UAE bankruptcy law is a lifeline for SMEs
Struggling start-ups can restructure debt by liquidating assets
Since its inception in 1971, the UAE has been distinguished as an icon for innovation and creativity in the GCC. The country is transforming itself from an oilbased economy to as knowledge based economy which is evident by the fact that knowledge-based industries and services now account for a greater part of the UAE’s gross domestic product (GDP) than oil revenues, having grown from 32.1 per cent in 2001 to 38.6 per cent in 2014.
It has once again accomplished a new feat by being the first nation in the GCC to approve the bankruptcy law, paving the way for cashstrapped businesses, particularly small and medium enterprises (SMEs), through effective debt restructuring mechanisms with an aim to end imprisonment or criminal prosecutions in case of bankruptcy.
The approval of this law is expected to be a significant move towards improving business confidence among SMEs, accounting for 60 per cent of the UAE’s GDP by enabling them to restructure their financial obligations within the legal framework. Amidst global financial uncertainties and sluggish growth in the UAE’s banking sector, this landmark law aims at strengthening the investment environment by improving financial accessibility.
The lack of a modern and comprehensive bankruptcy law in the UAE had long been cited as an obstacle in creating a sound and sustainable business climate that can promote the entrepreneurial ecosystem. Now the new law, which was first planned in the wake of the 2009 financial crisis when the absence of effective regulatory and legal framework to wind up businesses forced expatriates to leave the country in fear of criminal prosecutions, comes amid a regional downturn triggered by low oil prices that has left many companies in financial distress.
As a prelude to the law, discussions to suspend the legal actions against cash-strapped SMEs started around March this year after a surge in number of SME owners leaving the country aggravated, leaving behind bad debts of $1.4 billion in 2015 alone. Additionally, tightening on SME lending by the banks as a result of substantial increases in bad debts amplified the significance of an efficient bankruptcy regime.
Restructuring mechanisms
The need was also backed by the UAE Banks Federation, the International Monetary Fund and Dubai SME who had been lobbying for a robust bankruptcy law. With a strong focus on economic diversification, the need for an efficient insolvency regime couldn’t have been ignored any longer. Thus, the new federal bankruptcy law was approved by the UAE Cabinet, which applies to companies rather than individuals, while the government is drafting an additional legislation to cover personal insolvency.
The new federal bankruptcy law is expected to give a vital new thrust to the UAE’s business environment, especially SMEs which constitute around 94 per cent of the total companies operating in the country with expected GDP contribution to reach 70 per cent by 2021 from the current level of 60 per cent.
According to Dubai SME, part of the Department of Economic Development, more than 22,000 small businesses were established in Dubai in 2015, up 18 per cent compared to 2014. Though SME dynamics in the UAE has been really strong, the rate of success has remained mixed. With the enactment of the new law, struggling start-ups or companies in financial distress will have a lifeline to restructure by liquidating their assets in the event of bankruptcy, and secure fresh loans from creditors.
SMEs tend to thrive when they are given access to capital and when favourable business conditions are created through institutional and legislative reforms. Hence, this law could be an impetus for the venture capital industry to provide flexible financing options for SMEs to thrive and grow. This, in turn, could spur further activities in tech start-ups that are experiencing rapid growth but are also facing sustainability challenges.
Most importantly, an efficient bankruptcy procedure must maximise the recovery rate for its creditors, a key barometer to its effectiveness apart from instilling a faster resolution process. With the new enactment, the time taken for the resolution process is likely to reduce, benefiting both the SME creditors and debtors, as the company’s assets will not lose market value and remunerations of insolvency practitioners will remain affordable. Additionally, the heavy costs of bankruptcy procedures are expected to come down.
Win-win for debtor, creditor
Improvements in these aspects will increase the UAE’s ranking in ‘Resolving Insolvency’ parameter in the World Bank’s Ease of Doing Business 2016 index, where it currently stands at 91 out of 189 countries. With the bankruptcy law in place, lenders will be forced to do their due diligence when dealing with SMEs. However, the law will greatly help struggling SMEs come to an agreement with their lenders, instead of taking the case to court or jailing the debtor.
In March 2012, Bahrain-headquartered Arcapita Bank became the first company in the GCC to file for Chapter 11 bankruptcy proceedings under US legislation, as it was grappling with a $1.1 billion debt obligation in the wake of the financial crisis. The rescue was broadly hailed as a success, since Arcapita completed a $100 million fundraising from Gulf shareholders, to make new investments and acquisitions in the region in just one year after emerging from the restructuring.
In conclusion, it is inevitable that insolvency legislation and its practical implementation in the UAE will continue to be the subject of careful examination, particularly by those reviewing the merits of investing in the country. While the ability of companies to restructure without having to face criminal charges will encourage investors to take calculated risks, banks and financial institutions will find it less risky to take exposures to SMEs as the new law will enable entrepreneurs to restructure their businesses in difficult times, rather than skip the loans and flee the country.
Following the footnotes of the UAE, Saudi Arabia is also noted to be working on similar legislation. By upgrading its legal framework on corporate insolvency, the UAE has upped its stakes in global competitiveness that will be reflected in investment flows into the country.