The second draft of the Secured Transactions Law

The Draft Law proposes to govern security rights in movable assets and transactions serving security purposes regardless of their form or denomination, including:

1. fiduciary transfer of title;
2. financial lease;
3. assignment or transfer of receivables;
4. sale with retention of title;
5. secured financing of inventory and equipment acquisition without requiring the transfer of the possession thereof;
6. sale with a right of redemption and sale conditional on the payment of full price; and
7. sale with an option of repurchase.

The Draft Law excludes the following assets, which are exempt from security rights being created over them:

1. a legacy of a person who is still alive;
2. proceeds of insurance policy before the insured risk is achieved or the term defined in insurance contract becomes due and the insurer pays the due insurance amount;
3. the periodical entitlements such as pensions, salaries or wages exceeding 25% thereof every month including all bonuses;
4. frozen assets;
5. any assets or rights that may not be blocked under law.

There are certain other assets including shares, intellectual property rights, ships and aircraft, which are already subject to rules and regulations permitting security being placed over such, it is expected that these assets will fall outside of the scope of the Draft Law.

The Draft Law sets four ways in which a security right may be created over an asset and become effective against third parties:

• Registration of Notice – A security right shall be effective against third parties if a notice of such interest is registered in the proposed new security register, without the need to transfer the encumbered assets to the secured creditor.

• Possession – A security right over assets shall be effective against third parties if such assets are in the possession of the secured creditor or the person or persons approved by the secured creditor to receive the encumbered assets.

• Control – A security right over a bank account shall be effective against third parties if there is a control agreement is between the depository bank, the grantor of the security and the secured creditor. The control agreement shall not result in the freezing of funds credited to the bank account, unless agreed otherwise. The bank shall follow instructions issued by the secured creditor according to the control agreement regarding the cash withdrawal from the encumbered account.

• Automatic perfection with respect to consumer goods to finance the acquisition thereof – Where consumer goods are supplied on finance, a security right can be effective against third parties from the time it is created without the need for any formal registration, if the financing takes the form of the debtor receiving finance to purchase the goods in full or by instalment payments. This shall only apply to consumer goods the value of which does not exceed BD5,000.

A security right effective by concluding a control agreement (point 3) shall have priority over the security right effective by any other method (points 1, 2 and 4). A security right effective by possession (point 2) has priority over the security rights effective by registration of notice (point 1).

Under the Draft Law, a Security Agreement will be binding provided it is in writing between the grantor and the secured creditor and include:

1. details of debtor, grantor and secured creditor;
2. description of the encumbered asset;
3. description of secured obligation; and
4. specification of the amount of the secured obligation in respect of which the security right is effective or the maximum amount of the obligation or the amount up to which such obligation may reach to enforce the security right within its limits.

Under the Draft Law, a security right shall retain its priority in the proceeds of sale of an secured asset, and shall be automatically effective against third parties whether the proceeds are in the form of money, receivables, negotiable instruments or rights to payment of funds credited to a bank account and even if they are comingled with other assets of the same type.

The Draft Law introduces a registry of security rights and contemplates that the CBB and Ministry of Industry, Commerce and Tourism shall issue regulations in respect of the following:

1. governing all matters related to the creation, effectiveness and forms of a security right over bank accounts, commercial papers and negotiable documents by control;
2. all matters related to the creation and effectiveness of a security right in securities, execution against them, extinguishment of a security right and lifting of seizures of securities, taking into account the best credit practices; and
3. governing a security right in certain sui generis movable assets to promote the availability of secured credit and enhance the consistency of the provisions of this Law with modern financing transactions.

Under the previous draft of the Secured Transactions Law there was a requirement that all security rights that were in existence as at the implementation date would need to be registered within 90 days following its implementation. Provided that such security right was registered within 90 days, such security would be considered effective from the date of its creation. However, if a security right was not registered within the 90 day grace period, such security would only be effective from the date that the security is entered into the security register. There is no equivalent provision in the Draft Law, which may be due to the presence of other ways in which a security right may exist other than registration (e.g. possession), which did not exist in the preceding draft. The lack of a grace period under the Draft Law, means that there is a risk that if certain security interests, to which possession, control or consumer financing is not applicable, are not registered immediately upon implementation of the Draft Law, then such security will lapse.

Any bankruptcy or insolvency proceedings shall not affect the effectiveness of the security right against third parties, and the secured creditor shall maintain the rank of his security right against such asset.

The Draft Law sets out the ways in which the secured creditor may enforce their interest:

1. A secured creditor shall be entitled to the possession of the secured asset either by judicial proceedings by requesting the court to enable it to possess the secured assets in order to initiate execution procedures. Alternatively, the secured creditor may take possession of the secured asset without reference to the court provided the secured creditor obtains the consent of the debtor or the party in possession. If the secured creditor takes over the secured assets by coercion or assault, or acquires them secretly or by force, or if his possession thereof involves a confusion or constitutes a breach of peace, then the debtor or the party in possession may request the court to recover the possession of the secured assets within three months of his knowledge of the loss of possession. The secured creditor shall not possess the secured assets for execution thereon or apply for the possession thereof through judicial proceedings if the assets are in the possession of another creditor which has a higher ranking in priority, or if such assets are in the possession of another person based on a possession of higher preference.
2. A secured creditor has the right to sell or dispose of a secured asset by applying for permission from the court to sell or dispose of the secured assets, such as by leasing or licensing them to be used in a manner consistent with their nature and according to their customary use. The court shall determine the conditions and method for selling or disposing of the secured assets at a public or private auction. Alternatively, the secured creditor has the right to sell or dispose of a secured asset without reference to the court, provided that the secured creditor shall submit a written notice to the debtor, the grantor of security, all secured creditors which have registered a notice of their security right, the creditor which was in possession of these assets, and any secured creditor giving a notice of his security right.

Any agreement that provides the secured creditor the ability to acquire the secured assets, in the event that the debt is not repaid, at any price whatsoever or sell such secured assets with no consideration to the above procedures shall become null and void, even if such agreement is entered into after the security right is created. However, after the debt or a part thereof becomes due, it may be agreed that the creditor shall own the encumbered assets in fulfilment of his debt.

The deadline for comments on the new draft law was 6 April 2020. The CBB has yet to announce the outcome of the consultation, but a version of the law is expected to be issued later this year in line with a regional push to introduce laws enabling the creation of security over assets, for example, the Kingdom of Saudi Arabia introduced a similar law on 8 April 2020.

We recommend that all commercial parties review their portfolio of secured assets and then ensure that they have identified those that which will need to be registered to ensure that they are in a position to register such upon implementation of the Draft Law so that they shall be adequately protected against third party claims.