Banking update

Bankruptcy and corporate rescue in the UAE: overview and observations

15 July 2010

The United Arab Emirates (“UAE ”) insolvency laws have been brought into sharp focus following the much-publicised financial problems of Dubai World and related entities. While federal laws in the UAE provide for court-led bankruptcy, corporate rescue and liquidation procedures, this legislation is broadly untested in the UAE courts as there has yet to be a major corporate insolvency in the UAE which is governed by it. We understand that the UAE federal bankruptcy and corporate rescue laws are currently under review and it will be interesting to see what shape any revised laws will take and how they will be applied.

Corporates which have faced financial difficulty in the UAE and the Middle East region have typically initiated private restructurings with their relationship lenders to address their problems, and the current downturn is no exception. The existence of public bonds or sukuk, mandatory convertible securities, secured and unsecured conventional or Islamic bank financings as well as disparate groups of trade creditors have all made restructuring in the UAE and Middle East as a whole far more complicated. This has highlighted some key areas for discussion in the current bankruptcy and corporate rescue laws in the UAE.

This article sets out a summary of the bankruptcy and corporate rescue procedures available to companies in financial difficulties and their creditors under current UAE law (excluding the free zones such as the Dubai International Financial Centre (“DIFC ”)) and some observations on some key areas on which a new regime may seek to build.

Overview of UAE bankruptcy and rescue procedures

The bankruptcy and corporate rescue regimes are governed by Federal Law No.18 of 1993 (the “Commercial Transactions Law ”) and, broadly, are available to “traders”. This term includes both individuals who trade and companies governed by the UAE commercial companies law (Federal Law No.8 of 1984, known as the “Commercial Companies Law ”).

Click here to view a table which sets out a basic overview of the procedures under UAE law for protective composition (a company-initiated rescue procedure involving a voluntary compromise arrangement with creditors which could be likened to a company voluntary arrangement or a scheme of arrangement in the UK) and bankruptcy (which involves a settlement of debts and may involve a court-led compromise agreement with creditors known as judicial composition).

It is important to draw a distinction between bankruptcy and liquidation. Under UAE law, these are separate procedures, governed by different regimes (the Commercial Transactions Law and the Commercial Companies Law respectively) and having different objectives. The objective of bankruptcy is to rehabilitate a distressed company following discharge of its debts through agreement with its creditors, whereas liquidation is a termination procedure involving the realisation and distribution of the assets of the company to satisfy, as far as possible, its liabilities.

While bankruptcy may be a gateway to liquidation (a detailed discussion of which is beyond the scope of this article), the linkage between these two regimes is not wholly clear from the legislation. While it may be assumed that a bankrupt company would itself commence liquidation proceedings where it is, for example, unable to satisfy its debts or to reach an agreement on a judicial composition plan with its creditors, the law does not clearly set this out. It is, however, clear that the court may commence liquidation proceedings where the assets of the company remaining at the end of bankruptcy proceedings are insufficient to carry on its business.

Some observations on the current UAE bankruptcy and rescue regimes

Uncertainty over legal processes and interpretation

It is difficult to provide conclusive analysis on the UAE bankruptcy and rescue regimes. The principal reason for this is that the court processes in relation to these procedures are untested (at least in terms of any major corporate failures). The legislation itself does not cater for every eventuality nor is it always entirely consistent. It is also worth noting that the courts have the ability to adjourn a decision on making a bankruptcy order where it is in the national economic interest to do so, as well as general discretions in relation to the timetable for bankruptcy proceedings. Generally speaking therefore, there is uncertainty surrounding what would happen in practice, how discretions would be exercised by the court and how long proceedings might ultimately take. This uncertainty as to process and outcome makes the use of the procedures by a creditor or a debtor more challenging.

Challenges for directors

There is no unified statement of directors’ duties in the UAE, including in insolvency situations. It is therefore not always easy for directors to understand their duties or what they should do in a distressed scenario. The criminalisation of certain aspects of bankruptcy adds an additional complication for directors. For example, there is a requirement under the Commercial Transactions Law that a company petition for bankruptcy within 30 days of ceasing to pay its debts. Failure to do so could lead to a crime under the UAE federal penal code or potentially result in the directors being guilty of the criminal offence of bankruptcy by negligence. Despite this, and several well-known standstills, we are not aware of any director having petitioned for bankruptcy.

Limitations of the rescue process

Though a voluntary rescue regime exists in the UAE in the form of protective composition described above, there are practical challenges with this procedure and, to our knowledge, the regime has not yet been used. One key challenge is that the directors only have 20 days from the date of the company ceasing to pay its debts to devise a composition plan satisfying the criteria that 50 per cent. of outstanding debts be paid within 3 years and then to apply to court with all the necessary documentation. This, on top of the general uncertainty of how, in practice, protective composition would be run by the courts, is a significant limitation on the usefulness of this process for distressed companies.

What about security?

In common with other legal systems in the Middle East, the law of security is civil law based and remains less developed than, for example, under English law. For example, actual possession is often a key factor in creating or perfecting a security interest under UAE law. Additionally, there is no mandatory central register of security interests against UAE companies (though there are specialist registers for certain classes of asset, specifically real estate, ships and aircraft, and, in some emirates, for the registration of commercial mortgages).

It is, in practice, difficult or impossible to take effective security over some types of assets that are commonly secured in other jurisdictions, such as shares in private companies and bank accounts. Security is, however, commonly taken over real estate, specific and identified assets and shares in listed companies and it is generally possible to assign contractual rights.

The UAE bankruptcy and rescue regimes differentiate between secured and unsecured creditors. Creditors holding security over the types of assets listed above typically may enforce security over that asset independently (by way of sale of the secured asset at a public auction), as a separate proceeding outside of the bankruptcy process. Secured creditors who exercise their right to enforce are disenfranchised from voting as part of the general body of creditors in protective or judicial composition proceedings (although a creditor whose debt is not fully satisfied following enforcement is likely to claim, and be permitted to vote, as an unsecured creditor in respect of the outstanding amount).

Cross-border insolvencies

UAE courts typically will not recognise foreign judgments (even of a clear debt obligation) and may well rehear the case applying UAE law. Arbitral awards are more likely to be enforceable in the UAE on the basis that the UAE is a signatory to The New York Convention. There is, however, no jurisprudence to indicate the local courts’ likely approach to enforcing an award made in an arbitration where the seat is outside the UAE. It is therefore possible to imagine some delay in being able to prove foreign law debts in the UAE.

Additionally, the UAE has not incorporated into national law the UNCITRAL Model Law on Cross-Border Insolvency (which is designed to provide a harmonised approach to recognition when dealing with cross-border insolvencies) and it is therefore unlikely that the courts will recognise the appointment of foreign insolvency officials or proceedings without consideration of the issues independently under UAE law.

Governmental solutions

In the absence of established legal procedures, there is a perception that government intervention is likely in the case of large insolvencies or economically significant entities which experience financial difficulties.

While this adds to the uncertainty surrounding how insolvencies will be dealt with in the UAE, bespoke legislative solutions may be beneficial. Indeed there is international precedent for this approach, for example, the Marzano special extraordinary administration procedure was introduced in Italy following the collapse of Parmalat in 2003 and was subsequently amended in the context of the Alitalia crisis. In the case of Dubai World, the Ruler of Dubai issued Decree No. 57 on 13 December 2009 creating new insolvency regulations to govern any restructuring or insolvency of Dubai World and any of its subsidiaries. This clarified what laws would apply to Dubai World as it was uncertain whether the federal laws could apply to it as a decree company. It also set a much clearer backdrop to the ongoing creditor negotiations across the Dubai World group by overlaying an entirely new regime, based on the laws of the DIFC and incorporating elements of US Chapter 11.

Some conclusions

Given the uncertainties surrounding the legislative framework and the challenges faced by lenders under the existing procedures under UAE insolvency law, lenders and borrowers will continue to seek to negotiate mutually acceptable debt restructuring solutions outside of the formal court-led procedures.

Going forwards, new or revised legislation alone is unlikely to solve the shortcomings of the current bankruptcy and corporate rescue regimes. Banks and businesses will want to have a better understanding of the processes, likely outcomes and persons that will be involved in the bankruptcy or corporate rescue procedures. This, in conjunction with enhanced rules on security and corporate governance, should significantly enhance business opportunity in the UAE.