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Part I
General Concepts and Legal Issues
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Chapter 1
Rahn Concepts in Saudi Arabia: Formalization and a Registration and Prioritization System
Michael J.T. McMillen*
1.1 INTRODUCTION
The first limited recourse project financing in the Kingdom of Saudi Arabia, the Saudi Chevron petrochemical project, commenced in 1996.1 Conventional interest-based financing was provided by a group of international, regional, and local lenders to a special purpose entity established to construct, own, and operate the project. As recourse was limited to the assets comprising the project and cash flows generated by the project, the collateral security structure provided to those lenders was critical.2 A primary difficulty in creating an effective collateral security structure in 1996, and at all times up to and including the present, is the fact that mortgages, pledges, and other security interests may not be registered in Saudi Arabia.3 Which is not to say that mortgages and pledges are unavailable as part of a collateral security package in Saudi Arabia. They are available pursuant to the principles and precepts of Islamic Shariah (the āShariahā) as enforced in Saudi Arabia, most particularly those applicable to rahn (mortgage and pledge) arrangements.4 The Shariah is the paramount law of the land in the Kingdom of Saudi Arabia and is enforced in the courts of Saudi Arabia.5
The absence of recordation capability, and the uncertainties resulting from the absence of stare decisis principles and reliance on de novo case-by-case enforcement in the Saudi Arabian courts,6 have hindered certain aspects of development in Saudi Arabia. Those factors have also increased the need for involvement by the Saudi Arabian government in terms of additional government support undertakings, as would be the case in any jurisdiction subject to such factors. A couple of examples may give a flavour of those hindrances. Each example seems independent of the factors that have emerged in the post-2007 economic crisis. Development of infrastructure, real estate, industrial, and other projects in Saudi Arabia has remained robust throughout this economic crisis. However, the participation of international banks and financial institutions in the provision of financing may be characterized as modest, at best, due in large part to these systemic infirmities. Financing is provided primarily through local banks and financial institutions, a pattern that is apparent in many sectors of the Saudi Arabian economy. From a risk diversification perspective, this is not the ideal situation for the Saudi Arabian financial sector. Another example is the limited availability of home purchase financing in Saudi Arabia due to the reluctance of banks and financial institutions to provide financing because of the aforementioned factors. Home financing structures have been developed, and there has been some expansion of available credit for these purposes. However, given the uncertainties with respect to collateral security, current levels of credit availability seem insufficient and pricing may be suboptimal for home purchasers.
The dramatic growth of Islamic banking and finance, internationally and within Saudi Arabia, the lack of participation of international banks and financial institutions in financ-ings, and the pressing needs for home purchase financing, among other factors, have resulted in intensive consideration of formalization of collateral security concepts within Saudi Arabia. Specifically, drafts of different bills pertaining to rahn (mortgage and pledge) principles, including recordation systems and enforcement processes, have been prepared and were approved by the Shura Council of Saudi Arabia in mid-February 2010. These long-discussed pieces of ālegislationā have taken concrete form, although their ultimate form is as yet uncertain and there is no defined timetable for formal adoption. The primary substantive rahn bill is the āBill of Registered Real Estate Mortgage Lawā (the āMortgage Lawā). There are four other related bills, although it is uncertain whether all will be adopted together with the Mortgage Law: (a) the Real Estate Funding Project (the āRE Funding Projectā); (b) the Bill of Financial Leasing Definition; (c) a Bill of Finance Companies Control Law; and (d) a Bill of Execution Law (the āExecution Lawā). For convenience, the five laws are collectively referred to as the āFinancing Lawsā.7
This chapter considers the Mortgage Law and limited aspects of the other Financing Laws. The focus is on the correlations and divergences between the Mortgage Law and substantive principles of classical
rahn formulations, as embodied in the ā
Majelleā
8 and discussed in āAl-Zuhayl
ā
9 and āIbn Rushdā.
10 The Finance Laws, as finally effective, are likely to vary from the current drafts. However, given that the current drafts of the Finance Laws have been discussed and reworked for a considerable period, and received Shura Council approval, it seems appropriate, even prior to finalization, to consider the principles adopted by the new collateral security structure that appears likely to emerge.
1.2 THE MORTGAGE LAW
1.2.1 General Observations
As a general statement, the substantive Mortgage Law, and to some extent the Execution Law, embodies classical Shariah principles of rahn but does not appear to be wholly consistent with the classical formulations of those principles. Embodiment of those principles is consistent with the paramount position of the Shariah in Saudi Arabian law and is important given that the Mortgage Law will likely be enforced by the Board of Grievances (Qiwan Al-Mazaliāim) or a similar court or body, each of which applies Shariah principles.11 The Mortgage Law and the Execution Law contemplate local jurisdictional enforcement, rather than enforcement by the Banking Disputes Settlement Committee of the Saudi Arabian Monetary Agency (the āSAMA Committeeā) (which has jurisdiction over disputes between a bank and its customers) or the Office for the Settlement of Negotiable Instruments Disputes (the āNIOā). Thus, it can be surmised that, even if the SAMA Committee or the NIO has jurisdiction over the financing agreements for a transaction, enforcement of the mortgage will be within the jurisdiction of a separate Shariah court. That said, the jurisdictional ambits are not clearly delineated in the Mortgage Law, the Execution Law, or the other Financing Laws.
That raises a critical question of whether a local Shariah court will enforce a mortgage or pledge if the obligation secured by the mortgage is interest-based or otherwise violative of the Shariah. That issue, of course, is what has precluded registration of mortgages and pledges up to the present. And that issue is not specifically addressed in the Financing Laws.
The Mortgage Law applies to real estate and certain other movable assets that have a āregular recordā (other than āsecuritiesā). It does not specifically address other property, such as movable property that does not have a regular record. Specifically, the Mortgage Law and the other Financing Laws do not preclude, by their express terms, rahn arrangements under the Shariah in respect of such other property. The RE Funding Project is clearly directed, in part, at residential housing initiatives. The Mortgage Law is not so addressed and seems to have a broader application, although popular press discussions of the Mortgage Law have focused primarily on its application to residential housing matters. It is conceivable that the RE Funding Project also has a broader application to commercial properties and to securitizations, but that is not discussed in this chapter.
The Mortgage Law contemplates registration of security interests and addresses the rights of registered and unregistered holders of security interests, including the priorities of interests. A registered mortgage becomes effective as against third parties upon registration, subject to certain third party proprietary rights predating registration.12 The mortgageeās priority is determined by the entry number and registration date of the mo...
