Many foreign investors are drawn to establishing businesses in the United Arab Emirates (UAE) because it is a vibrant hub for diverse commercial activities and transactions. It’s natural for these investors to desire full or significant ownership of the wealth generated by their enterprises. In the UAE, the Limited Liability Company (LLC) is a popular business structure due to the unique advantages it offers across various Emirates.
When setting up an LLC in Dubai, investors can benefit from several advantages, including:
- No specific minimum capital requirement.
- The ability to partner rather than act solely as depositors.
- Visa permits with specific privileges.
- Opportunities to rent office space and establish branch offices both within the UAE and internationally.
- Security and reliability, as assets and capital are held in the company’s name rather than under a UAE national partner.
- Broad trading opportunities across the UAE.
However, one key challenge for foreign investors is the legal requirement for an LLC in the UAE to have a UAE national partner who holds 51% ownership and its associated economic benefits, leaving foreign investors with only 49% ownership. To circumvent this, many investors and UAE nationals enter into “side agreements.” These agreements act as an ancillary arrangement to the main contract, where the UAE national waives rights to ownership and economic benefits, effectively becoming a silent partner.
What is an LLC, Side Agreements, and Their Legalities?
Under Article 71 of Federal Law No. 2 of 2015 on Commercial Companies (the Companies Law), an LLC is defined as an entity where partners’ liability is limited to their shares in the capital. An LLC must have at least two partners but not more than 50. The liability protection feature safeguards the personal interests of partners during crises.
Article 72 of the Companies Law requires the LLC’s name to reflect its business objective or the name(s) of its partners, followed by “Limited Liability Company” or “LLC.” Furthermore, Article 10(1) mandates that at least 51% of an LLC’s share capital must be held by one or more UAE nationals.
To bypass this ownership requirement, foreign investors often enter into nominee shareholder agreements (NSAs) or side agreements with UAE national partners. Through these arrangements, the UAE national relinquishes all economic benefits and ownership rights, acting only as a silent partner. The UAE national is typically compensated with an annual fee. However, such side agreements raise questions about their validity and legality, as they directly conflict with the ownership provisions in the Companies Law.
How Do Side Agreements Work?
Side agreements are supplementary contracts made alongside the primary agreement to address:
- Obligations omitted in the main contract.
- Additional terms or amendments to the primary agreement.
In the context of UAE LLCs, side agreements enable foreign investors to claim full control of the company by ensuring the UAE national shareholder surrenders their voting rights, dividend entitlements, and share in profits. The UAE national retains nominal ownership while the economic interests remain with the foreign investor. However, the enforceability of such agreements is debatable due to their conflict with both the Companies Law and the primary Memorandum of Association (MOA).
Relevant Legal Provisions and Cases
Legal Framework:
- Article 29(3) of the Companies Law: Declares void any contract clauses that deprive partners of profits or exempt them from losses.
- Article 395 of Federal Law No. 5 of 1985 on Civil Transactions Law (the Civil Code): States that if a concealed contract contradicts the original agreement, the original contract takes precedence.
Key Cases:
- Civil Appeal 30 of 2015 (Abu Dhabi Court of Cassation):
- Facts: A UAE national sold their 51% shareholding to a foreign investor through a side agreement but later claimed profits when the company became profitable.
- Outcome: The court deemed the side agreement void as it violated the Companies Law and ordered the restoration of the parties’ original positions.
- Cassation No. 211/2009 (Dubai Court of Cassation):
- The court invalidated side agreements that concealed true ownership, declaring the LLC a bogus company.
- Cassation No. 7/2009:
- The court ruled that companies operating contrary to their MOA are non-existent, and side agreements tied to such companies are null and void.
- Cassation No. 77/2010:
- Highlighted that only written side agreements are considered, but even written agreements are illegal if they circumvent the Companies Law.
Legal Analysis
While written side agreements may occasionally be considered by courts, they are fundamentally illegal as they breach the Companies Law. Article 353 of the Companies Law imposes fines ranging from AED 20,000 to AED 200,000 for violations of the 51% ownership rule. Similarly, Federal Law No. 17 of 2004 on Commercial Concealment prohibits UAE nationals from hiding foreign ownership or lending their name for such purposes.
Alternatives to Side Agreements
To avoid legal risks associated with side agreements, foreign investors can explore alternatives, such as:
- Establishing a UAE branch of a foreign company, where the UAE national acts only as a service agent without ownership or management rights.
- Partnering with corporate service providers offering UAE nationals as nominal partners for a fixed fee.
By pursuing legitimate options, foreign investors can safeguard their business interests while adhering to UAE laws.
