In a landmark ruling, the High Court of Uganda sitting at Kampala has declared credit facilities advanced by a Kenyan bank, Diamond Trust Bank (K) Ltd (DTBK), to two Ugandan borrowers to be illegal and unenforceable because it did not have a licence to conduct “financial institutional business” in Uganda.

The ruling delivered in Kiggundu and Others v Diamond Trust Bank (U) Limited & Another (the Ruling) has drawn mixed reactions  as industry commentators try to define the impact  of the Ruling on the banking sector and the larger Ugandan economy. According to a statement by the Uganda Bankers’ Association the syndicated portfolio currently at risk as a direct result of the Ruling is estimated to be over UGX 5.7 trillion (approx. USD 1.5 billion).

In this alert, we briefly analyse the case and discuss the potential impact of the ruling on the banking sector across East Africa.

The Background

Between February 2011 and August 2018, Ham Enterprises Ltd and Kiggs International (U) Ltd (the Applicants), received various credit facilities for commercial construction and development. The funds were advanced by DTBK with Diamond Trust (Uganda) Ltd (DTBU) (the Respondents) acting as a collection agent in country. The credit facilities were secured with mortgages over certain properties in Uganda belonging to the Applicants.

DTBK and DTBU contended that the credit facilities became non-performing with an outstanding liability of over USD 10 million. This non-performance moved the Respondents to make deductions on account of interest and other charges from the Applicants’ accounts in accordance with the relevant loan agreements. The Applicants contested the apparent non-performance of their loan obligations and through their amended charge, argued that they had settled all debt obligations and were in fact owed USD 23 million on account of the unlawful deductions by the Banks.

The Applicants therefore brought the application seeking to recover the deducted sums and ultimately avoid their loan obligations.

An Overview of the Key Arguments

Through their application, the Applicants sought to have the Banks’ written statement of defence struck out on the grounds that it was perpetrating illegalities by DTBK and DTBU. The Applicants’ arguments turned on the assertion that by advancing the credit facilities without a license to do so as required under the Financial Institutions Act, 2004, DTBK illegally conducted “financial institutions business”.

Two definitions are important in understanding this assertion.

First, the Financial Institutions Act, Act 4 of 2004 (the Act) (as amended in 2016) defines a financial institution to mean “a company licensed to carry on or conduct financial institutions business in Uganda and includes a commercial bank, …”. Second, the Act defines financial institutions business to include “the lending or extending money held on deposit or any part of that money including by way of (i) consumer and mortgage credit…”.

In fact the words “held on deposit” were added to the definition of financial institutions business by an amendment introduced under the Financial Institutions (Amendment) Act 2016.

According to the Applicants, the financial institutions business alluded to in this case was commenced in Uganda, evidenced by factors such as the mortgage facility letter being drafted in Uganda by Ugandan lawyers and even witnessed in Uganda. Furthermore, the Applicants were Ugandan companies based in Kampala and issued securities for the loan facilities through mortgages, debentures and other securities registered in Uganda. Even though the loan had been advanced by DTBK out of Kenya, and given that DTBK never sought the permission of the Bank of Uganda   to carry out its business in Uganda as required, the whole credit transaction was deemed null and void under the Financial Institutions Act section 4 (1) (because the court held that lending in Uganda requires a licence from the BoU) and section 117

(1) (which requires anyone wishing to open a representative office to obtain the Bank of Uganda’s prior approval).

In addition, the Applicants claimed that no prior approval of the Bank of Uganda and the Central Bank of Kenya was sought for DTBU to act as an agent on behalf of DTBK which contravened Uganda’s agent banking provisions.

On the other hand, the Respondents argued that when making a determination     on conduct of financial business in Uganda, the relevant financial institution under consideration has to carry out the lending or extending of money held on deposit in Uganda so as to amount to financial institution business in Uganda. On the basis that DTBK was not engaged in deposit taking business in Uganda and a further contention that the credit facilities in fact originated in Kenya not Uganda, no illegality existed as claimed by the Applicants.

In addition to the above, the parties also canvassed weighty technical legal issues such as the appropriateness of the swearing of affidavits on contentious matters of fact by legal counsel rather than the actual officers of the Applicants and the striking out of the Respondents’ written statement of defence without the benefit of judicial consideration in the main suit yet it contained substantial questions of law.

The Court’s Orders

To the surprise of many in the banking community, Justice Henry Peter Adonyo agreed with the Applicants and held that DTBK was in fact conducting financial institution business in Uganda and its failure to obtain a licence to conduct financial institution business in Uganda rendered the credit transaction  illegal,  void  ab  initio and consequently unenforceable. The High Court went further to order the unconditional discharge of all securities and the return of the money taken by DTBK on account of the alleged non-performing loans. Essentially, therefore, the Court held that because of the illegality, the corresponding underlying payment obligation was also null and void.

Ramifications of the Ruling

Contrary to media reports, this specific case does not in fact involve a syndicated loan given that the credit facilities were only advanced by DTBK. However, it goes without saying that any foreign lending into Uganda, whether as part of a syndicate or not, will have to be reassessed in light of the Ruling.

In order to reassure development partners and financing institutions on Uganda’s syndicated financing arrangements and public debt obligations, the Ministry of Finance, Planning & Economic Development has released a public statement reiterating Uganda’s commitment to repay its public debt obligations. Although the reassurances are undoubtedly welcome, international development partners will no doubt be forced to think twice before extending any credit facilities into Uganda.

We also note that according to the list of licensed banks maintained by the Bank of Uganda, it is clear that the financial sector in Uganda is dominated by foreign owned banks many of whom are likely to have similarly structured facilities as DTBK/DTBU. In addition, multilateral creditors constitute the largest share of Uganda’s external debt providers, which is estimated at USD 5.8 billion, according to a report by the Ugandan Ministry of Finance, Planning and Economic Development. This implies that there is a high likelihood that financial inflows into Uganda from offshore lenders will be severely restricted as a direct result of the Ruling.

Finally, while we await to see the outcome of an appeal against the Ruling, it is clear that lenders need to reconsider how they conduct their business not just in Uganda, but across the East African region. We will continue to monitor the situation and keep you apprised of any developments. In the meantime, the Bank of Uganda has just issued a statement confirming that foreign lenders do not have to seek a licence to lend monies – that it is only lending of deposit monies taken from the public in Uganda that requires licensing. See the full statement just released today here.