What does the UAE’s new bank­ruptcy law mean for busi­nesses?

Cyn­thia Trench delves into the UAE’s bank­ruptcy law and what it means for the coun­try’s busi­nesses

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The ab­sence of a le­gal frame­work for bank­ruptcy has long been a hin­drance to UAE busi­ness.

In the past, fi­nan­cial prob­lems spelled trou­ble for com­pa­nies, as lo­cal courts could not be per­suaded to of­fer a mora­to­rium on debt, which would have given firms the chance to re­struc­ture their busi­ness and fi­nance. In the ab­sence of proper bank­ruptcy laws, even a bounced cheque could land an en­tre­pre­neur in jail. It comes as no sur­prise, there­fore, that the in­tro­duc­tion of a new bank­ruptcy law in the UAE is be­ing lauded as a huge step for­ward in im­prov­ing the coun­try’s eco­nomic and reg­u­la­tory environment. But what does this law re­ally mean?

What is the new bank­ruptcy law?

The Fed­eral Bank­ruptcy Law (the ‘New Law’) was is­sued un­der the Fed­eral De­cree No 9 of 2016. It was first pub­lished in the

Of­fi­cial Gazette on Septem­ber 29, 2016 and came into force on De­cem­ber 29, 2016. Drafted by the Min­istry of Fi­nance, it marks a new step for­ward in pro­vid­ing a le­gal frame­work to help distressed com­pa­nies in the UAE avoid bank­ruptcy and liq­ui­da­tion.

To whom does the law ap­ply?

The New Law ap­plies to com­pa­nies and not in­di­vid­u­als. It ap­plies to com­pa­nies that are partly or fully owned by the fed­eral or the lo­cal gov­ern­ment and com­pa­nies and in­sti­tu­tions es­tab­lished in Dubai main­land and free zones that are not gov­erned by ex­ist­ing bank­ruptcy pro­vi­sions.

It does not ap­ply to com­pa­nies es­tab­lished and op­er­at­ing within the Dubai In­ter­na­tional Fi­nan­cial Cen­tre and Abu Dhabi Global Mar­ket as th­ese fi­nan­cial free zones have in­ter­nal leg­is­la­tion in place re­gard­ing bank­ruptcy and in­sol­vency.

How will it help?

The New Law will do much to enhance the credit dy­nam­ics of the UAE econ­omy. It is hoped that it will fa­cil­i­tate more pre­dictabil­ity and en­able a le­gal frame­work to re­struc­ture or liq­ui­date distressed busi­nesses. This will in­crease in­vestor con­fi­dence and be of great value to SMEs who have long been in need of leg­is­la­ture that of­fers them greater sta­bil­ity.

What are the key points?

De­ter­min­ing in­sol­vency: Cri­te­ria for eval­u­at­ing when a com­pany in in­sol­vent has been put into ac­tion. This ‘ bal­ance sheet’ test de­ter­mines if the as­sets of a busi­ness are suf­fi­cient to cover its li­a­bil­i­ties. This will be favourable in en­cour­ag­ing debtors fac­ing dif­fi­cul­ties to reach out for help to re­struc­ture at an early stage.

A new reg­u­la­tory body: The Com­mit­tee of Fi­nan­cial Re­struc­tur­ing (CFR) will main­tain an ap­proved list of ex­perts in the field of fi­nan­cial re­struc­tur­ing. It will also ad­min­is­trate a reg­is­ter of in­sol­ven­cies

Dis­qual­i­fi­ca­tion: A dis­qual­i­fi­ca­tion sys­tem – sim­i­lar to that found in English in­sol­vency law – has been in­tro­duced. Di­rec­tors found guilty of bankrupt­cy­con­nected of­fences may be dis­qual­i­fied from play­ing any role con­nected with the ad­min­is­tra­tion of a com­pany for up to five years and may also be sub­ject to fines.

Fil­ing bank­ruptcy: This must be made if a com­pany is in a state of 'ces­sa­tion of pay­ments’ of due and payable debts, or in a state of ‘over-in­debt­ed­ness’ – in ei­ther case for 30 con­sec­u­tive busi­ness days. A cred­i­tor may also pe­ti­tion for a com­pany’s bank­ruptcy if a statu­tory de­mand of Dhs100,000 (min­i­mum) has been served, and has re­mained un­paid for 30 con­sec­u­tive busi­ness days. Fi­nally, the court or a reg­u­la­tor may also ini­ti­ate bank­ruptcy pro­ceed­ings.

Routes for in­sol­vency as­sis­tance

The new law of­fers sev­eral paths to as­sist com­pa­nies fac­ing fi­nan­cial dif­fi­cul­ties.

In­sol­vency with re­struc­tur­ing: The com­pany’s debts are re­struc­tured with cred­i­tor ap­proval. This process is over­seen by the courts. A pe­riod of five years (ex­tend­able by a fur­ther three years) is al­lowed for im­ple­men­ta­tion.

Pro­tec­tive com­po­si­tion: A debtor-led, court-spon­sored process, this fa­cil­i­tates the res­cue of a busi­ness that is in fi­nan­cial dif­fi­culty but not yet in­sol­vent. It re­quires the ap­proval of the un­se­cured cred­i­tors (a ma­jor­ity in num­ber and two-thirds by value). This must oc­cur within three years of court ap­proval but can be ex­tended three years more with cred­i­tor ap­proval.

In­sol­vency and liq­ui­da­tion: This oc­curs if a pro­tec­tive com­po­si­tion or re­struc­tur­ing scheme is in­ap­pro­pri­ate, not ap­proved or ter­mi­nated. The law in­cludes spe­cific time lim­its for mak­ing fil­ings and lodg­ing ob­jec­tions. A trustee must be ap­pointed to over­see the process.

New fi­nanc­ing: This can be sought fol­low­ing a pro­tec­tive com­po­si­tion or re­struc­tur­ing scheme. Safe­guards are in place for ex­ist­ing se­cured cred­i­tors.

Could com­pany mem­bers be li­able in any way?

Given that the New Law only came into ef­fect in De­cem­ber 2016, the time scale of pro­ceed­ings means there are no prece­dents in re­gard to the way in which the law shall be ap­plied by the courts. A pri­mary con­cern, how­ever, is the ex­tent to which li­a­bil­ity could pass to in­di­vid­ual mem­bers such as di­rec­tors and/or gen­eral man­agers.

The Com­mer­cial Com­pa­nies Law makes clear that a lim­ited li­a­bil­ity com­pany has a dis­tinct and sep­a­rate le­gal iden­tity to that of its mem­bers and is re­spon­si­ble for its own debts. Any debt col­lec­tion, in­sol­vency or other case must there­fore be brought against the com­pany it­self, rather than against any mem­ber. As a re­sult, many com­pany mem­bers con­sider their li­a­bil­ity to con­sist of paid-up share cap­i­tal only. Af­ter that the com­pany is ex­pected to ab­sorb any and all fi­nan­cial li­a­bil­ity in­curred.

How­ever, a Court of Cas­sa­tion De­ci­sion judge­ment in 2013 held that a share­holder will be held per­son­ally li­able should he ex­ploit the prin­ci­ple of a com­pany’s in­de­pen­dent li­a­bil­ity as a means to con­ceal his fraud­u­lent acts and/or mis­ap­pro­pri­a­tion of com­pany funds. In such cases, the pro­tec­tion be­stowed by law for a share­holder in a

lim­ited li­a­bil­ity com­pany was deemed not to ap­ply. Rather, the said share­holder will be held li­able in his per­sonal ca­pac­ity for such dis­po­si­tions, and his li­a­bil­ity ex­tended to in­clude his per­sonal as­sets.

This con­cept of per­sonal li­a­bil­ity is ex­pressly in­cluded in the New Law un­der Ar­ti­cle 198, which pro­vides that “di­rec­tors of the board, man­agers and those in charge of liq­ui­da­tion of the com­pany” shall be sen­tenced to a max­i­mum term of five years’ im­pris­on­ment and a fine of no more than Dh­s1m in the event that they hide in­for­ma­tion / con­ceal fi­nances / em­bez­zle funds / ad­mit to debts which are not owed by the com­pany.

To some ex­tent, UAE law al­ready catered for such a sit­u­a­tion by way of the Com­mer­cial Trans­ac­tions Law – how­ever the fact that the New Law reaf­firms the po­si­tion and cod­i­fies the 2013 Court of Cas­sa­tion judge­ment would sug­gest that the cor­po­rate veil should no longer of­fer au­to­matic pro­tec­tion.

In re­cent times, the po­si­tion of a com­pany’s gen­eral man­ager has also be­come pre­car­i­ous in the event that the com­pany has be­come ‘in­sol­vent’ (in the gen­eral sense of the word). This is par­tic­u­larly the case in in­stances whereby the com­pany has in­suf- fi­cient funds to cover any cheques that have been is­sued, given that bounced cheques is­sued by com­pa­nies can in­cur crim­i­nal li­a­bil­ity upon the sig­na­tory di­rectly. How­ever, Ar­ti­cle 162 of the New Law now pro­vides that fur­ther to the court ac­cept­ing a vol­un­tary ap­pli­ca­tion for bank­ruptcy (i.e. with­out lit­i­ga­tion) pur­suant to Ar­ti­cle 78 thereof, and un­til such a time that any re­struc­tur­ing scheme has been ap­proved as per Ar­ti­cle 108, all ju­di­cial claims and pro­ceed­ings shall be sus­pended. This shall in­clude any ac­tion for bounced cheques.

The idea is to en­cour­age com­pa­nies in fi­nan­cial dif­fi­culty to ap­proach the courts for as­sis­tance with re­struc­tur­ing debt. The avail­abil­ity of this op­tion is to dis­cour­age com­pany mem­bers from ab­scond­ing and leav­ing cred­i­tors with no means of re­cov­ery. How­ever, the fact that this op­tion has been in­tro­duced im­poses the risk of an al­ter­na­tive li­a­bil­ity. Now, in the event that a com­pany does not ap­ply for bank­ruptcy upon meeting the cri­te­ria pre­scribed by Ar­ti­cle 68 of the New Law (i.e. that it ceases re­pay­ment of a ma­ture debt for more than 30 con­sec­u­tive busi­ness days on ac­count of its fi­nan­cial po­si­tion), the pro­vi­sions of Ar­ti­cle 162(1) of the Com­mer­cial Com­pa­nies Law may be deemed as ap­pli­ca­ble:

“Mem­bers of the board of di­rec­tors shall be li­able to­wards the com­pany, share­hold­ers and third par­ties for fraud­u­lent acts and mis­use of power, as well as for any vi­o­la­tion of the law, Com­pany's AOA and mis­man­age­ment.”

As a re­sult, di­rec­tors or man­agers may be held ac­count­able for mis­man­age­ment – an act for which Ar­ti­cle 84(1) of the Com­mer­cial Com­pa­nies Law holds in­di­vid­u­als per­son­ally li­able.

Con­clu­sion

Ul­ti­mately the new law is a pos­i­tive devel­op­ment in the UAE, es­pe­cially given the fact that the UAE Vi­sion 2021 sets a firm tar­get to make the UAE ‘the world’s first in ease of do­ing busi­ness’.

Nonethe­less, the proof will be in the pud­ding, and there will need to be real ev­i­dence of im­prove­ment in terms of time to re­solve in­sol­vency, cost of in­sol­vency to debtors, and re­cov­ery rates. Fur­ther­more, ef­fects upon the in­di­vid­ual mem­bers of any com­pa­nies un­der­go­ing bank­ruptcy pro­ceed­ings will re­quire clar­i­fi­ca­tion in or­der to achieve the aim of en­cour­ag­ing distressed com­pa­nies to ap­ply. Prac­ti­cally speak­ing, and ac­cord­ing to the World Bank report, re­solv­ing in­sol­vency in the UAE costs 20 per cent of debtors’ es­tate and yields an av­er­age re­cov­ery of about 29 cents on the dol­lar. This leg­is­la­ture there­fore of­fers the po­ten­tial for marked im­prove­ment. The re­moval of the crim­i­nal of­fence of bank­ruptcy by de­fault, the pro­vi­sions in re­la­tion to bounced cheques and the new thresh­old and re­quire­ments for cred­i­tor-ini­ti­ated in­sol­vency pro­ceed­ings will be of help to thou­sands of UAE busi­nesses, es­pe­cially SMEs, which are the back­bone to the UAE econ­omy.

Nonethe­less, this rel­a­tively new law is com­plex. There­fore, when it comes to in­sol­vency, busi­nesses and in­di­vid­u­als would be best ad­vised to seek out a good in­sol­vency ex­per­tise and in­formed le­gal ad­vice. Di­rec­tors of UAE com­pa­nies would be wise to re­act promptly to any sign of fi­nan­cial de­cline and seek­ing le­gal coun­sel early on will mean that they can mit­i­gate risk and be guided in tak­ing ad­van­tage of the new op­tions of­fered in this new leg­is­la­tion. Cyn­thia Trench is prin­ci­pal at Trench & As­so­ciates

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