The implications of the UAE Bankruptcy Law on debtors & creditors

Legal experts largely agree that the new UAE Bankruptcy Law is an improvement on the previous law, but is it all good news for debtors and creditors?

What is the UAE Bankruptcy Law?

The Federal Decree Law No. 9 of 2016 (UAE Bankruptcy Law) provides a framework for companies in financial distress to avoid liquidation and protects employees, shareholders and directors of organisations going through court-led insolvencies. It contains 230 articles and primarily works to bring flexibility to those going through financial difficulty, providing more support for both debtors and creditors. Since its implementation on December 29th,2016, it has removed the risk of facing legal prosecution and jail time, and special tribunals are no longer required for the insolvencies of large companies.

Who does the UAE Bankruptcy Law affect?

The UAE Bankruptcy Law applies to commercial companies, companies owned by the UAE or any Emirate’s government, individual traders and civil companies established in the UAE. It excludes companies established in the financial free zones and non-trader individuals, who will remain subject to the UAE Civil Code in the event of financial distress and who will therefore continue to be at risk of legal prosecution.

What are the key changes implemented by the UAE Bankruptcy Law?

The law is centred around the implementation of four new court-supervised procedures:

The preventive composition

A process for solvent debtors who are facing financial difficulties. Only a debtor may apply for this and it should be initiated at the early stages of difficulty before insolvency, to protect the debtor and provide more time and support to fulfil the debt with the court’s supervision. The unsecured creditors must approve this within three years of the court’s approval and it may be extended by three years.

The restructuring process

For an insolvent debtor facing financial difficulties that have led to failure to meet debts for 30 working days or more. This can be initiated by the debtor or by unsecured creditors who have issued a formal demand for a debt of Dh100,00 that is overdue by 30 working days or more. The debtor is allowed five years for restructuring the debts and this may be extended by three years.

Insolvent liquidation process

To be initiated by the order of the court, for the debtor to cease commercial activity if the previous two options are unsuccessful or are not approved. The court will appoint an insolvency trustee or official to oversee the process and monetise the debtor’s assets.

Financial restructuring of financial institutions

This may be initiated following preventative composition or restructuring and includes safeguards for existing secured creditors.

Accordingly, greater flexibility is available for debtors and creditors. For the first time courts can amend loan terms and debtors can apply for support from the court during financial difficulties, which can potentially provide three to six years of protection and support. The UAE Bankruptcy Law provides more options for debtors in the UAE and this in turn brings greater protection of the debtor’s business, and of the creditor’s assets. It creates more security and predictability and can help to prevent financial problems from growing and becoming unmanageable whilst there is still potential to fulfil the debts owed. To encourage debtors to apply for rehabilitation when facing financial issues, the law states that once the court accepts the application, all other claims and proceedings are suspended until approval. This is to encourage restructuring finances rather than leaving the creditor without their owed debts, but it means that existing debts are suspended, bringing risk of alternative liability.

What are the implications for debtors?

The UAE Bankruptcy Law helps to support debtors’ businesses maintain viability and aims to protect them during a restructuring. It can also protect Directors and Managers from arrest or being forced to flee the country as a result of their company’s debt. However, it’s important to note that the removal of the criminal offence of bankruptcy does not remove the criminal offence of fraudulent bankruptcy or any breach of the Commercial Companies Law. It is clear that using the UAE Bankruptcy Law as protection from such a breach will render the individual exempt from protection. This will lead to the member being held personally accountable for the debts and damage.

Criminal proceedings regarding bounced cheques are suspended once a preventive composition or restructuring process has begun, which can help debtors maintain viability, although misuse of this protection can be a fraudulent insolvency offence. The UAE Bankruptcy Law states that members involved in the liquidation of the company are accountable for a Dh1 million fine and up to five years in prison if found guilty of altering records to harm the creditors, embezzlement, acknowledging unpayable debts, deceiving the court in their application for any of the processes in the UAE Bankruptcy Law, or sharing false information about the capital.

It is important to consider the time frames enforced for new processes in the UAE Bankruptcy Law. There are time frames for approvals, appeals, and initiating processes that must be observed to maintain protection. For example if the debtor does not apply for bankruptcy within the thirty working day window of failing repayment, the liability can shift to the members and Directors and can leave them personally liable for mismanagement. A preventive composition is not available to a debtor that has already entered into the procedure in the past year and cannot be used by a debtor for which bankruptcy proceedings have initiated, so both processes should be carefully considered. It appears the best advice is to be prepared, act quickly and seek help at the first signs of difficulty to maintain business integrity and protection from greater difficulty further down the line.

For debtors, the UAE Bankruptcy Law provides some leeway, but does not relieve the requirement to fix the debts owed and depends upon the handling of the court and the court appointed officials as to how effective a strategy it can be. Applications require preparation and time to complete and therefore it is necessary to undertake a risk analysis and keep the preparation process in mind when considering the time frames. The plan for preventive composition must be effectively prepared as, once agreed and in process, failure to comply can result in the court ordering for bankruptcy or liquidation. In addition to this, the debtor must have funds to cover the cost of the procedure and approval is required from shareholders.

What are the implications for creditors?

The UAE Bankruptcy Law appears to offer a debtor-centric approach but creditors also benefit from more security and legal rights than before. Creditor initiated insolvency proceedings will be useful in protecting assets and the removal of the criminal offence and more options to debtors means more likelihood that debts will be cleared rather than absconded from. Research by the World Bank has shown that insolvency processes in other countries have up to nearly 60% higher recovery rates than the UAE, so this is a much needed improvement for UAE creditors. As a result, the UAE also becomes more attractive to international investors and businesses and benefits the economy as a whole.

Secured creditors are prioritised by the UAE Bankruptcy Law, and again must consider enforced time frames. Secure creditors require court approval to claim against the trustee regarding their secure assets. The court’s decision will be published by the trustee, then creditors have a window of 20 working days to bring their claims. Following publication the debtor has 45 working days to submit an initial preventive composition plan for a vote of approval by unsecured creditors. This gives unsecured creditors an understanding of timings and proposed chances of success, but to vote their debts must be accepted by the court and a majority vote requires at least two thirds relating to the value of the debt. After this the unsecured creditors, regardless of whether they voted, are bound to the agreement. This process appears to favour larger investors and may encourage more investment, but could discourage smaller investors from becoming involved initially.

Whilst the debtor continues to run the business, the court-appointed trustee has rights to act for the debtor to preserve the assets needed to complete the process. Any activity that could impact the position of secured creditors must be approved by the court and the court may order for liquidation of the debtor’s assets if they do not comply with the agreed terms of the preventive composition.

In summary, the law provides much more transparency and more confidence and predictability for creditors.

Outlook and future developments

The UAE Bankruptcy Law aims to improve the business environment and economy by offering debtors more opportunity to resolve debt without facing liquidation and prison. Investors can invest more knowledgeably and confidently, and those seeking investment will have better access and support to avoid liquidation. This should influence a further rise in investments and business growth in the UAE, particularly for entrepreneurs and SMEs.

Further encouragement to debtors to seek support early on in their financial decline may help to prevent bankruptcy, however, it does not necessarily stop debtors fleeing the country to escape criminal sentencing in fraudulent cases. This also relies on debtors being financially aware and knowing their rights early on in, or before their decline.

Whilst greater co-operation is possible between debtor and creditors, the processes are managed by courts and court appointed officials. Given its recent implementation, it is too early to know how successfully issues will be managed which creates uncertainty. It will work on a case by case basis and relies on there being an experienced talent pool with knowledge of the relevant industries. Experience and understanding of the issues and outcomes will come with time and there is no doubt opportunity for the law to evolve. Larger more structurally diverse companies may complicate the process and we are yet to see how these instances will pan out, but the new law looks like a step in the direction of a smoother, slicker business environment with more international appeal.