Legal Briefing

Legislative advice for establishing LLCs and JVs

The In-House Lawyer Logo

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.