Unravelling the UAE’s bankruptcy law

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 bankruptcy-connected 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 insufficient 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