Over the past three years Kuwait has promulgated a number of laws concerning public-private partnerships (PPPs). Although relatively new to the PPP regime, Kuwait has, at least for now, embraced the concept, as evidenced by the diverse pipeline of projects that have either already commenced or are actively being considered.
The projects cut across business and industry sectors including the power, transportation, health and telecommunications sectors. Although the vision for Kuwait’s PPPs holds great potential and promise, the new and untested nature of the legal framework poses potential challenges. In this article we look at the project company structures proposed by the PPP Law and related financing considerations.
LEGAL FRAMEWORK: The main regulations governing PPPs is Law 7 of 2008 (PPP Law), which is a general law that covers all PPP projects undertaken on state-owned land. Further guidance on the implementation of projects under the PPP Law is provided by the Project Guidebook published by the Partnership Technical Bureau (PTB). The PTB is an institution established by Article 12 of the PPP Law to provide technical assistance to the Higher Committee (HC), a committee set up by Article 11, the mandate of which is to oversee the development of PPPs on a national level and to establish general policies concerning the same. In addition to the PPP Law, there have been a number of other sector-specific PPP laws passed that cover power production, public warehousing, labour cities and other projects. A common trait in these laws is the requirement for the incorporation of a public joint stock company (PJSC) to carry out the various PPP projects. Such companies are incorporated pursuant to the Commercial Companies Law.
THE PROJECT COMPANY: Under Article 4 of the PPP Law, no public entity or company that manages state real estate may contract with any investor for projects to be carried out on public land on the basis of build-operate-transfer (BOT), build-own-operate-and-transfer (BOOT) or any other similar system without the HC’s approval of the same.
Article 5 of the PPP Law also provides that all projects to be undertaken on state real estate properties on the basis of BOT, BOOT or any other similar system and which are estimated to cost above KD60m ($216.3m), an amount derived from the project’s feasibility study, including the estimated market value of the project land or market value of its usufruct, shall be undertaken by a PJSC established for this purpose rather than offering the same for public tender. Moreover, incorporation of a PJSC is governed by Chapter 1 (Articles 70 to 184) of the Commercial Companies Law.
INCORPORATING A PJSC: A PJSC generally requires at least five shareholders (or promoters) to initiate the incorporation process. In brief, this process is initiated by the promoters submitting an application to the Ministry of Commerce and Industry (MOCI) including a copy of the company’s draft memorandum and articles of association. The company’s memorandum and articles of association must include the overall objectives of the company and shall also state its share capital. Once the application is approved by the MOCI, the MOCI will apply for an Amiri Decree. Once an Amiri Decree is issued to this effect (i.e. approving the incorporation of the project company, its objects and the distribution of shares), such decree would be published in the official gazette. A note of caution: although the company would be considered a legal entity at this point, the incorporation process would not be complete as yet and the company cannot commence operations.
Following issuance of the Amiri Decree, the promoters may then move on to inviting public subscription for the company shares (for 50% of the share capital as per the PPP Law). In doing so, promoters must adhere to the Companies Law, in addition to the capital Markets Law, as well as other applicable regulations. The promoters must issue a prospectus that would also be published in the official gazette. Such a prospectus would, among other things, include: a summary of the articles and memorandum of association of the company, its share capital, the names of the promoters, the value of the shares, as well as the date and place and conditions for subscription.
SUBSCRIPTION: The subscription may be made in one or more of the accredited banks and all amounts collected shall be deposited into an account opened in the name of the company. The subscription period must be open for at least 10 days but no more than three months. If, however, within the time limit set for subscription all shares are not subscribed for, the promoters are permitted to extend this time limit for a period not exceeding three months.
Once the shares are fully subscribed for, the promoters must then call a Constituent General Assembly comprising the subscribers to approve the incorporation process. The Constituent General Assembly must then elect the first directors and auditors who then declare the company legally incorporated. The directors will enter the company in the Commercial Register at which point the company will be recognised as being legally incorporated.
The entire incorporation process may take anywhere between five and nine months. The timing and synchrony of this process with the rest of the project structuring will therefore be crucial to the successful closure of the financing.
EQUITY DISTRIBUTION: Under Article 5 of the PPP Law, the PJSC’s equity is to be distributed as follows: i) 40% of the shares shall be auctioned to companies listed on the Kuwait Stock Exchange (KSE) and other local or foreign companies approved by the HC to participate in such auction (the investor); ii) 10% to the initiator of the approved project (at a discounted price) if the project was a result of an unsolicited proposal. If there is no iniator, or the initiator opts out of this 10% (or any part thereof, such percentage will be auctioned in the same way as the 40% in (i) above; iii) 50% will be offered for public subscription to Kuwaiti citizens through an initial public offering (IPO). If not all shares in this category are subscribed for, the unsubscribed shares shall be offered in the same way as the 40% in (i) above; iv) The government, however, retains the right to allocate to governmental bodies a percentage not exceeding 20% equally deducted from the percentages offered to an investor and Kuwaiti citizens. Therefore, under Article 5 of the PPP Law, the equity holding of the project company may take various structures including; Scenario A:
• Investor – 40%
• Initiator of the project – 10%
• Kuwaiti citizens – 50% Scenario B (where there is no initiator of the project and the government does not allocate shares to a governmental body):
• Investor – 50%
• Kuwaiti citizens – 50% Or, if the investor is not successful in acquiring the 10% that the initiator (where there is one) chooses not to take up:
• Investor – 40%
• Third party – 10%
• Kuwaiti citizens – 50% Scenario C (where the government allocates up to 20% to a governmental body):
• Investor – 30%
• Initiator of the project – 10%
• Kuwaiti citizens – 40%
• Government entity – 20% While the “investor”, for purposes of the project, is defined in Article 10 of the PPP Law as any private sector company established pursuant to the laws of the State of Kuwait, with which any public entity may enter into contract to execute any project pursuant to the provisions of Articles 4, 5 or 6 of this Law, the term is used here to mean the private entity (or consortium) that would be awarded 40% shares in the project company.
FOREIGN OWNERSHIP: It would appear that Article 5 of the PPP Law provides an exception to Article 68 of the Commercial Companies Law, which restricts foreign ownership in Kuwaiti joint stock companies (like the PJSC) to 49%. It is, however, yet to be seen whether it would apply as an exception.
Once the company is listed and traded on the KSE, though, a foreign entity may own more than 49% of the company’s shares. It should be noted that the entity awarded 40% of the company (discussed above) is not simply the entity that offers the highest bid price for the shares that are auctioned; rather, there will be a full procurement process that will entail a technical and financial bid being presented (referred to as the competition process in the PTB Guidebook). The entity that provides the most comprehensive technical bid (reflecting its technical capacity to undertake the project) will earn the highest ranking in this category. The financial bids will be evaluated, and essentially the entity that is ranked highest based on the two sets of criteria – and that also provides a competitive bid for the shares – will win the tender for the project and with it the percentage meant for the investor.
AUCTION RULES: Article 5 of the PPP Law provides that 40% of the shares offered to the investor shall be offered by public auction to all companies listed on the KSE and other companies approved by the HC to participate in the auction.
Chapter 8 of the executive regulations provides for the rules and procedures for offering the shares of the project company established to carry out the project for public bidding. Article 46 of the Executive Regulations provides that, as per Article 5 of the PPP Law, all companies listed on the KSE and other companies approved by the HC shall be invited to participate in the auction of the said shares (i.e. the 40%).
The bidding process shall be conducted in accordance with the procedures approved by the HC. This essentially means that all companies listed on the KSE are pre-qualified to bid for such shares/projects while those companies not listed on the KSE (including foreign companies) must go through a pre-qualification process.
Further guidance on the process of the sale of the shares is provided in Sections IV.8.3, IV.8.3.2 and IV.8.3.3 of the Project Guidebook, which provides that the competition process shall be applied to the auction of the shares. Section IV.8.2 of the Project Guidebook provides for the procedures of the competition process. This essentially entails; i) the formation of a joint committee for evaluation of bids; ii) the preparation of bid documents (including the expression of interest (EOI), the request for qualification (RFQ) and the request for proposal (RFP) by the relevant public entity (in conjunction with the PTB and the appointed transaction adviser); iii) approval of the tender documents by the HC; iv) prequalification of unlisted/foreign companies; v) an invitation to bid on the project to listed companies and pre-qualified entities; vi) an evaluation of the bid documents (including both the technical and financial bids) by the transaction advisor; vii) submission of bid evaluation results to the PTB and the HC for approval; viii) selection of the preferred bidder; and ix) negotiation and signing of the contract documents.
EXEMPTIONS: Article 6 of the PPP Law provides for an exception to having to incorporate a PJSC to undertake the project. If exempted, the project may be undertaken by any company listed on the KSE or other company permitted to participate in bidding for the same pursuant to the PPP Law and Project Guidebook. Such company’s equity will not have to be distributed as provided for in Article 5 of the PPP Law. In order for the Article 6 exemption to be applied, however, the project must be; (a) valued at less than KD250m ($901.3m), (b) classified as a “special nature” project and (c) the Council of Ministers must issue a decision exempting the project from the requirements set out under Article 5 following the HC’s proposal.
Such special nature projects may be offered out by public auction or competition to companies listed on the KSE and those other companies that are pre-qualified to participate in such public tenders. There is no clear guidance provided by the PPP Law or the Project Guidebook on the criteria to qualify as a special nature project, and it remains to be seen how the PTB and HC will deal with this issue.
FINANCING CONSIDERATIONS: Certain projects that are undertaken on the basis of the PPP Law may require some form of financing which may need the project company (or the individual companies comprising the investor) to provide its lenders with some form of security. The PPP Law expressly prohibits the granting of certain securities and is silent with respect to other asset categories that may potentially serve as security for the project lenders.
However, the government’s willingness to permit security packages comprising the non-restricted security is likely to vary to the extent it considers a particular asset category is one that should ultimately be preserved for the benefit of the state. With respect to matters of security, the operative provisions of the PPP Law are set forth in Articles 7 and 13 which provide in part as follows:
ARTICLE 7: “…Moreover, any of such entities, i.e. public entities or companies that manage state real estate may not dispose of any of the state’s real properties in relation to which it has an usufruct, whether such disposal is assignment of the usufruct, of such properties, swapping them for other properties or any other manner of disposal to third parties. Such entities shall, in case of absence of need to such properties, return them to the Ministry of Finance, State Property Department…Any disposal to any of such properties to any third party contrary to the provisions of this law shall be absolutely null and void, and any consequences in relation to any such act of disposal shall be invalid.”
ARTICLE 13: “The [project] contract may not be assigned, either wholly or partly, to third parties [and the legal entity of the investor] may not be changed unless after [1] obtaining the approval of the Supreme Committee and [2] the expiry of the design and execution period [3] as well as the elapse of an appropriate period to be fixed by the Supreme Committee from the start of operation not less than three years, and [4] the respective third party replaces the investor in all the terms, rights and obligations stipulated in the contract. Moreover, the investor may not sell or pledge the land or the constructions or buildings erected thereon, nor may he sell or pledge any of them that shall accrue at the end of the project to the state. In addition, the investor may not establish any in-kind rights on such land.”
The PPP Law was published with an explanatory memorandum that provides an insight into the legislators’ intentions in drafting the law. The operative provisions of the explanatory memorandum in this regard are set forth in the commentary on Article 13, which stipulates: “The [project] contract – totally or partially – may not be assigned or the legal entity of the investor may not be changed unless after obtaining the consent of the supreme committee and the elapse of an appropriate period from commissioning to be determined by the committee at not less than three years. The investor also may not sell or mortgage the land, the installation or buildings constructed upon the same and whatever that may be transferred to the state there from at the end of the project.
In addition, it will not create tangible right against the project. Otherwise, the investor may take credit procedures, including pledging his due amounts in consideration of service rendered under the investment contract or in consideration of the income due to him [and resulting from investment].”
Based on the above, we specifically consider below, those assets relating to the project company and/or the investor which are: 1) expressly prohibited by the PPP Law from being pledged as security (i.e. project land, buildings and constructions (fixtures) erected thereon); 2) expressly permitted to be pledged as security under the law (i.e. rights to receive payment under the project contract); and 3) not otherwise mentioned by the law (i.e. bank accounts, insurance proceeds, and non-project contract rights).
EXPRESSLY PROHIBITED: Articles 7 and 13 of the PPP Law make it clear that the state does not intend that any real property and buildings are permitted to be pledged as security for the project. This prohibition seems fairly straightforward insofar as such items are for the most part non-fungible, and will accrue to the state upon final completion of the project. Where the law is less straightforward perhaps is with respect to the definition of “installations” – this term arguably equates to what one would ordinarily term “fixtures”. Whether all such fixtures could be prohibited from being pledged as security would ultimately depend on whether they meet the government’s definition of “installations” a term that is not specifically defined by the law.
EXPRESSLY PERMITTED: Assignment of Rights to payment and bank accounts. The project company will have the right to receive certain payments under the contract, which may serve as a source of collateral. The commentary on Article 13 in the explanatory memorandum of the PPP Law contemplates such proceeds being used for collateral purposes.
It therefore seems to logically follow that accounts wherein such proceeds are held on deposit can also be pledged. Furthermore, pursuant to Article 364 of the Kuwait Civil Code, a creditor (in this case the project company) has the legal right to assign whatever right is owing to it from its debtor (i.e. the state entity that is counterparty to the project contract) and such an assignment can be completed without the need for the debtors’ consent.
However, there are three notable exceptions to this general rule: i) where the assignment is barred by law, ii) where an agreement of the contracting parties prohibits such assignment, and iii) where the obligation prevents such assignment.
Therefore, any such assignment of debt between the assignor and assignee (i.e. between the lender and the project company) would be valid between the parties if none of the exceptions listed above apply to such assignment (for example, if the project documents do not prohibit assignment).
SECURITY WHERE THE PPP LAW IS SILENT: As noted above, the PPP Law is silent with respect to several asset categories that may potentially serve as security for the project lender. As such, each of the items of security that are not expressly prohibited as being pledged/mortgaged under the PPP Law are presumably subject to negotiation by the project company/investor and the government or relevant public entity.
However, the government’s willingness to permit the use of such assets as security is likely to vary to the extent it considers a particular asset category as being one that should ultimately be preserved for the benefit of the state, regardless of whether such asset is expressly mentioned in the PPP Law.
MOVEABLE PROPERTY: The PPP Law is silent in terms of whether moveable assets may be pledged as security. Generally, under Kuwaiti law mortgages and pledges over specific moveable assets may be taken by virtue of a possessory mortgage. On the other hand, a business premises mortgage may be used as a type of “blanket” security interest over all moveable assets on the business premises.
A possessory mortgage is a contract by which a person undertakes, as security for a debt owed by him, to transfer the possession of an asset to his creditor or to an agreed third party giving the creditor a right in rem in the asset and authorising the creditor or a third party to retain such asset until repayment of the debt and/or to obtain payment of the debt out of any proceeds of sale of the asset handed over. Furthermore, possession must be obtained by the secured party for the security interest to be protected against third parties.
Possession is deemed if the mortgaged asset is placed at the secured party’s disposal in such a manner that will lead others to believe that the mortgaged asset has come into that person’s custody or if the secured party receives a document representing the mortgaged asset that entitles the holder of such document the sole right to take delivery of the asset. Generally, in the case of aircraft and vessels, the mortgage must be notarised by the Notary Public at the Authentication Office at the Ministry of Justice, and must be in Arabic. The mortgage would be registered at the Vessel Registration Office at the Ministry of Communication or the Directorate General for Civil Aviation (as the case may be). A business premises mortgage is another type of mortgage on moveable assets in Kuwait and contemplated in Articles 40 to 46 of the Law of Commerce. Such a mortgage is similar to a floating charge over personal property and is generally made by way of mortgage deed between the creditor and the debtor and registered in the Commercial Register of the Ministry of Commerce and Industry.
Generally, this type of security will enable the creditor to enforce against their assets ahead of unsecured creditors in cases of insolvency. It would be necessary to provide in the mortgage deed a description of the property covered by the premises mortgage. Failing such specification in the mortgage deed, the mortgage will only cover the trade name, the right to the lease and goodwill of the debtor. The registration of the premises mortgage is valid for a period of five years, and may be renewed.
INSURANCE AND REINSURANCE POLICIES: The PPP Law is silent as to whether insurance proceeds over project assets are permitted to be pledged. A great deal will depend on the nature of the particular insurance coverage, and whether the state would view insurance proceeds as merely a transmutation of project assets from tangible into monetary form.
BANK ACCOUNTS: There is no prohibition in the PPP Law against the project company pledging its bank accounts. Since the explanatory memorandum makes it clear that the project company is entitled to pledge its income stream under the project contract, it logically follows that accounts wherein such proceeds (as well as any others belonging to the project company) are held on deposit could also be pledged. Where security is to be taken over a debtor’s bank account located in Kuwait, security should be taken in the form of a mortgage or pledge over the account. The debtor’s interest in the account with regard to the account bank would be considered “rights” as there is a debtor/creditor relationship between the same. To obtain valid and effective security over the account, therefore, there must be a written security agreement in this regard establishing the mortgage and a passage of possession.
SHARES IN THE PROJECT COMPANY: The PPP Law is also silent on whether the project investor may pledge its shares in the project company as security. This is presumably recognition that the PPP Law is primarily concerned about those assets that will ultimately accrue to the state, notwithstanding the fact that the project investor’s shares may allow for effective control over the project.
However, other matters concerning Kuwaiti law will have implications on the ability of the investor to pledge its shares as collateral. Under Article 109 of the Commercial Companies Law, shares issued in newly incorporated PJSC companies will be subject to a three-year lock-up period. During this time such pledges are generally not permissible.
In sum, there are two methods under which a pledge over shares may be implemented: one type of pledge under Kuwaiti law is a “direct pledge” made by contract and perfected by a notation on the share certificate and in the share ledger of the company issuing the shares, indicating that such shares are pledged to the pledgee (i.e. the lender or a security agent acting on its behalf).
For listed shares, the pledge must be also noted at the Clearance Chamber at the KSE (Article 9 of KSE Committee Decision Number 6/2005). The second type of share pledge is referred to as a “floating pledge” of a portfolio (account) with a custodian or the lender (which contains the shares and maybe cash or other assets), which may be made by contract, whereby the legal owner agrees to pledge the portfolio containing the shares for the benefit of the pledgee.
The custodian would be acting on behalf of the pledgee in holding the security. Title to all assets in the portfolio, including the shares must be transferred to the custodian specifically. Touched on above, the law provides that promoters in a KSC/PJSC may not “dispose of” their shares within three years from the date of the legal incorporation of the company. Any disposal effected otherwise will be null and void. Courts in Kuwait have broadly interpreted “dispose of” to include pledges as security.
However, this is the strictest reading of the law and the area is not altogether settled, as less restrictive approaches have also been found to be valid, including an interpretation that the pledge would not be enforceable during the three-year period, but would be so thereafter. As an alternative, the lender could also require the investor to provide a notarised promise to mortgage. With this document, once the three-year period has elapsed the lender could proceed with the perfection of the mortgage.
LEASES AND RENTS: The PPP Law is also silent with respect to the project company’s ability to pledge other rights to payment under agreements it may have with third parties, even if such agreements have an ancillary attachment to the project.
STEP-IN RIGHTS: A key issue arises on whether the PPP Law would allow the project company’s lenders to be provided “step-in” rights with respect to the project. Under a typical scenario, the governmental authority, the project company and the project lender would enter into an agreement that provides the lender the means with which to mitigate an event of default on the part of the project company without having to exercise against the collateral.
Article 13 of the PPP Law and its commentary appear to contemplate limited step-in rights under circumstances where; i) the approval of the HC has been obtained; ii) the design and execution period has expired; and iii) an appropriate period of time determined by the HC (but not less than three years) has elapsed, since the commencement of operation. Consequently, while limited step-in rights appear to be contemplated under the PPP Law, such rights do not appear to be viable during the first three years of the project and until after the design and execution period has expired.
EARLY DAYS: Since most of the PPP projects initiated by the state are still in their initial phases, it has yet to be seen whether there is credence to the proposed Kuwait approach. What is clear at this stage, however, is the country’s willingness to actively engage in PPPs and to learn from those jurisdictions that have already implemented such partnerships.
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