CMS’s John O’Connor and Harkee Wilson discuss the challenges and issues businesses face operating in the UAE and investigate some of the recent changes in the business environment.
The Middle East presents a very attractive proposition for international businesses looking for expansion into growth markets. The UAE is a common entry point, for a number of reasons, including familiarity, prevalence of English language, transport and logistics, the regulatory regime and access to talent and finance. This note discusses some of the challenges faced by businesses operating in the UAE and some of the recent changes in the local business environment.
The UAE in snapshot
The UAE is a federation of seven independent emirate states comprising Abu Dhabi, Ajman, Dubai, Fujairah, Ras Al Khaimah, Sharjah and Umm al Quwain. It is a civil law jurisdiction and, where legislation is silent, the principles of Shariah law fill in the gaps. Federal legislation applicable across the UAE is enacted by the Federal Supreme Council and each emirate also retains power to enact laws applicable within that emirate. The core piece of federal law for UAE businesses is the UAE Commercial Companies Law (Federal Law No 2 of 2015) (the Companies Law).
The UAE is home to over 45 ‘free zones’ which are specially designated areas with their own rules and regulations that apply within the confines of that area and to all businesses registered in that free zone. Those rules are promulgated and overseen by an independent regulator established within that free zone. Where a free zone has enacted its own laws or regulations on a subject matter, these will generally override any conflicting federal or emirate law. All areas outside these free zones are commonly referred to as being ‘onshore’ UAE, where federal and emirate-level laws will apply (including the Companies Law). As a result, there has developed a dual system of onshore and free zone business environments.
In addition, there are two ‘financial’ free zones which are a special subset of free zones, namely the Dubai International Financial Centre (DIFC) and the Abu Dhabi Global Market (ADGM). Like other free zones, they have their own regulator, laws and regulations; however the financial free zones are common law jurisdictions with more substantial bodies of law largely based on English law. They also have established independent financial services regulators, whose rules are based closely on the UK FCA regulatory regime, and have their own court systems.
Barriers to business
On top of this complex patchwork of regulations, there are also a number of important hurdles that international businesses will need to navigate when doing business in the UAE. We have highlighted a few of the more common issues below, including the steps that the UAE authorities are taking to address the issues.
Foreign ownership restrictions
The Companies Law states that foreign investors can only hold a maximum of 49% of the shares in an onshore company. While there are common workarounds, including some quite exotic structuring solutions, the basic principle remains that an international business cannot simply set up a wholly-owned company onshore in the UAE. In a major policy change, in 2018 the UAE implemented the Foreign Direct Investment Law, which paved the way for the UAE Cabinet of Ministers to announce in July 2019 that 122 activities will benefit from a relaxation of foreign ownership restrictions, permitting foreign investors to own ‘up to’ 100% of companies carrying on those specific activities. Mars, the confectionary group, recently announced that they have re-registered as a 100% foreign-owned LLC, which we understand is one of the first practical examples of this relaxation being implemented. For any businesses that are not engaged solely in those 122 permitted activities, the previous position of foreign ownership restrictions remains in place.
Where can I do business?
Historically, a business licensed in a free zone or onshore in any of the seven emirates is only allowed to ‘carry on business’ within its home emirate or free zone. For example, a business registered onshore in Abu Dhabi would not be permitted to carry on business in Dubai or any other emirate without a separate branch office or subsidiary in that emirate, which would require a separate office/lease and trade licence in that target emirate. Similarly if it were registered in DIFC free zone, you would not be permitted to carry on business in any other free zone area, onshore in Dubai, or in any other emirate without a second licence. The term ‘carrying on business’ is not fully defined, and so there is a grey area of interpretation. What if your business is an online service you can deliver remotely from your desktop? Arguably this means you would not be carrying on business outside of the area you are registered in. On the other hand, a business that requires the company staff to install machinery at a customer’s premises outside its home location (for example) is likely to be carrying on business in areas where it is not duly licensed. Aside from the potential double standard applying across different business types, this creates unnecessary cost and red tape for businesses that want to expand across the UAE. The UAE authorities have recognised this issue and have been taking steps to smooth out the ability for businesses to work more freely across the country. For example the emirates of Abu Dhabi and Dubai have introduced a ‘dual licensing’ system, which is intended to allow businesses registered in a free zone in that emirate to apply for a dual licence permitting it to also carry on business ‘onshore’ within that emirate, without needing to set up a second office.
The all-important trade licence
Every business registered in the UAE, whether onshore or free zone, is issued with a trade licence by its licensing authority (ie the relevant free zone authority, or the department of economic development). The trade licence stipulates the activities that that business is authorised to carry on. A business is not permitted to undertake activities beyond the scope of its trade licence, compared with other jurisdictions which take a more liberal approach permitting businesses to carry on whatever activities are within scope of its constitutional documents. The trade licence is renewed annually and is the key document to evidence the incorporation and licensing of a business. When dealing with any third-party business in the UAE, obtaining a copy of its trade licence is the first step in your know-your-customer process.
Distribution of products
Appointing a local agent to import and sell products under a distribution agreement is often an attractive and simple way for international businesses to test the local UAE market. However, businesses should be aware that although the process to appoint a local agent is relatively straightforward, the UAE laws governing distributorship afford surprisingly high levels of protection to local distributors/agents, as against foreign principles, and include some unusual statutory provisions to look out for. It can be very difficult to terminate registered commercial agencies and the appointed agent/distributor can also freeze imports during any dispute, putting the distributor/agent in an unusually strong position. A registered commercial agency gives the agent exclusivity over the relevant products and grants them rights to commission on all sales of the product in the territory, even by third parties. The Commercial Agencies Committee (the first instance committee charged with hearing disputes in respect of registered agency arrangements) and local courts enforce the statutory protections afforded to registered commercial agents. From the outset, foreign principals need to take a measured decision to appoint a local agent as, if UAE agency laws apply, it can be extremely difficult to later move to an alternative agent or to cut out the middle man and sell directly into the region.
UAE law generally recognises freedom of contract and the UAE civil code expressly provides that parties are free to choose the law governing their contract. For certainty, international counterparties to high-value contracts often opt for English law as the governing law, or as a compromise, DIFC or ADGM law. For similar reasons, counterparties often choose DIFC or ADGM courts or arbitration based in the DIFC-LCIA Arbitration Centre as the forum for disputes. However, these may not be options when dealing with public bodies or state-owned corporations who may insist on UAE governing laws and onshore courts.
Employment laws and end of service gratuity
In the UAE, an employment contract with a validly-registered UAE entity is required in order to obtain a residency visa, which is necessary for all expatriates to legally reside in the country. There are different employment laws applicable depending on where the employee is employed, with the Federal Labour Law No 8 of 1980 (the Labour Law) being the main labour law governing onshore entities and most free zones and separate employment laws applying in the DIFC and ADGM free zones and to public sector employees. The Labour Law is outdated and focuses on minimum rights to protect the worker with a number of strict requirements, particularly around termination. As such, it is common for entities to adopt a dual employment contract approach with one short form basic employment agreement in the relevant authority’s standard form (which is registered with the authority for visa purposes) and a longer form contract (often on the employer’s standard form) containing more comprehensive provisions, eg restrictive covenants and IP rights. In the event of any dispute, both contracts would be considered so the two should not be contradictory. In contrast, the employment laws within the DIFC and ADGM are more modern, covering concepts such as discrimination, parental rights and allowing more flexibility on certain employee rights. In line with the employee protectionism approach, salaries for all employees under the Labour Law are required to be paid through a wages protection system monitored by the authorities to ensure workers receive payment on time. The basic employee rights in the UAE include employer-provided health insurance and a payment of end-of-service gratuity on termination (linked to the employee’s length of service) for those meeting the criteria, in place of traditional pensions (although GCC national employees are entitled specific GCC pension contributions). The DIFC will be moving away from the outdated end-of-service gratuity requirements to a third party administrated employee savings scheme in 2020.
So in summary, there is a vast layer of issues to consider for in-house counsel and decision makers of businesses looking to set up in the UAE, but there is invariably a route through the UAE legal matrix that allows a foreign business to carry on its activities in the UAE in a way that fits within its risk appetite. Careful planning is needed from an early stage to ensure the correct corporate and commercial approach is taken, and to ensure any staff who are moved over to the UAE to help run the new business are dealt with in a fair manner and without overly exposing the business under local employment laws. Moreover, the clear direction of travel indicated by the UAE authorities is intended to boost foreign investment into the UAE and to ease the burden on doing business here, which is a welcome development and a trend that we expect will continue for the foreseeable future.