis-a-vis other banks?

Internal bank systems

  • Is the totality of documentation provided by the borrower/obligor group of companies, which will be input into the bank's electronic systems, sufficiently clear and quickly retrievable to enable the bank's operations team to correctly corroborate and validate the corporate authorities authorising all future transactions?
  • Does the information contained within the documents held in the bank's physical storage system tell the same story as the electronic versions of those documents held within the bank's electronic storage system?

Conclusion
The global financial crisis has changed the banking landscape forever. Things will certainly not be the same. Strong relationships with customers remain the key to successful contractual lending and borrowing arrangements. However, lending on the strength of relationship (or name) alone is not economically viable or justified. The cost of maintaining sufficient economic capital will dictate the new future. In the UAE, there will indeed be a new age for name lending.