Shareholders' agreements are extremely common in the UAE and have been for some time. This is due in part to a long-standing requirement under the Commercial Companies Law of the United Arab Emirates (Federal Law No. 8 of 1984, as amended) (the "Companies Law") stipulating that every limited incorporated within the UAE must have one or more national shareholders whose share in the company's share capital must not be less than 51%. In other words foreign parties are limited to 49% ownership in UAE companies, subject to some exceptions made for ownership by nationals of the Gulf Cooperation Council (GCC) states.
Accordingly into entering shareholders' agreements between foreign investors and their UAE partners is one way protect the (minority) interests of those foreign investors in UAE companies.
Where the company in question is owned entirely by UAE or qualified GCC nationals there may be a less of an impetus for a shareholders' agreement to be put in place. However these agreements are increasingly being accepted as necessary in any event as part of good commercial practice.
There are no formal requirements for shareholders' agreements in the UAE. Contracts concluded in written or oral form and even by telephone are given equal recognition by the Civil Code (Federal Law No. 5 of 1985, as amended). Commercial practice however is to have a written shareholders' agreement signed by the parties.
It is important to note that there are important formal requirements stipulated under the Companies Law for the Memorandum and Articles of Association ("Memorandum") of each LLC and for any subsequent Schedule of Amendments to the Memorandum, altering its terms. These documents – which are themselves contracts among the stakeholders - will often be drafted to conform their terms to substantive matters provided for under a shareholders' agreement or to include key aspects of such agreements. The Memorandum or any amendments must follow strict the form requirements of the Companies Law, must be executed by the parties before a notary Public and must be properly filed with the Department of Economic Development or similar authority in the Emirate in which the company is formed.
Limits on Term
There is no limit on the term of the shareholders' agreement itself; it is simply a matter of contract. However the Companies Law does require the Memorandum of a limited liability company to stipulate an expiry date for the company (Article 224). The Memorandum of such companies may state varying terms for the existence of the company – ranges of between 5 to 50 years are not unusual. The Memorandum may also stipulate rights of renewal for the stipulated terms.
Assignments of Shares and Preemption Rights
The Companies Law stipulates that:
a. No assignment of shares will be effective if:
i. It results in the shareholdings of the national shareholders of the company being reduced to less than 51% of the total shares of the company; or
ii. Results in the increase in the number of shareholders in the company in excess of the number prescribed for a private company (currently 50); and
b. Where a shareholders does wish to sell his shares in the company he is entitled to do so subject to the preemptive rights of existing shareholders as set out in the Companies Law.
These statutory preemptive rights deserve some special consideration given their importance in the general scheme of corporate law in the UAE. Under Article 231 of the Companies Law where a shareholder proposes to assign his shares to a third party non-shareholder (whether for value or not) he must first offer to sell his shares to the remaining shareholders. Each shareholder has the right (pro-rata to their holdings if more than one take up the offer) to purchase the shares of the departing shareholder at any agreed price or, in the absence of agreement, at a value determined by the auditors of the company. If at the expiry of 30 days from the date of the initial notice none of the shareholders has exercised their right to acquire the departing shareholder's shares that shareholder shall be free to dispose of his shares.
No shareholders' agreement can deprive a shareholder of this fundamental right although many such agreements augment or flesh out the terms of the preemptive rights – for example providing guidelines to the company's auditors for valuation methodology or setting out basic representations and warranties to be given by the departing shareholder on the sale of his interest. So long as such terms do not violate the terms of the Companies Law or other applicable law they will in all likelihood be permissible.
The parties may also seek to include other contractual restrictions into their shareholders' agreement and potentially company Memorandum. Again to the extent that these do not contravene the law or in particular impinge upon a shareholder's legislated preemptive rights they will be acceptable restrictions. Such restrictions would include "lock-ins", drag along and similar rights and buy-sell provisions.
Shareholders in UAE companies are motivated to enter into shareholders' agreements as a matter of best practice for the same business reasons as in other jurisdictions, namely to set out their respective rights and obligations and to protect their local commercial interests.
This latter concern is of particular importance to foreign parties conducting business through limited companies where their UAE partner has no real involvement in the business itself. This is often the case in the UAE where the local shareholder merely acts as a "sponsor" to the commercial activity carried on by the foreign party. This type of arrangement is often enshrined in a form of shareholders' agreement under which the local national is systematically stripped of his shareholders' and management rights and proportionate share of the company's profits while the de jure ownership is reflected in the company's Memorandum and trade licence. The same type of arrangement may be accomplished through other forms of agreements such as trust declarations in favour of the foreign party or though loan and pledge arrangements.
While common these types of arrangements are not favoured in the UAE. On a strict reading of the Companies Law these types of "side agreements" as they are known are legally void. In fact in 2004 the UAE Federal National Counsel enacted Federal Law No. 17 of 2004 - the Anti-Concealment (Fronting) Law for the purpose of fighting the quasi-established practice of implementing side agreements in commercial activities. The Anti Fronting Law provides that that any arrangement designed to circumvent the ownership requirements of the laws of the UAE would be considered unlawful, punishable by fines and possibly imprisonment.
To date the Anti-Fronting Law has not been implemented. The UAE courts have - pending the law's implementation - recognised the interests of foreign parties in considering the validity of such agreements however they have also required the companies subject to such arrangements to be dissolved subsequently. Foreign parties entering the UAE market need to be aware of these considerations when entering into the agreements relating to their local company.
Reconciliation with Memorandum
Unlike many jurisdictions, entering into a unanimous shareholders' agreement in the UAE does not bind the parties to the exclusion of the company's constating documents. Under the Companies Law, where there is a discrepancy between these constating documents and the terms of a unanimous shareholders' agreement, with few exceptions, the provisions of the Memorandum will prevail.
A properly drafted shareholders' agreement together with a compatible company Memorandum can be structured so as to protect the minority. The Companies Law does provide some rights to minority shareholders most notably the right to receive the annual audited accounts of the company and to inspect its books and records. The shareholders' agreement can expand upon these terms so that the minority will be able to monitor the business operations of the company.
The law also provides that special majorities may be set for decisions of the board of managers of a company and that special majorities in excess of statutory requirements (being 50% for ordinary resolutions and 75% for amendment of the company's Memorandum) can be established for shareholder resolutions. These majorities can be set at a threshold sufficient to require minority input, effectively giving them "negative control" over the company. However in order to be effective these types of provisions – while they can be embellished or expanded upon in a shareholders'' agreement – must be included in the company's Memorandum.
Valuation on a Sale or Valuation Event
The UAE does not have its own accounting standards. International Accounting Standards are widely used for the preparation of financial statements for distribution to shareholders, government bodies, and banks or upon the occurrence of a valuation event under a company's Memorandum or shareholders' agreement.
The Companies Law provides that a company's auditors are required to value the company in the event that shareholders cannot agree a price on the triggering of shareholders' preemption rights. The parties should also be required under the shareholders' agreement to appoint an independent firm of chartered accountants or independent business valuator to effect the valuation on the occurrence of a valuation event.
Asset, market and income based valuation are all valid methods of valuation dependent upon the nature of the business. A clause in the shareholders' agreement to the effect that any required valuation will be based on the valuation principles promulgated by the International Valuation Standards Council would be enforceable in the UAE and is advisable to ensure a degree of certainty impartiality and fairness in the valuation process.
Dispute Resolution - Litigation
Shareholders' agreements for UAE companies are generally stated to be governed by UAE law. However the parties are entirely free to elect the governing law of their contracts and jurisdiction of their choice, including the law and jurisdiction of another country. There are some practical problems however in the election of a foreign law or in adhering to the jurisdiction of a foreign court.
Enforcing a foreign judgment within the UAE can be a difficult matter. The UAE is a party to very few treaties relating to the reciprocal enforcement of judgements with any countries outside of the Gulf region (France currently being the sole European exception) and UAE law imposes stringent requirements on the judgements of non-treaty states as a prerequisite to permitting their enforcement.
Dispute Resolution - Arbitration
The parties may also wish disputes arising under their agreements to be settled by arbitration. A reasonable choice for companies with operations in the UAE, depending upon the circumstances, would be to stipulate for arbitration in the Dubai International Arbitration Centre ("DIAC") under the DIAC Rules.
It is also completely permissible for the parties to elect for arbitration for the settlement of their disputes and to choose the governing law they wish, including a foreign forum. However foreign arbitration awards may be easier to enforce than the judgements of foreign courts. The UAE ratified the UN Convention on the Recognition and Enforcement of Foreign Arbitral Awards in August of 2006.
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.