Legal Briefing

A guide to corporate restructuring in the UAE

The In-House Lawyer Logo

UAE | 01 February 2011

Commercial markets in the UAE are still feeling the shock of the global economic recession, forcing many companies to undergo restructuring to ensure better efficiency and productivity. Yet, many of them are not aware of the legal intricacies and practical complexities surrounding a corporate restructuring.


OVERVIEW

Corporate restructuring is the process through which the legal, proprietary, operational or other structures of a company are reorganised for better commercial results. The reasons behind a restructuring may vary from company to company. They could be financial, technical, or organisational in nature and are generally performed to reduce liabilities, improve financial performance, exploit technological expertise, better protect shareholders’ interests, or streamline management. Similarly, the manner in which a restructuring is carried out also differs, and may take various forms such as mergers, acquisitions, joint ventures, strategic alliances and conversions.

RESTRUCTURING IN THE UAE

In the UAE, current trends suggest that most companies undertaking restructuring exercises are owned or controlled by foreign shareholders. The preferred investment vehicle of foreign shareholders is the limited liability company (LLC) and under the UAE Commercial Companies Law, foreign shareholders can only own up to 49% of a company’s shares, with 51% of the shares being owned by a UAE national partner, or ‘sponsor’ as they are commonly known. It is not uncommon for the UAE partners to remain silent in the business as many foreign shareholders execute agreements with them to manage the LLCs. Similar arrangements are normally made in the case of sole establishments (establishment), another investment vehicle that can be legally owned only by UAE nationals or entities.

Restructuring a company is a complex and time-consuming process. Solutions must be tailored to fit the specific needs and objectives of the company or companies involved.

LIMITATION OF LIABILITY

Generally, the liability of the shareholders of an LLC is limited to the extent of their investment and they are not personally liable for the debts of the company (except in certain cases, for example fraud). The law does not differentiate between the owner of an establishment and the establishment itself. As a result, the owner will be liable to the extent of all their assets, including personal assets, for the liabilities of the establishment.

Accordingly, if an establishment that is de facto owned by a foreign shareholder (by virtue of a side agreement) incurs liabilities, the de jure owner (UAE national) will be legally held accountable for all the liabilities. In such a situation, the de jure owner is likely to resort to all possible means to relieve themselves from the liabilities and this, in turn, could put the foreign shareholder in a difficult position. The likelihood of a challenge on the validity of side agreements before the courts cannot be ruled out. In this context, it is important to note that the validity of side agreements is yet to be tested before the UAE courts.

Therefore, it is not ideal to use an establishment as the umbrella for holding stakes in other companies. Similarly, if foreign shareholders own interests in establishments through side agreements, it is advisable that they convert these establishments into LLCs to limit the extent of their liability.

LEGALLY PERMITTED ACTIVITIES

The activities that a company is permitted to carry out in the UAE differ considerably depending on the legal form of incorporation (establishment, LLC or branch office), the nationality of the shareholders (UAE nationals and Gulf Co-operation Council nationals have somewhat equal status), and the emirate in which the company is registered. For example, the competent authority in Dubai (the Department of Economic Development) may permit an LLC with foreign shareholders to engage in transportation activities, whereas in Abu Dhabi, it is reserved for an LLC fully owned by national shareholders. Likewise, no foreign companies are allowed to establish branch offices in Abu Dhabi except for those engaging in consultancy and construction related activities, whereas in Dubai, there are no such limitations.

ROLE OF OFFSHORE ENTITIES

It is common in the UAE for foreign businesspeople to use offshore entities (mainly British Virgin Island companies) to acquire stakes in companies registered in the UAE proper (excluding free zones). In this context, it is vital to note that the authorities would not generally permit offshore entities to acquire stakes in companies registered in the UAE proper unless the offshore entity produces at least two years’ audited balance sheets and substantiates a credible past.

Moreover, the banks are believed to be reluctant to grant financial facilities to companies owned or controlled by offshore entities that are relatively new.

FINANCIAL FACILITIES

Banks normally look into the credit worthiness of the shareholders of an LLC or the owner of an establishment when banking facilities are sought. If facilities are sought by an establishment, the banks generally require personal guarantees from the owner, which means that the owner may be personally liable to the extent of all their assets if the establishment fails to repay the facilities borrowed.

DOWNSIZING

In the recent past, one of the main reasons behind the restructuring of many companies in the UAE was to downsize its personnel to reduce company overheads. However, many such actions were made hastily and without giving due consideration to the labour laws and regulations of the UAE. As per the UAE Labour Law, employers are permitted to terminate the services of their employees only under certain circumstances. If the terminations are not legal, the labour courts may order the employer to pay compensation to the employee. In addition, employees are entitled to termination benefits, which are sometimes substantial, depending on their latest salary and length of service with the company.

TRANSFER OF RIGHTS

If a restructuring involves taking over another entity, other issues can arise, such as assignment or novation of existing contracts and associated rights and obligations, transfer of assets including real property, and approvals/authorisations from various authorities. The transfer of ownership of real property might also require payment of transfer fees to the competent authorities.

Many contracts executed in the region generally include a provision permitting either of the parties to terminate the contract, if the other party undergoes restructuring or amalgamation. Hence, it is important that the other party to a contract is informed of the planned restructuring and permission is obtained in advance to avoid any material breach of contract.

CONCLUSION

The restructuring of a company, if properly executed, can result in improved efficiency and flexibility with regards to operations, and can bring about financial improvements. However, to obtain optimum results, it is imperative that the reasons behind the restructuring, the objectives that need to be achieved and the legal framework of the UAE are precisely identified.