The conundrum of Unsecured bank loans to “expat” family businesses in the Middle East

A typical expat family business is founded by either the father or the mother of the 2nd generation that joins the business right out of university or a few years after gaining some industry experience. The founder pretty much decides, or in some cases, dictates, the direction and functioning of the company. They wholly take responsibility for the actions of the company, and to lead/represent the company to the its clients and the outside world.

Business Setup

Family businesses in the Middle East is a lot to do with the local cultural setting. Although 100% foreign ownership of private companies is possible in certain countries in the Middle East, the shareholding is typically setup as 51% local partners and 49% expat partners. Expats usually do not acquire the citizenship of the Middle East country they conduct business in as per the local laws.

Such a private company known as an LLC (Limited Liability Company) in the Emirates or a WLL (With Limited Liability) in Kuwait typically will have a local partner either invest in the business along with the expat partner or just be a silent partner having a side agreement. Silent partners are generally eligible only for a monthly or annual fee and they do not get paid any dividends from profits at the end of the year. Such a company is owned 49% by the expat on paper (to satisfy the Companies Law) but in reality they are owned 100% by the expat partner. They control all decisions, departments, inventory, employees, and the direction as well as the growth of the company.

When such a business starts to mature and eventually grow then the owners may be able to approach a local bank (or a local branch of an international bank) for a corporate loan. Banks usually provide facilities such as Bank Guarantees for advance payments from a client, Performance Guarantees for a construction sub-contract, Letters of Credit for payment to suppliers, Tender Guarantees for bidding on government projects, or Maintenance Guarantees needed for providing maintenance of a building or any other project.

In countries like India, usually, corporate bank loans are provided to a company against mortgage of properties owned by the Directors or Partners of the company but what happens in countries like Kuwait where expats are not allowed by law to own any land or property? Enter Unsecured corporate bank loans.

Unsecured Loan Process

Before giving a corporate loan a bank will typically study the company that is requesting for the loan: 3–5 years of their balance sheets, management profile, KYC (Know-Your-Customer) documents, company future growth report, list of projects (for a contracting company), inventory (for a trading company) and ofcourse a face-to-face meeting with the partners and senior management in their headquarters. Companies normally start off a relationship with the bank by asking facilities for a particular project or for trade finance.

The bank reviews the documents, interviews the partners of the company. Files typically move for approval from the Corporate facilities department to the Risk department to the Management committee before the CEO of the bank approves the corporate loan. Such a loan is “very loosely” secured by making the partners sign Promissory notes and getting their personal guarantees for the amount of the corporate loan provided by the bank to the company.

From this moment on, the bank pretty much depends on the good actors in the company to grow the business as they declare in their application process. The bank has really no recourse to collect the money back from the business in case things go south. And yes, things do go south. There could be many reasons but some of them could be: the founder’s death, force majeure, lockdowns, recession, business losses, inflation, bad debtors, non-moving inventory, high overheads, change in government policies, in-fighting between the partners, economic downturn etc.

The bank will struggle to get any personal guarantees from the sponsor of the company as he or she usually will have no clue of what is happening in the business, nor they benefit or suffer the consequences of profit or loss in the company respectively. However, if the bank demands that the sponsor also become a guarantor in the facility documents then the expat partners have to give additional security or insurance to the sponsor for a negative situation where the company isnt able to repay its debt to the bank. This security is typically in the form of undated cheques issued by the company in favor of the sponsor that are held by the lawyer of the company until they are required to be issued to the sponsor.

The Conundrum

Things in a business (or life in general) never go as per plan. So now this company that has taken an unsecured corporate debt from its local bank goes about its business. Somewhere down the road problem hits the business!

So now what does the bank do? They start off by having a meeting with the partners and after understanding the situation they will most probably restructure the outstanding debt. If the company is able to meet its obligations then all good, but what if it doesn’t?

Since such Unsecured loans are not backed by any collateral, which means that the expat borrowers didnt have to pledge any real assets (that they may have in their home country) as security for the loan, the bank has only one recourse: Legal.

The Conundrum: Should the bank have started a banking relationship with such a company in the first place? Could the bank have assessed the risk correctly of dealing with such partners? Comment below!

The next blog will shed light on the interaction between the company, its partners and the bank under the murky process of Litigation.