The laws regulating insolvencies of United Arab Emirates-based businesses have recently been revised, with the new UAE Bankruptcy Law taking effect on December 29, 2016 (the “Bankruptcy Law”). Traditionally, most corporate bankruptcies in the UAE were settled through a negotiated agreement to restructure the debtor company’s obligations, since market participants were unwilling to put their faith in legislation that was still somewhat experimental. The Bankruptcy Law is a significant development, owing to the influence of various insolvency law systems in other countries, as well as global bankruptcy law developments.
The Bankruptcy Law streamlines and modernizes UAE bankruptcy law, placing a new emphasis on the early resolution of debts for distressed businesses in general. We can only hope that the program will serve as a catalyst for cultural change in the region, leading to the development of a more robust legal framework for entrepreneurs and an improved climate for investors. However, there is a lot to be said for how the Bankruptcy Law is employed in practice, as well as the will and capacity of both businesses and practitioners to adapt to take advantage of the statutory changes.
A crucial disadvantage of the Bankruptcy Law is that secured creditors are not bound by proceedings begun under it, so security may be collected outside of those procedures (with the permission of the court in the case of Protective Compositions (see below)). This may have a detrimental impact on the Bankruptcy Law’s efficacy in practice and will most certainly hinder the number of debtors seeking protection under the Bankruptcy Law as part of large financing transactions.
The Bankruptcy Law, which went into effect in January 2012, is considerably broader than the previous bankruptcy law in its application. It applies to all firms established under the Commercial Companies Law (except for those incorporated in free zones with their own comprehensive insolvency legislation such as the DIFC and ADGM), individuals trading for-profit and licensed civil companies of a professional nature.
However, the Bankruptcy Law does not apply to firms that are either fully or partially state-owned unless they have opted in by including it in their corporate charters. This ambiguity also extends to businesses incorporated by decree, since these firms are frequently controlled directly or indirectly by the government, so the expectation would be that the Bankruptcy Law does not apply to them unless they opt into it.
The Bankruptcy Law reduces and updates certain pre-existing bankruptcy-related criminal penalties, as well as expanding the bankruptcy system into two key court-driven procedures:
1, Preventive Composition; and
2, Bankruptcy (which comprises both a formal rescue process and insolvent liquidation).
The threshold for declaring a firm insolvent has been extended and clarified. The Bankruptcy Law also includes an optional balance sheet test (which is used when the debtor’s assets are insufficient to pay its debts) in addition to the cash flow test (which applies when a debtor is unable to pay its debts). In general, a debtor must file for bankruptcy within 30 days of being insolvent under one test or another, or seek protection within that time period. A debtor who fails to take action within the allowed time frame can face a variety of criminal and civil consequences that have been repealed.
The Bankruptcy Law establishes a Financial Restructuring Committee (the “Committee”) to govern the implementation of debt restructuring options. The Committee’s duty is to ensure that debt restructuring procedures are managed in order to enable mutually acceptable restructuring. The National Bankruptcy Rules also establish a committee with the power to approve expert fees and a list of qualified insolvency experts who will assist the courts in assessing the grounds for and implementing, the chosen insolvency procedure (as described in further detail below). The Committee is also delegated the power to oversee the financial re-organization of regulated financial institutions, including commercial banks and insurance companies, regardless of whether or not the Bankruptcy Law applies.
The Bankruptcy Law’s preliminary versions called for a confidential out-of-court procedure for companies in financial distress without yet being insolvent, which was similar to international trends in bankruptcy law reform. Unfortunately, such a process has not been incorporated into the Bankruptcy Law as it currently stands, but it is to be expected that the possibility will be considered in future revisions of the Bankruptcy Law.
The UAE legal system allows for the use of protective compositions or arrangements developed between the debtor and creditors that are based on the French safeguard mechanism. Such programs enable a person to avoid the consequences of his or her bankruptcy being adjudicated.
Preventive Composition is a debtor-driven, court-supervised procedure that may be utilized by a debtor who is i) not yet insolvent but in financial difficulties or ii) has been insolvent (under either of the tests described above) for less than 30 days. The goal of the process is to assist a debtor to reach an agreement with its creditors.
Only the debtor can apply for Preventive Composition, and it must be done so by the court. The service will not be accessible to debtors who have already sought legal advice within the previous year or who have gone through bankruptcy procedures. The composition application must contain thorough information on the debtor, including an overview of its financial condition, assets, workers, creditors, and debtors, as well as copies of financial books and statements. A shareholders’ resolution in support of the application for Preventive Composition also must be submitted.
A court-appointed expert will then prepare a report on the debtor’s financial status, which will determine whether the required conditions have been met, including whether there is enough money available to pay for the procedure. If the debtor’s application is accepted, the debtor will be placed under the supervision of a court-appointed expert – or trustee – and all bankruptcy actions, other claims, and enforcement measures connected with them are automatically halted. Creditors who hold specific security and seek to make, or continue to make, claims against the trustee in relation to specific assets must obtain court approval. Within 20 working days of being named, the trustee will publish the court’s decision and request creditors submit their claims.
The debtor has 45 working days from the publication of the court’s decision to submit a draft preventive composition plan, as long as they comply with certain conditions. The debtor’s proposals should be included in the draft plan, as well as the chances of success and a timetable for implementation, which must not exceed three
The plan is then voted on by creditors after it has been reviewed by the court and permission to convene creditors’ meetings has been given. Creditors who have accepted the court’s decision are eligible to participate in the election. A majority of creditors who vote in favor of it must be from at least two-thirds of the total debt by value.
All unsecured creditors (secured creditors are not permitted to vote unless they have given up their security) will be affected by the composition’s adoption whether or not they took part in the voting for it, so long as the relevant threshold is met. Only if they relinquished their security rights and voted in favor of the composition will secured creditors be bound by it.
During the composition process, the debtor retains control over the business under the supervision of the trustee, who has broad authority to act on behalf of the debtor in terms of asset preservation, settlement of claims, and any other actions necessary to achieve the goal of the procedure.
The following are some of the most important tools available under the composition process:
The tools outlined in Chapter 5, which include debt negotiations and master leases, are clearly influenced by comparable provisions in US bankruptcy law.
Failure to comply with the provisions of the agreement may result in it being voided and a court order for bankruptcy and asset liquidation. The composition may also be revoked owing to fraud by the debtor. Otherwise, after the debtor has complied with all of its obligations, the arrangement comes to an end.
The court may compel the insolvent winding-up of a firm if:
The primary aim of liquidation is to terminate the company’s corporate existence, as opposed to composing or restructuring, where the goal is to rescue the debtor’s business.
The company’s board of directors conducts a liquidation, which is carried out by one or more court-appointed liquidators. The appointment of the liquidator transfers all authority and rights of the company’s board of directors to him. The ability to raise or defend legal actions, determine the company’s assets and liabilities, take possession of the business’s accounts and books, sell the corporate property and generally do everything necessary for the protection and preservation of a firm’s assets and rights are just a few of them.
The liquidator is required to contact all creditors and inform them of his or her appointment, as well as request them to present any outstanding claims (which have not already been reported in accordance with the bankruptcy petition above), within 10 days from the date of notification.
According to the Bankruptcy Law, a liquidator is required to sell all of the debtor’s belongings and distribute the proceeds among creditors in accordance with a revised order of priority. Secured creditors will be paid ahead of any unsecured creditors, based on the amount of their security.
The court may order the board of directors, together or separately, to pay all or part of a company’s obligations if the liquidated assets are insufficient to cover at least 20% of its total liabilities. Directors can also be compelled to make payments where it is shown that they have acted improperly in the two years leading up to the date of the liquidation order.
The court will issue a decision to terminate the case after the liquidator has completed the final distribution. The liquidator is then required to publish a notice informing creditors of their status, the amounts owed, and any remaining sums.
The Bankruptcy Code retains the old regime of civil and criminal liabilities that apply when a company’s failure is due to the actions of its directors, general managers, and shadow directors. However, the directors will not be held criminally liable if they fail to file for bankruptcy within 30 days after becoming aware of their financial catastrophe. However, the Bankruptcy Law establishes a framework for the disqualification of directors (similar to that which exists in the United Kingdom) and failure to file within the designated period may result in the director(s) concerned being disqualified from managing a firm in Dubai for up to 5 years or face fines.
A Preventive Composition, bankruptcy, and liquidation are all governed by the Bankruptcy Law. The legislation establishes a claims waterfall to show which claims receive priority in a Preventive Composition, bankruptcy, and liquidation, as well as a class of creditors with privileged debts who may get priority over other creditors. Judicial fees or expenses (including court-appointed officials such as trustees and experts’ fees), employee salaries and other benefits debts, and payments owed to public authorities are examples of unsecured debts not covered by bankruptcy.
In accordance with most civil law legal systems, the UAE civil code allows for the set-off of linked debts. Set-off, on the other hand, is not expressly authorized by the Bankruptcy Law. It is only permissible between a creditor and debtor if it was previously agreed in writing before the bankruptcy, but it is not allowed in connection with obligations that become payable after the commencement of the relevant insolvency procedure. A creditor may also ask for a post-insolvency set-off in the debtor’s bankrupt estate, and a creditor who has deposited money into the bankrupt party’s account is required to pay it back if the sum is owed by him or her to the insolvent party. In light of this, it is assumed that the provisions of the UAE civil code relating to set-off will still apply to any evaluation of insolvency set-off; in particular, the creditor and debtor must owe one another a debt of equal type and amount. However, in any reorganization strategy authorized in accordance with the aforementioned standards, the court will have considerable freedom to include set-off arrangements into the settlement.
When the court has accepted an application for Preventive Composition or formal bankruptcy reorganization, judicial procedures are halted under the Bankruptcy Law. This should also apply to criminal cases where people have bounced cheques, for example. A bounced cheque would be treated in the same manner as any other unsecured claim against the debtor, and any judicial action would be suspended until the bankruptcy has been completed or otherwise annulled or terminated.
The Bankruptcy Law is a positive development for the UAE’s bankruptcy system. The new system’s effectiveness will ultimately be determined by how effectively it is operated. It will be critical to set up strong support structures and training for the judiciary, given that a great deal of trust is placed in local court systems and court-appointed experts. The fact that secured creditors are not subject to bankruptcy procedures may limit the utility of the Bankruptcy Law in major financing and construction deals. The Bankruptcy Law, on the other hand, is a step in the direction of a more flexible and internationally-aligned strategy that should help firms in the UAE work through financial difficulties and, where feasible, avoid liquidation.
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