Legal Briefing

Side Agreements in the UAE: Reconciling with the Companies Law

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Corporate & Commercial | 04 June 2011

In the UAE it is common knowledge that many limited liability companies (LLCs) are in fact owned and managed by foreign shareholders, though the legal ownership may reflect differently. It is common for the shareholders to execute ‘side agreements’, as they are commonly known, between them to mirror their real understanding of the ownership and management of the company and its operations.

These side agreements can take various forms and generally they contain provisions contrary to the UAE Companies Law and the company’s memorandum of association (MOA). For example, a foreign shareholder may give a loan to a UAE shareholder for the latter to purchase shares in the company. Because the shares were purchased with money loaned from the foreign shareholder, the foreign shareholder obtains a pledge over the UAE shareholder’s shares.

The UAE shareholder may also execute certain other deeds or arrangements in favour of the foreign shareholder, enabling the latter to control and manage the company until the loan is repaid.

This article looks at commonly used shareholding arrangements and whether they are in violation of the provisions set out in the Companies Law.

PROVISIONS OF THE UAE COMPANIES LAW

As per the Companies Law, every company incorporated in the UAE must have one or more UAE national shareholders (individuals, or companies wholly owned by UAE nationals) collectively holding at least 51% of the company’s share capital. It is mandatory for a company to register its MOA and all future amendments before the competent authorities.

The Companies Law specifically provides that in the event of a dispute between the shareholders, testimony to prove a matter in variance or in excess of the stipulations in the MOA shall be inadmissible. The Companies Law prescribes penal sanctions for those who intentionally insert false particulars or an infraction of the provisions of the law in the MOA. This also applies to persons who knowingly sign or distribute these documents.

MARKET REALITY

In reality, as previously mentioned, many companies are absolutely owned and managed by foreign shareholders, with UAE national shareholders acting as ‘sleeping partners’. In such cases, the investment relating to the establishment and operation of the company would be made entirely by the foreign shareholder. The UAE national shareholder may act as a ‘sponsor’, providing administrative assistance to the company (liaising with the authorities and arranging for the visas) for an annual sponsorship fee that is agreed between the parties.

Though the company’s MOA and trade license may reflect the de jure ownership, side agreements may assist the foreign shareholder in protecting their interests and ensuring that they have control over the company.

A literal interpretation of the provisions of the Companies Law renders most side agreements illegal and void ab initio. Although some UAE courts have acknowledged the presence of these agreements, there are no comprehensive judgments on their legality or enforceability.

ARRANGEMENTS INVOLVING LOAN AND PLEDGE

When establishing a company, it is natural for shareholders to experience various of issues and financial hurdles. A foreign shareholder may wish to establish a company with the help of a specific UAE national as partner, for many reasons, such as market knowledge or influence or experience in the relevant sector. However, the UAE national may not be in a position to purchase 51% of the company’s shares outright.

In such situations it is seen that the local shareholder would purchase 51% of shares through the money given by the foreign shareholder as a loan. The parties agree that the loan shall be repaid by the local shareholder at the time of dissolution of the company. In consideration for the loan, the local shareholder will pledge their shares in the company in favour of the foreign shareholder for the duration of the loan. The local shareholder may authorise the foreign shareholder or a nominee to represent the former in all general meetings of the company and to vote. The local shareholder may also authorise the foreign shareholder to receive all the dividends and other distributions that may be paid by the company in future in respect of their shares.

ANALYSIS OF THE ARRANGEMENT

The sequence of events is as follows:

  1. a foreign shareholder and a local shareholder agree to establish a company, in the ratio 49%: 51%;
  2. the parties agree that the foreign shareholder shall grant a loan to the local shareholder to enable the latter to purchase their shares;
  3. in consideration for the loan, the local shareholder pledges their shares to the foreign shareholder;
  4. the local shareholder authorises the foreign shareholder to represent the former in all the general meetings and to receive the dividends on their behalf; and
  5. consequent to this arrangement, the foreign shareholder controls and manages the company.

Apparently, no sequence of the above arrangement is in violation of any laws, including the Companies Law. The fundamental provisions of the Companies Law relating to establishment of companies are observed by the parties and the information provided in the MOA is correct: the local shareholder holds a minimum of 51% of the shares and the value of all shares have been paid up at the time of incorporation. There are no documents or understanding between the parties that contradict the MOA, that is the legally binding document of a company towards third parties.

Likewise, it is permissible for a creditor and a debtor to agree on conditions relating to the repayment of a loan, including the time of its repayment. Further, in consideration for the loan, if the local shareholder authorises the foreign shareholder to represent the former in all the general meetings and to receive dividends on his behalf, there does not seem to by any inconsistency with the relevant laws.

The above may reflect that this arrangement, as many would argue, would not violate the provisions of the UAE laws. Though this may not bluntly touch on the issue of ownership, this may enable the foreign shareholder to control and manage the company on their own.

CONTRARY VIEWS

Any discussion on this arrangement is likely to attract counter arguments. It might be contended that this arrangement is aimed at sabotaging the spirit of the legislations. The Companies Law intended to restrict foreign investment to a maximum of 49% and this arrangement may assist the parties to circumvent these provisions. This might result in a situation where a company may be controlled and managed by foreign investors, with the local shareholder reduced to the role of a ‘sleeping partner’. It is also extremely difficult to identify the genuinity of such arrangements.

CONCLUSION

It is true that these arrangements are highly intricate in nature. However, if a UAE national shareholder honestly enters into such an arrangement with a foreign shareholder, can the law penalise them? If the answer is yes, how would the law discriminate between a shareholder pledging their shares to a financial institution and another shareholder if the purposes of both are simply to raise funds?