Restructuring and insolvency law in United Arab Emirates

Federal Law No. 9/2016 (the “Bankruptcy Law”) is the primary legislation governing insolvency and restructuring proceedings in the UAE. The Bankruptcy Law applies to the majority of UAE companies, covering all companies established under the UAE Commercial Companies Law (Federal Law No.2 of 2015) and most free zone companies (with a few exceptions for free zones with their own bankruptcy and insolvency regime, such as the Dubai International Finance Centre and the Abu Dhabi Global Market).

In brief, the Bankruptcy Law provides for two primary options for businesses in financial distress: Preventative composition and Bankruptcy. Both processes are initiated through an application to the court. Preventative composition is a process initiated by the debtor to ask for the court’s assistance in settling debts with its creditors with the ultimate aim of working through the financial hardship to recover the business, whereas bankruptcy proceedings can involve either a rescue procedure or a liquidation. Under the Bankruptcy Law, directors of the company must file for bankruptcy where the company fails the Bankruptcy Test (see section 3 below).

Bankruptcy Test

Bankruptcy under the Bankruptcy Law is assessed on a cashflow basis and on a balance sheet basis (the “Bankruptcy Test”). The cashflow test asks if the company has been unable to pay its debts when they fall due for more than 30 consecutive business days, while the balance sheet test asks whether its assets are less than its liabilities. If a company fails either limb of the Bankruptcy Test, the directors/managers of a company must apply for bankruptcy.

Creditors

A creditor with a debt in excess of AED 100,000, and which has not been paid for 30 business days after final demand, may also petition the court for bankruptcy to recover the debt due to it.

Preventative composition

This is a process only available for companies that do not meet the formal Bankruptcy Test, but where the directors feel that they will be unable to trade out of their existing indebtedness. In a preventative composition, the company would make an application to the court supported by a detailed overview of its trading position and net assets (and various other information) and their plan for how the preventative composition plan should proceed to enable them to settle their debts to a position where they can exit the plan and begin business as usual again.

If the court accepts the application, the company’s debt obligations will be suspended, during which time the court will appoint a trustee to supervise the directors’ management of the company. The trustee would seek to agree a plan for the company to trade out of its existing position. The plan would require the approval of a majority of its creditors holding not less than two thirds of the value of the total outstanding debts of the company. The trustee, with assistance of the court, would then oversee implementation of the preventative composition plan over a period of up to 3 years. During the term of the plan, the company is restricted from taking certain measures (such as settling claims that arose prior to commencement of the plan, taking on new debt or disposing of its assets etc.) and must generally manage the business in accordance with the terms of the court-approved plan and under the supervision of the trustee and the court. If at any time during the implementation of the plan, the company fails the Bankruptcy Test or the court determines that the plan is impossible to implement, it may terminate the plan and convert it into a declaration of bankruptcy, described below.

Bankruptcy

There are two limbs of bankruptcy under the Bankruptcy Law: Formal restructuring and Insolvent liquidation.

Formal restructuring

The initial view to be taken by the court on an application for bankruptcy is to assess whether the company can be restructured, settle its debts, and become profitable again. So, similar to the preventative composition, an expert and trustee are appointed to determine the company’s financial position, compile a complete list of creditors, and assess whether the company can be restructured in order to become profitable once more. Any such plan presented to the court requires the approval of the company and the approval of a majority of its creditors holding not less than two thirds of the value of the total outstanding debts of the company. The trustee and company then implement the restructuring plan, in a similar way to the preventative composition plan, but with the trustee taking a more executive role.

Insolvent liquidation

If a restructuring is not possible, the court shall issue a judgement to declare the company bankrupt and order liquidation of its assets. A declaration of bankruptcy and liquidation could also be issued in a range of other scenarios, including if the required majority approval of creditors is not reached for the restructuring plan, or if the company applied for bankruptcy and is deemed to have acted in bad faith or applied in order to delay or evade payment to a creditor. The court may also order the insolvent winding-up of a company if a plan for preventative composition or restructuring fails or becomes, in the court’s opinion, impossible to achieve.

Once bankruptcy is declared, the trustee shall arrange to liquidate the company and its assets and distribute the proceeds to the creditors in order of priority, and the balance back to the company for distribution among its shareholders.

The Bankruptcy Law distinguishes between “privileged” creditors and normal unsecured creditors. Privileged creditors are creditors with privileged debts, such as judicial fees or expenses, any amounts owing to employees for salaries/benefits and amounts owed to governmental authorities. Privileged creditors also include secured creditors.
Privileged creditors are first in the waterfall of payments on an insolvency. It is not until privileged creditors’ debts have been satisfied that unsecured creditors can be paid.

It is important to note that the preventative composition process does not prevent any third party holding a secured debt from enforcing their debts against the debtor. The court would review those claims but has limited scope to prevent the secured creditors from enforcing their debts when due. This point has not been well tested before UAE courts, and so the position a court might take when being presented with a secured debt is difficult to predict.

Article 68 of the Bankruptcy Law sets out a strict obligation on a debtor to file for bankruptcy if it fails either limb of the Bankruptcy Test.

If the debtor fails to file for bankruptcy within the required timeline, its directors and management may face civil and criminal penalties. Punishable offences also include fraud, embezzlement, distributing false profits and doctoring company books and can attract significant penalties of up to 5 years’ imprisonment and AED 1 million in fines. Additionally, the Bankruptcy Law introduces a regime for the disqualification of directors; and failure to file for bankruptcy within the prescribed timeframe may constitute a ground for disqualification of the director(s) concerned for a period up to 5 years and/or attract fines.

Directors and managers of a company can also be found criminally liable if they are proven to hide company assets from creditors, prejudicing certain creditors by, for example, paying one creditor to the detriment of others or failing to provide the requested information to the court/trustee in charge of the proceedings. “Managers” of a company are broadly defined under the Bankruptcy Law and include anyone who is acting in a managerial capacity. Penalties under the Bankruptcy Law are therefore not limited only to directors and officers, but also potentially heads of department or anyone else acting in a “managerial” capacity.

In an insolvency/bankruptcy/restructuring situation, the actions and decisions of the company’s directors, and those other persons determined to be a “manager” (as described above) in the time leading up to such an event will be carefully reviewed to confirm whether those individuals managed the company’s business correctly with a view to all relevant stakeholders, including its creditors.

Directors and officers have an obligation to cooperate with the appointed trustee/liquidator and provide all requested documents. Failure to do so could lead to severe penalties (see point 6 above). The directors and managers of a company can also be held personally liable if the court determines that the company’s assets cover less than 20% of its debts and the directors or officers are proved to be liable for the company’s losses due to a breach of their duties. In this situation, the court has the authority to declare directors and officers jointly and severally liable to pay all or any of the company’s debts.

In addition, in the period of 2 years prior to a declaration of bankruptcy, if the directors or officers, or any one of them, is found to have disposed of assets at an undervalue, given preferential treatment to creditors or used commercial methods “without considering their risks” (such as commercial deals which are not on arm’s length terms entered into to avoid or delay bankruptcy), the directors or officers (or any of them) can be jointly and severally liable to pay any or all of the company’s debts, save for any director or officer who voted against taking the relevant action. The directors and officers have a defence if they can prove that they have taken all precautionary measures to minimise potential losses in relation to their assets and the company’s creditors

A trustee and potentially an expert are appointed in the court order ordering the opening of preventative composition and bankruptcy proceedings. It is the trustee, with the court’s approval, that oversees or administers the company’s dealings during such proceedings. The “representative bodies”, i.e. the directors and officers of the debtor, are therefore normally not involved in the proceedings. However, they have duties of disclosure and cooperation in order to assist the trustee with the fulfilment of their duties (and see point 6 above regarding penalties for failure to do so).

A plan for preventative composition or a restructuring plan will inevitably require the support of the company’s shareholders when making the application as the creditors and court will want to know that the plan proposed by the company to trade out of its financial difficulties has the support of the company’s shareholders. However, the obligation to file for bankruptcy is an obligation on the directors of the company to initiate the process, rather than the shareholders.

In general, other than voting on the preventative composition/restructuring plan, shareholders are not actively involved in proceedings as the court-appointed trustee or the liquidator (in liquidation proceedings) will take control over the company’s assets. Creditors will be given a chance to submit their claims against the debtor once proceedings have commenced. The trustee will then work with the creditors to establish their claims and prepare a restructuring plan (in the case of preventative composition or restructuring).

It is also worth noting that the Bankruptcy Law includes the concept of a “shadow directorship”, which means that if a person (including a shareholder) instructs the management of a company, that person may be liable under the Bankruptcy Law if any of the offences listed in the Bankruptcy Law (such as those listed in point 6 above) are committed.

There are two types of insolvency proceedings:

Members’ voluntary liquidation

The shareholders of a company can apply for a liquidator to be appointed with the aim of entering into a voluntary liquidation when the company in question is still solvent. However, this can only happen once the company (through its board of directors) has made a formal declaration for voluntary liquidation.

Creditors’ voluntary liquidation

If the company becomes insolvent, the liquidator will call a creditors’ meeting and the proceeding becomes a creditors’ voluntary liquidation. The process can be started by the board of directors of an insolvent company (i.e. when the company fails the Bankruptcy Test).

Yes. See above in respect of preventative composition in the UAE.

To date, the Bankruptcy Law remains relatively untested by significantly-sized restructurings and insolvencies. Given that the Bankruptcy Law only came into effect in December 2016 and has therefore not been much tried and tested, it is not possible to determine the average success rate of completed restructuring/insolvency proceedings at this stage.