A striking feature of the UAE business landscape is the fact that a foreign investor must structure any operating company so that at least 51% of the issued shares are owned by UAE nationals. In this landscape, minority shareholder rights assume great importance.
Minority protection agreements commonly seen in the UAE seek to
give minority shareholders very significant rights of participation
and control over the management and business of the company. Such
minority protection agreements reflect the reality of situations
where foreign minority shareholders make the major contribution to
the business in terms of assets, expertise, contacts and capital,
but UAE nationals must have 51% of the issued share to comply with
foreign investment rules applying outside the UAE free zones.
This article examines:
- The tools available to minority shareholders in the UAE; and
- The way in which a minority shareholder can use these tools to construct a safe haven for their investment.
The analysis is confined to legislation in force applying to "onshore" UAE companies, but with one exception the legal regulations governing UAE free zones follow the substance of the "onshore" companies legislation considered here. The position under the Dubai International Financial Centre ("DIFC") Companies Law is markedly different, as this law is similar in its treatment of shareholder rights to the United Kingdom legislation. However, the DIFC law is confined in its operation to companies established in the DIFC.
The First Tool – The Board Seat
"What is called "foreknowledge" cannot be elicited from spirits, nor from gods nor by analogy with past events nor from calculations. It must be obtained by men who know the enemy situation".
"Sun Tzu" (Chinese general and author) – circa 400 B.C
It is vital for a minority shareholder to have representation on the Board, as all major corporate transactions should come to the Board for approval. All significant problems and issues should likewise be discussed by the Board. Moreover, any director has a full and unrestricted right of access to the company's management and to its records and so can obtain information about matters of concern.
The UAE Commercial Companies Law 1984 ("CCL") makes some differentiation between the powers and duties of Board members in joint stock companies and those in limited liability companies.
In the case of joint stock companies Article 95 of the CCL
states that each must have a Board of Directors and its role is to
"manage the company". There must be not less than three
directors and not more than 15. Their term of office is limited to
3 years, but this period can be extended by re-election.
In contrast, limited liability companies (the most common type found in the UAE) have one or more "managers". Article 235 of the CCL states that a limited liability company may have one manager (a general manager who runs the company) or a Board of Managers appointed by the memorandum of association or by shareholders' resolution. There can be no more than five members of the Board of Managers.
Article 237 gives the General Manager or the Board of Managers full capacity to manage the company and to bind the company in all things. It states expressly that the responsibility of a manager shall be commensurate to the responsibilities of a member of the Board of Directors of a joint stock company.
The Advantages of a Board Seat
There are three key advantages to having the right to fill a Board seat:
- Board members have unrestricted access to confidential information to the companies' files and records and to management, as requested from time to time.
- In a properly governed company the Board members should have "foreknowledge" of any significant transactions/dealings/financial commitments, allowing preventive action where necessary to protect shareholder interests.
- The Board controls the appointment of key signatories (e.g. bank signatories, bank account signatories, authorised officers responsible for obtaining and signing labour visas and officers responsible for changing the company office holders).
The Disadvantages of a Board Seat
The two primary disadvantages of a minority shareholder being represented on the Board are:
- Board members are sometimes constrained in their freedom to represent shareholder factions appointing them by Board confidentiality. Sometimes, Board members are even restricted from reporting back to the shareholders appointing them if the matter is sensitive.
- Any member of the Board is exposed, along with their fellow Board members to claims based on fraud, abuse of power or "mal-management" under Article 111 of the CCL. In this context, Article 112 of the CCL states that all Board members are legally liable for the Board's actions where Board decisions are taken unanimously. Board members who dissent are expressed not to be liable, but they must ensure that their dissent is recorded in the Board minutes.
The Second Tool – Control over "Corporate Actions"
"In the practical art of war, the best of all is to take the enemy's country whole and intact, to shatter and destroy it is not so good" – Sun Tzu
It is much better for shareholders to preserve corporate assets and value by avoiding disadvantageous transactions before they occur, rather than argue after the event over poor or oppressive decisions already made and implemented.
The usual way minority shareholders can protect themselves is to
insist upon a shareholder's agreement (sometimes called a
"minority protection agreement") which restricts the
capacity of majority shareholders to engage in designated
"corporate actions" without the prior consent and
agreement of the minority shareholder (or the supporting vote of
the minority's Board representative).
A well crafted shareholders' agreement will contain terms which make it clear that a variety of "reserved decisions" should be taken only where there is unanimous, or 75%, approval of the Board or the shareholders. The "usual" list of "reserved matters" will generally extend to the following, although this list is not exhaustive:
- Changing the company's scope of business;
- Selling major fixed assets;
- Changing the auditors;
- Issuing new shares;
- Reducing or increasing share capital;
- Entering a joint venture
- Buying major fixed assets;
- Entering into any major financing or leasing commitments
- Hiring or changing senior executive management;
- Giving guarantees;
- Paying dividends;
- Entering into related party transactions.
Although Article 103 of the CCL, in the absence of express provisions in the company's articles of association, requires prior shareholder approval to the Board entering into loan agreements for a period longer than the duration of three years; or to the Board agreeing to sell fixed real estate assets, it has limited utility for the protection of minority shareholders, for two reasons:
- The articles of association can and normally do authorise the Board to do these things; and
- The majority can usually gather 50% + 1 vote required to pass an ordinary shareholder resolution.
Enforcement of Shareholder Agreement's Outside the Courts
Although shareholder agreements are usually enforceable through the UAE Courts, because they are merely private contracts it can be difficult to rely on them in dealings with government authorities and third parties. In these situations it is better if minority shareholder rights are actually embedded and reflected in the company's memorandum of association and articles of association. If there is a serious shareholder dispute, unless the shareholder's rights are "mirrored" in the memorandum and articles of association those rights will be "invisible" to, and will likely be disregarded by, important outside parties and authorities, e.g.:
- The company's bankers;
- The Department of Economic Development;
- Other government departments (e.g. Ministry of Labour); and
- Free zone registries.
Many shareholders are understandably reluctant to repeat and embed detailed provisions of their shareholders' agreements in the memorandum of association and articles of association, because these documents are, to some extent, public documents. However, crucial terms needed to uphold minority rights (e.g. the composition of the Board and the taking of important corporate actions) should always be reflected in the company's constituent documents as a matter of best practice. Otherwise, the onus rests with minority shareholders to enforce them as private contracts through the Courts.
Enforcement of Shareholder Agreements in the UAE Courts
Shareholders' agreement will be enforced as binding contracts by the UAE Courts but the remedies for a breach of contract are limited. The general practice of the UAE Courts is to award financial damages after the loss making event.
In general terms, the UAE courts do not make interim orders, e.g.:
- Restraining orders (e.g. injunctions); or
- Mandatory orders compelling a party to take specified action;
until the case before the court is tried in full. This process can take months or years.
The Third Tool - Control of Directors' Remuneration
"The skilful employer of men will employ the wise man, the brave man, the covetous man and the stupid man" – Sun Tzu
Article 118 of the CCL requires the company's articles of association to specify the directors' remuneration. The CCL provides that the remuneration drawn by the Board collectively must not exceed 10% of the net profit of the company (less certain statutory deductions).
Effectiveness of the Statutory Limitations
In reality, the restrictions under Article 118 the Commercial Companies Law are often circumvented. The reason is that there are no substantive restrictions imposed by the CCL on any company entering into related party transactions. So, in practice, there are a number of avenues for controlling shareholders to channel additional benefits to themselves in addition to director remuneration, e.g.:
- Entry by the company into management contracts with entities owned by directors or their families;
- Supply contracts with entities owned by the directors or their families;
- Outsourcing contracts with entities owned by the directors or their families.
In the case of listed public joint stock companies, the entry into these types of related party contracts has been subject to controls, under regulations issued by the Securities and Commodities Authority. However, the position with respect to limited liability companies remains substantially unregulated.
The Fourth Tool – Access to Confidential Corporate Information
"It is only the enlightened ruler and the wise general who will use the highest intelligence of the army for the purposes of spying, and thereby they achieve great results" – Sun Tzu
Where a shareholder does not have a Board seat and is concerned about corporate actions or corporate governance, access to reliable and timely information is critical to protecting both their investment and their legal rights.
Under the CCL, the shareholders in any UAE company in general are entitled to only limited information namely:
- Signed financial accounts (annually); and
- Signed audited report (also annually) where an auditor is in office.
The CCL contains a provision (refer Article 149), which specifically forbids auditors to disclose "confidential" matters to shareholders outside the context of a general assembly meeting.
If a company is listed on a financial market in the UAE regulated by the SCA and is a public joint stock company, there are also obligations to disclose matters affecting the market value of the listed shares to the market generally (not just to shareholders).
There is an interesting provision in the CCL which, so far as I know, has never been tested in the Courts. It may be a "sleeper" tool lying in the shareholder's tool box. This is Article 170, which provides:
"The shareholder may review the company books and its documents by permission of the Board of Directors or the general assembly in accordance with the provisions of the company articles. The court may oblige the company to provide the shareholder with particular information that does not conflict with the company's interests".
Although the time required to bring a matter before the Courts under Article 170 may render the information non-current, it may nonetheless be a useful avenue where the shareholder suspects, but cannot otherwise prove, misuse or misappropriation of company funds or assets.
The Fifth Tool - Agreement for Cash Exit
"When you surround an army, leave an outlet free. Do not press a desperate foe too hard" – Sun Tzu
For a minority shareholder, achieving a cash exit may be difficult or impossible unless the exit door, and the key to that door, are "hard-wired" into a shareholder's agreement or the company's articles of association.
Where the minority shareholder has lost confidence in the
management and/or governance of the company then the best thing is
usually to liquidate the shareholding for cash. However, the other
shareholders will usually be reluctant to agree. Firstly, because
competing demands for cash liquidity may be being made at that time
on the company and the other shareholders. Secondly, if the
relationship has deteriorated the majority shareholders may
consider it unreasonable for the minority shareholder to withdraw
support and capital whilst the majority must continue to provide
There are four common cash exit routes available to minority shareholders:
- The sale of all shares in the company to a third party. Generally, in an LLC, this would require the agreement of 100% of the shareholders, unless the position is modified by the company's articles of association or a shareholder's agreement.
- The sale of the business assets to a third party and subsequent voluntary liquidation of the company. A Board majority is usually needed to sell the business, but a 75% majority will be required to wind up the company and return the cash to shareholders.
- Sale of the minority shareholder's own shareholding in the company. Generally, in the case of a limited liability company, this avenue will be restricted because the other shareholders have the rights to prevent shares being sold to an outsider and in any event minority shareholdings in closed companies have very limited value. Usually, only another existing shareholder wanting to increase its equity will be interested in purchasing such a holding.
- Exercise of a contractual "put option" under which the minority shareholder can require the majority to purchase its shares. This is best documented in the shareholder agreement at the outset, as it is less likely to be agreed in an amicable way once the relationship between shareholders has already deteriorated.
When a put option is framed, two questions are paramount:
- What should be the "trigger" for the exercise of the put option?; and
- How is the option price to be set?
The Sixth Tool - Shareholder Litigation
"There has never been a protracted war from which a nation has benefited" – Sun Tzu
Generally, litigation is the last resort for the minority shareholder because shareholder litigation will often degrade or destroy the company's value, as the parties may argue for years whilst customers, employees and creditors seek to disengage from the business.
The key provision of UAE Law in this context is Article 111,
which makes directors liable to be sued by both the
company and the shareholders. It is the most likely avenue for shareholder litigation. It is open to any minority shareholder to sue the Board majority for "mal-management". In this respect, UAE law places fewer obstacles in the path of suing shareholders than many other jurisdiction (e.g. under common law jurisdictions, there are substantive restrictions on the rights of shareholders to bring action directly against Board members).
Article 114 further amplifies the remedies available under Article 111 by permitting shareholders to bring action against directors in the name of the company for losses suffered by the company. In this way, the shareholder litigation can seek to recover all losses suffered by shareholders, not just the portion referable to the equity holding of the shareholder bringing the claim to court.
Defensive Measures against Shareholder Litigation
One obstacle to shareholder litigation can be the passage of shareholder resolutions exculpating or indemnifying directors of the company.
Article 132 bars directors from voting on general assembly resolutions which might excuse directors of liability for:
- Managerial actions related to their private interests
- Matters relating to an existing dispute between the directors and the company.
Article 136 of the CCL provides grounds to resolve general assembly resolutions where the partners have chosen to pass resolutions:
- Without consideration of the company's interests and in favour of a particular group of shareholders; or
- Which cause damage to the company's interests; or
- Which confer "a private benefit" upon directors or third parties.
An interesting question arising under the CCL is the likely degree of effectiveness of release and/or indemnity provisions in the company's articles of association which purport to absolve directors from liability for claims brought against them by the company or by shareholders.
I think it is reasonably clear that such provisions are, by implication, inconsistent with Article 111 of the CCL to the extent that they purport to exclude any claim brought under that provision. Article 111 would override any such release or indemnification provision contained in the company's articles of association.
What is Missing from the UAE Minority Shareholder's Toolkit?
Important protections for the minority shareholders found in other legal jurisdictions are not available in the UAE. Therefore, these statutory protections must be replaced by other protections when the articles of association and shareholders agreements are negotiated.
I think there are three important gaps under the existing UAE Commercial Companies Law:
- Shareholders have no remedy under the CCL for majority conduct
amounting to undue prejudice, discrimination or oppression. The
closest parallel to this type of remedy is the "abuse of
power" ground which can be used to found a claim against
directors under Article 111 of the CCL. There are also grounds for
voiding a shareholder resolution contrary to the company's
interests (refer Article 136).
In my view, the CCL should give minority shareholders legal recourse where there is calculated and systematic unfair treatment of the minority. It would be a worthwhile reform to add a right to bring claims against majority shareholders for conduct of this nature, as well as directors.
- Minority shareholders have no legal avenue to obtain access to sensitive corporate information - even where that information relates to related party dealings.The only recourse is the unused provisions of Article 170. These could take considerable time to argue in court as the wording of the provisions almost invites objection by the company in every case on the grounds that disclosure would be prejudicial to the company's interests. The solution to this problem of confidentiality found in other jurisdictions is to deny the shareholder direct access to corporate records and information but to give access to an independent lawyer or financial advisor representing the shareholder. The legal obligation of confidentiality then binds that independent person. This can provide the court with a higher level of confidence that the confidential information will not be used to the detriment of the company. It will also benefit minority shareholders, by facilitating indirect but nevertheless effective access to information which would otherwise be denied.
- There are no controls imposed by the CCL over related party transactions, even those involving directors. The regulation of related party transactions has been addressed in the context of listed companies by recent corporate governance regulations issued by the SCA. But agap remains in the case of unlisted companies. A closely related problem for minority shareholders who seek to attack and prevent improper transactions is the general unavailability of urgent interim protective orders, which in other jurisdictions are used to suspend or restrain proposed corporate actions pending a detailed examination of their propriety by the courts.
In the UAE the onus is on minority shareholders to display self-reliance and to use the tools available to them to construct their own defences against exploitation or mismanagement by the majority. These defences need to be constructed using the available tools at a very early stage of the relationship and embedded in legally binding shareholder's agreement. The key terms of this agreement should also be reflected in the formal statutory documents such as the memorandum of association and the articles of association.
The legal protections need to be carefully integrated with practical control (e.g. controls of access to funds, selection of the signatories to bank accounts and selection of officers authorised to apply for labour visas etc).
If these precautions are taken, minority shareholders should be able to protect their interests effectively.
But the most important precaution to take is to select your majority business partners with the utmost care.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.