UAE | 01 May 2010

During the boom times, Dubai and the UAE seldom experienced insolvency cases, so it became a widespread rumour that the UAE does not have an insolvency law. In addition, it had also been widely speculated that the UAE has a very archaic regime in which debts can lead a debtor to jail.

By opposition to such rumour, an insolvency law does indeed exist and it is shockingly modern in more than one aspect. Looking more deeply at this law might be very useful in the near future, due to the credit and financial crisis that is affecting Dubai and its business sector.

By looking at Federal Law No 18 1993 (Commercial Transactions Law) it is clear that out of 900 articles of which this law is composed, 255 articles are dedicated to insolvency and bankruptcy procedures, which means that almost a third of the Commercial Transactions Law is dedicated to such procedures.1 This is not bad in a country considered to be without insolvency law.

The provisions apply solely to both individual traders and commercial companies when they have stopped paying their due commercial debts (Articles 645 and 650). The articles are subdivided as follows:

  • Articles 645 to 763 are related to insolvency;
  • Articles 764 to 799 are related to the arrangement by the court;
  • Article 800 relates to small insolvencies;
  • Articles 801 to 816 are related to companies insolvency (although Article 801 specifically provides that all above articles are applicable to companies in addition to the articles in this section);
  • Article 817 to 830 are related to the rehabilitation of the insolvent individual (such as traders and partners in partnerships);
  • Articles 831 to 877 are related to voluntary arrangement; and
  • Articles 878 to 900 are related to bankruptcy.

It is clear that this a very comprehensive law with specific procedures. Unfortunately, it remains largely untested and only two judgments are published on the Dubai Courts’ website:

  1. 1) a Dubai Supreme Court judgment dated 9 September 2008, which provides that a single unpaid commercial debt is enough to provoke the insolvency of a company; and
  2. 2) an older, more interesting, judgment by the Dubai Court of Appeal dated 25 May 1998, where the court considered that the insolvency provisions and procedures are of public order since they were meant to promote confidence, and have been put in place to protect the creditors and to safeguard the debtor of good faith).2

The above judgment has clearly defined what the UAE insolvency law is all about: protecting the creditors and safeguarding the debtor of good faith.

The different procedures that are outlined in the Commercial Transactions Law are described in the remainder of this article.

Bankruptcy

In the event of bankruptcy (whether fraudulent, negligent or gross negligent bankruptcy), the Criminal Court shall be competent and shall sentence the bankrupt trader or manager of a company, or the member of its board or its liquidator, to a prison term that may not exceed five years in the event of fraudulent bankruptcy (Articles 878 and 879). Alternatively, a fine of 20,000 dirhams in the event of a gross negligent bankruptcy (Article 880) and no more than two years of prison or a fine of 10,000 dirhams in the event of negligent bankruptcy (article 881) may be issued.

In addition to the above, Federal Law No 3 1987 (the Criminal Code) contains provisions related to bankruptcy in Articles 417 to 422. Articles 417 to 419 of the Criminal Code are very similar to Articles 878 to 881 of the Commercial Transactions Law, while Article 420 provides:

‘If a commercial company is bankrupt, its board of directors and managers shall be convicted with the sentencing related to fraudulent bankruptcy if it was proven that they have committed any of the acts provided in Article 417 of this Code or assisted in the company ceasing its payment, whether by declaring wrongful facts about its subscribed capital or its paid-up capital, or by publishing wrongful balance sheets or by distributing fictious dividends, or by taking to themselves more than they are entitled to in the company articles of association.’

The discussion in this article does not apply to the member of the board of directors or the manager who proves that they were not involved in the crime or their objection to the resolution that was taken in its respect. It can be deducted from the above provisions that a shareholder of an insolvent company who was not involved in its management may never be considered as bankrupt. The board of directors or managers of a company that never committed any of the actions mentioned above shall never be considered as bankrupt themselves.

Insolvency

Insolvency is covered by Articles 645 to 763, 800 and 801 to 816.

Companies insolvency

Focus shall be made here on the articles more specifically related to companies.

Article 802 provides for the declaration of insolvency of a commercial company when it ceases payment of its commercial debts, due to the disruption of its financial activities.

Article 806 is very interesting, since it entitles the court, de facto, or on the request of the company to postpone the declaration of insolvency for a period not exceeding a year, if its financial position is likely to be supported or if the interest of the national economy so requires. The court can order that appropriate measures should be taken for maintaining the assets of the company.

This article is in addition to the provisions related to the arrangement that are discussed later, which gives the company a breath of fresh air, allowing it to arrange itself before being declared insolvent.

Article 809 provides that if the assets of the company are insufficient to satisfy at least 20% of its debts, the court who has declared the insolvency may order the members of the boards of directors, or some or all of the managers, jointly or individually, to pay the debts of the company, in whole or in part, in the cases where they are held responsible, in accordance with the provisions of the Commercial Companies Law (CCL).

The articles in the CCL provide for the liability of the chairman and members of the board of directors towards the company and its shareholders for all acts of fraud and abuse of power, and for any violation to the CCL or the articles of association, or the management violations, and any provisions to the contrary shall be annulled (Article 111 of the CCL).

The liability mentioned in the previous article shall be borne by all the board members if the violation has arisen as a result of a unanimous decision. Otherwise, if the resolution was approved by the majority, the opponents shall be absolved if they prove that they had opposed the resolution in the minutes of a meeting. An absentee may still be liable unless they prove that they were unaware of the resolution or were aware of it without being able to object to it (Article 112 of the CCL).

It is important to remember that Article 237 of the CCL provides that the liability of the manager of a limited liability company is similar to that of the board members and any stipulation to the contrary shall be annulled.

Procedure

The insolvency is declared on the request of the commercial company or on the request of one of its creditors. The court may declare the insolvency on the request of the public prosecution or ipso facto (Article 647).

The commercial company may request to be declared insolvent if its financial activities are disrupted and it has ceased paying its debts. Such a request becomes mandatory if 30 days have elapsed since the cessation of payments, otherwise this would be considered a case of negligent bankruptcy (Article 648).

The request shall be submitted within a report explaining the reasons for the cessation of payment and to which shall be attached several documents, such as the accounting books, the last audited financial statements, the profit and loss account, a detailed statement of movable and immovable assets, a statement of the names of the creditors and the debtors, their address, their rights and obligations, and security (Article 648).

In its insolvency judgment the court shall determine a provisional date for the cessation of payment, shall seal the debtors premises and shall appoint a trustee (Article 655).

In all events, the date of cessation of payment may not be deferred back to more than two years prior to the insolvency judgment date (Article 659).

In the insolvency or in a subsequent judgment, the court shall appoint a remunerated attorney to manage the insolvency: the insolvency trustee (Article 668).

The judgment shall be published in the Trade Register and in the Court’s Board for 30 days. The trustee shall take care of the publication of the judgment in a daily newspaper, as determined by the court, with all the details pertaining to the insolvent company and the summon to the creditors to come forward with their debts.

The judgment shall also be published in the name of the Assembly of Creditors at the Land Register within 30 days of the issuance of the judgment (Article 661).

The insolvent shall be prohibited from managing its assets or disposing of them (Article 685).

Article 691 provides that any lawsuit emanating from the insolvent or against them shall be prohibited.

Any activities undertaken by the insolvent that are detrimental to the Assembly of Creditors may be cancelled if the counterparty was aware of the cessation of payment of the insolvent (Article 697).

An Assembly of Creditors shall be created by law on the issuance of the insolvency judgment composed of the insolvent’s ascertained creditors. Any holder of mortgage or special privilege shall not be a member of the Assembly of Creditors (Article 703). This is because these secured creditors are at liberty to sue the insolvent individually (in contradiction to Article 691 and 704 ) and they have preferential rights over the attached assets.3

Competent court

As mentioned above, the competent court to oversee the insolvency is the Court of First Instance in whichever jurisdiction the headquarters of the insolvent company is located (Article 653).

In the Dubai Court of Appeal judgment, the insolvency is related to the public order of the state and is therefore closely linked to its judicial system. Any arbitral proceeding should therefore be excluded.

However, Article 747 entitles the insolvency judge, after hearing the supervisor (being the creditors’ representative) and the insolvent, to allow the trustee to settle or approve the arbitration in any dispute related to the insolvency, even if related to rights in rem (Article 678).

This could mean that the arbitration agreements executed before the launch of the insolvency procedure may still be valid after such a launch. The arbitral tribunal will only be in a position to declare a debt and determine its amount without being able to sentence the debtor to pay.

Nevertheless, providing such a clause in the insolvency law is very innovative of the UAE legislator, considering the public order nature of the UAE insolvency law.

Arrangement by the Court and Voluntary Arrangement

Arrangement by the court

This procedure involves the invitation of the creditors by the insolvency judge to deliberate on the arrangement (Article 764). The creditors may attend personally or through an attorney. However, the insolvent must attend personally (Article 765). It is assumed that in the case of a company, it should be its authorised signatory (ie the manager in an LLC and the chairman of the board or the CEO in a joint-stock company).

The trustee must submit a report to the meeting, related to the insolvency procedure and their opinion about the arrangement. The insolvent shall also be heard (Article 766).

The arrangement shall not be approved unless a majority of creditors, holding two thirds of the debts, agrees. Any creditor not attending the meeting shall be considered as dissenting to the arrangement (Article 767).

The secured creditors are not part of the Assembly of Creditors and shall not be entitled to vote on the arrangement, unless they waive their privileges (Article 769).

However, no arrangement is possible in the event of fraudulent bankruptcy (Article 771), but it is possible in the event of negligent bankruptcy (Article 772).

The arrangement might involve delays for the insolvent to pay its debts or a waiver by the creditors of some parts of the debts (Article 773).

The arrangement shall not be applicable on the secured creditors for the reasons mentioned earlier. Nor on the ordinary creditors where debts have arisen during the insolvency procedure (Article 775).

The arrangement shall remove all effects on the insolvency, without prejudice to any criminal pursuit. The debtor shall be reinstated with all their belongings and effects (Article 777).

This is, when going through the voluntary arrangement, a deficiency in the UAE insolvency law, which has failed to give enough power to the judicial authority, allowing it to take the necessary steps to allow a good company to survive without its failed or dishonest management. Since at the exception of the criminal pursuits that shall de facto lead to the insolvency of the company again, no provisions entitled the judicial authority to replace the former management of the company to protect its staff. Indeed, the arrangement shall be dissolved if, after its ratification, the insolvent is condemned with the crime of fraudulent bankruptcy (Article 778).

Voluntary arrangement

46 articles (from Article 831 to Article 877) are related to a voluntary arrangement by the company, with the assistance of a trustee appointed by the court (Articles 843 and 844 of the law). The trustee’s role in this procedure is only as formal as evidenced in Articles 844 and 852, and the trustee will not intervene at all in the management of the company.

The voluntary arrangement may be initiated before or after the launch of the insolvency procedure.

These articles are progressive and protective of the company, provided that the latter submits a comprehensive plan evidencing means to continue operations and secure at least a payment of 50% of its debt within a period not exceeding three years.

Such a voluntary arrangement applies to both secured and unsecured creditors, and thus the secured creditors are bound by the voluntary arrangement and are not at liberty to pursue with their individual lawsuits.

However, as pointed out above, in relation to the arrangement by the court, very little is provided in relation to the management and operation of the company during the voluntary arrangement period. Nothing is provided in relation to the fate of the management of the company, since Article 846 of the law provides that the debtor shall continue to manage its assets and shall perform all regular acts necessary for the management of the business.

In that sense it may be argued that UAE insolvency law is not in tune with modern insolvency laws that have made a distinction between the failed management of a company and its survival, mainly to protect its staff. In other words, in modern legislation, if a company is able to survive, it should do so. However, it should not necessarily survive with the same management that could be subject to civil and criminal sanctions. In this sense the UAE insolvency law does need improvement and evolution.

Conclusion

The UAE has a very modern and comprehensive insolvency law, which has unfortunately been unnoticed by the most prominent legal experts, since they ask for its amendment without even having read it.

The main impediment for the application of insolvency law is the security asked by the creditors and mainly post-dated cheques, which if not honored would constitute a crime leading its drawer to jail.

So the creditors, instead of having recourse to the normal insolvency procedure, prefer resorting to a speedier process consisting of filing a criminal complaint for a dishonored cheque, thus avoiding any chance for the company to survive.

Therefore, it is best practice to decriminalise the cheque, and this security may be replaced by other security and further information on the debtors. A credit bureau was envisaged last year by the UAE, which could be the first step towards decriminalising the cheque and towards applying the insolvency law.

Notes

  • The word bankruptcy is used to describe fraudulent or criminal insolvency. Insolvency is used to describe the procedure that does not comprise a criminal element.
  • This is understood by the provisions of Article 645 of the Commercial Transactions Law, which provides that any trader that has ceased paying its commercial debts on its due dates may be declared insolvent for the disruption of its financial standing and precariousness of its credit.
  • Article 704 provides that the individual lawsuits and measures taken by ordinary creditors and the holders of general privileges shall be frozen.

 

UAE | 01 April 2010

Foreign corporate ownership in the UAE presents an interesting opportunity for entities, whether they are corporate bodies or individuals, seeking to establish a foothold in the Middle East. There are a myriad of corporate vehicles available, with a structure to suit the majority of potential commercial goals.

This article aims to provide a brief overview of some of the most widely used entities and also the salient commercial realities that are applicable when evaluating whether to take the plunge into the UAE marketplace.

legal background

Company formation in the UAE is governed by the provisions of the Commercial Companies Law (CCL), which was introduced by Federal Law No 8 of 1984 (as amended). The guiding tenant of the CCL is to provide a solid, cohesive legislative framework under which commercial entities can be created and administered. The CCL has many similarities to its Egyptian counterpart, which in turn draws considerably from civil companies legislation found in European civil law jurisdictions.

The CCL provides the UAE with one of the most attractive corporate environments through which to formalise business relationships in the Middle East. There are, however, several legislative and regulatory considerations that must be taken into account when establishing a presence in the UAE.

Seven distinct commercial entities are recognised under the CCL, each possessing certain unique characteristics. The seven entities are:

  1. general partnerships;
  2. limited partnerships;
  3. joint ventures (JV);
  4. public joint stock companies;
  5. private joint stock companies;
  6. limited liability companies (LLC); and
  7. partnerships limited by shares.

Some of these entities are not suitable or attractive to non-UAE nationals or entities wishing to transact business in the UAE. This article therefore focuses on the relevant merits and key considerations for a foreign entity establishing an LLC or those embarking on a JV.

As an over-reaching principle it must be recognised that all of these entities require varying levels of ownership and/or participation by UAE nationals, or an entity wholly owned by UAE nationals. The required level of ownership and participation is currently a topical issue in the UAE, as the continuing global economic downturn necessitates enhanced commercial competitiveness and flexibility. Attracting foreign direct investment is of paramount importance to ensure future success. Although reform has been ongoing for several years, the current financial situation has led many commentators to opine on the possibility that restrictions on foreign ownership within the UAE may very soon be widely liberalised and reformed in an effort to attract greater levels of investment. However, at the time of writing, no specific time frame has been set out for such advances.

Another consideration that will apply, regardless of the type of entity chosen, will be the need for a license, which must be obtained from the relevant Department of Economic Development of the emirate in which it intends to transact business. This licence will entitle the holder to carry out a specified commercial or trading activity. Many different forms of licence are available, and careful consideration and correspondence with the relevant government department is required to ensure that the licence obtained is sufficient to allow the holder to carry out the business for which it has been set up.

In this author’s experience the LLC and JV companies offer foreign investors a relatively higher degree of autonomy and security when carrying on business in the UAE.

LLCs

Guidance for entrants

When incorporating an LLC the most pressing and delicate issue for foreign entities is the requirement that a UAE national or a corporate entity wholly owned by UAE nationals must hold 51% of the share capital of the company. Although this requirement can be daunting and difficult for investors to swallow when dipping their commercial toe in the water for the first time, the practical effects can be mitigated through the use of certain legislative mechanisms. For example, profits do not necessarily need to be distributed pro rata to each shareholder’s relative shareholdings. The legislation provides scope for the distribution of profits to be detailed through the Memorandum of Association, ensuring that the interests of the non-UAE shareholder are facilitated. Prospective entrants should, however, note that in practice authorities are reticent to register an LLC that allocates less than 20% of the profits generated to the local UAE shareholder.

Additionally, control of the LLC can be vested in managers (read directors), of which there must be at least one but not more than five. The appointment and powers of a manager can also be specified pursuant to the Memorandum of Association. There is no restriction on the nationality of a manager, and they can be given an unfettered ability to operate and conduct the affairs of the LLC.

Changes in legislation

Recent amendments to the CCL have done away with the requirement for a set minimum amount of share capital in an LLC. The amount of share capital can now be set by the shareholders on a case-by-case basis, provided that the amount of share capital is sufficient to enable the LLC to carry out the objectives for which it has been incorporated.

This requirement, however, cannot be viewed in isolation. To do so would deny the existence of certain commercial realities. It is worth making reference at this point to the licencing requirements of the individual emirates as mentioned above. Currently, to obtain certain licences, a minimum share capital is required. Specifically, and by way of example, the Department of Economic Development in Dubai requires LLC’s seeking a licence for investment activities to have a minimum share capital of AED3m (circa £540,000) before it will issue a license. It is therefore important that detailed research is carried out to establish whether any specific requirements have been put in place by the individual licencing agencies before deciding on the amount of share capital for an LLC.

A minimum value per share of AED1,000 (circa £180) is required by most economic departments to affect registration, although the legislation no longer sets a minimum value. It is also necessary to appoint a UAE-accredited auditor to the LLC. Under the legislation there must be a minimum of two shareholders and a maximum of fifty. The liability of the shareholders will be limited to the amount unpaid on their share capital.

Validity of side agreements

Foreign investors have been known to circumvent the legislative requirements relating to UAE ownership by entering into contractual arrangements known as ‘side agreements’. These side agreements endeavor to vest the beneficial ownership of the shareholding, as well as profit entitlements of the local UAE party in the foreign shareholder. Although the validity of such agreements has been acknowledged by the UAE judiciary, available jurisprudence suggests that the existence of any such side agreement in contravention of the legislation will result in an order for the disillusion of the LLC.

It would be remiss at this juncture not to refer to the so-called anti-fronting legislation, which was introduced under Federal Law No 17 of 2004 (combating of commercial concealment) and was intended to be effective from 2007. Essentially, the anti-fronting legislation aims to deal specifically with, and outlaw the practice of, entering into side agreements that attempt to circumvent the legislation. Specific penalties are contained in the legislation, ranging from monetary fines to incarceration. To date, however, it remains unclear as to whether or not this anti-fronting legislation has in fact been enacted, and, ultimately, the current position regarding its applicability and enforcement remains unclear.

JVs

Another option

Under the CCL, JVs receive a specific mention as a recognised corporate entity. This definition is misleading because the legislation actually aims to govern the relationship that exists under JV agreements. A JV agreement is a contractual marriage between two or more parties that aims to formalise the terms of a commercial relationship and is not a corporate entity. In the UAE, however, certain specific legislative provisions apply to entities pursuing such an arrangement. The CCL specifically prescribes certain legislative rules that govern the relationship between the parties of a JV.

The legislation provides the foreign party with an enhanced level of comfort when entering such agreements. This type of agreement has been particularly attractive to companies wishing to carry out project-based work in the UAE, and in the past, such agreements have been widely utilised by foreign construction and engineering entities wishing to benefit from the opportunities available in the UAE.

Articles 56-63 of the CCL deal specifically with the legislative provisions governing JVs in the UAE. The JV will be carried out in the name of one or more of the parties to the JV, while the existence of the other parties will remain undisclosed to third parties contracting with the JV.

The legislation stipulates that the JV agreement will:

  • govern the relationship between the parties;
  • govern the respective distributions of profits;
  • govern the distribution of losses that may occur between the parties; and
  • govern the various rights and obligations of the individual parties to the JV.

In addition to the above, one of the most important factors prescribed for under the legislation relates to the liability of the parties to the JV when dealing with third parties. Third parties will only have recourse against the party to the JV who they have dealt with and who gave rise to the liability in question. The provisions of the CCL have been interpreted to mean that third parties will not have recourse to the JV as an entity or the other parties to the JV agreement, except for limited instances where the JV holds itself out as a contracting party capable of entering into contractual relationships. The legislation also specifically affords the parties to a JV access to the books and accounts relating to the business of the JV.

Certain commercial contracts and the formation documents of all companies in the UAE must be registered in the state-maintained commercial register. However, the legislation specifically exempts JV agreements covered under Articles 56-63 from registration, thereby providing the parties with an added level of confidentiality in their dealings.

Essential tips

When entering into a JV agreement with a UAE national or local corporate entity, a foreign party should seek expert legal advice to ensure that the licence of the UAE national or entity is sufficient to successfully achieve the objectives for which the JV has been created. This is extremely important because, as mentioned, the recipient of a licence can only carry out the specific objectives detailed in the licence.

Essentially, the purpose of specific legislative provisions relating to JVs aims to accommodate and encourage such relationships between foreign and UAE entities by limiting the liability, legislative requirements and exposure of the parties to the JV.

Comment

The exponential increase and movement of capital experienced by the UAE in the past decades has resulted in an astounding level of growth, precipitating a rise in corresponding commercial activity. As a consequence of this, many foreign entities have successfully navigated the challenges of setting up and doing business in the UAE. Despite continued efforts to update legislation in tandem with the commercial realities, there can be no doubt that legislative reform needs to continue. To this end, a new CCL is currently in draft form, which on its inception will undoubtedly further enhance the UAE’s reputation as a secure and efficient commercial center.

Corporate & Commercial | 01 March 2010

In light of the recent economic developments in the gulf region and more specifically in the UAE, many disputes have stemmed out of contracts. To be in a position to claim damages under contracts (amongst other remedies offered by the UAE legal system) the claimant or the defendant should be more familiar with the contractual liability concept, the types of damages recognised under UAE law, the elements of contractual damages under UAE law and, in particular, the conditions required for contractual damages under UAE law. [Continue Reading]

UAE | 01 February 2010

Based in Dubai, Habib Al Mulla & Company has witnessed first hand the worst effects of the 2009 financial crisis. The Dubai construction market has suffered more than most and the number of construction cases through the Dubai International Arbitration Centre (DIAC) has tripled over the course of 2009. The launch of the DIFC LCIA Arbitration Centre (DIFC LCIA) could not have come at a better time although, inevitably, the take up of cases has been slow at the new centre. [Continue Reading]

UAE | 01 December 2009

The Dubai International Financial Centre (DIFC), a 110-acre free zone that was established by the government of the Emirate of Dubai in December 2004 to promote Dubai as a fully-serviced ‘onshore’ capital market, constitutes an autonomous jurisdiction within the UAE. It has an independent judicial system, with its own courts and an independent judicial authority, which deals with civil and commercial transactions arising from and within the DIFC. The DIFC judicial system is modelled on the common law and inspired, in particular, by the English legal tradition, which explains why the procedure before the DIFC courts is very much akin to the procedure before the English courts. To facilitate its implementation, a whole series of laws, such as DIFC Law No 6 of 2004 on contract law, DIFC Law No 6 of 2005 on implied terms in contracts and unfair terms and DIFC Law No 7 of 2005 on damages and remedies, have been adopted, governing civil and commercial transactions that are carried out within or have a qualifying connection with the DIFC.

[Continue Reading]