United Arab Emirates: New UAE Bankruptcy Law – How Are Creditors Protected?

Last Updated: 25 November 2016
Article by Adrian Low and Justine Reeves

In our previous two briefings on the Bankruptcy Law, we have looked at a summary of the key changes made by the Law, and the potential personal liability faced by directors of UAE companies in financial difficulty.  In this briefing, we turn to creditor protection.

In the current economic conditions, creditors of UAE businesses are focused on their chances of debt recovery.  How will the Law assist?

Take-away points from the new Law

  • Promotion of business rescue, reduced power for smaller creditors:
    • decriminalisation of bankruptcy
    • stay of proceedings forbounced cheques
    • new AED 100,000 minimum threshold and debtor notification requirements for creditor-led bankruptcy
  • No "Chapter 11" equivalent - no statutory process for consensual restructurings
  • Bond holders no longer a separate class for voting purposes
  • Special provisions for landlord creditors
  • Provisions to allow new financing with higher priority
  • Removal of statutory requirement for "close connection" for set-off/netting arrangements
  • Clarification of creditor rankings on liquidation

What are the key issues for creditors with the current regime?

The current UAE corporate insolvency regime has been long in need of an overhaul to be fit for the country's modern economy.  According to the World Bank's Doing Business 2016 report, the UAE ranks 31st overall out of 189 countries, but just 91st in "Resolving Insolvency". 

Some of the issues with the current regime include:

  • The risk of criminal prosecution for "bankruptcy by default" and bounced cheques – it is argued that this encourages traders in financial difficulty to abscond rather than attempt to restructure their businesses.
  • Culturally, bankruptcy is not considered a normal part of economic risk and reward, and there is often reluctance to admit when a business is in financial difficulties.
  • The procedures in the Commercial Code are court-driven.Court insolvency schemes are generally costly, time-consuming and, in some cases, more unpredictable than out-of-court consensual arrangements.

In an attempt to address these problems, the UAE Bank Federation introduced a scheme (the mini insolvency law) earlier this year, allowing debtors a 15-day period to agree a restructuring scheme with creditors, followed by 90 days in which the banks would refrain from "pre-emptive action", including prosecution in the courts and travel bans.  The arrangements applied to companies with minimum borrowings of AED 50 million or a turnover of more than AED 100 million.  The Federation continued to lobby the government to modernise the UAE's insolvency laws.

Decriminalisation of bankruptcy

The decriminalisation of bankruptcy under the Law signals an important change in approach by the UAE government.

  • The failure to file for bankruptcy within 30 days of a payment default ("bankruptcy by default") will cease to constitute a criminal offence.Although not actively prosecuted, the threat of criminal action was sometimes used (or abused) by creditors to force settlement of their outstanding debts – this will no longer be an option.
  • The Law contains provisions allowing for proceedings in respect of bounced cheques issued by a debtor to be stayed once a preventive composition or restructuring scheme has been initiated.However, potential criminal liability has not been removed entirely, and the common practice of banks and other creditors to require post-dated cheques is expected to continue - albeit that the negotiating leverage of the holder of such a cheque has been reduced.

These provisions are part of a number of measures in the Law designed to encourage debtors to address their financial difficulties quickly by offering some legal protection for those who do so.  The promotion of a "rescue culture" in the UAE is in the interests of creditors overall.

The triggers for bankruptcy

The test of "bankruptcy" under the Commercial Code is solely based on cash flow, with the ability of a creditor to initiate bankruptcy proceedings triggered by a payment default of any magnitude. 

New balance sheet test

The Law introduces a new "balance sheet" test.  The test cannot be invoked by a creditor to initiate bankruptcy proceedings – only by the debtor itself or, if it is regulated, by the relevant regulator.  A debtor that is insolvent on a balance sheet basis must file for bankruptcy (and cannot file for preventive composition). 

The "balance sheet" test applies where the assets of the debtor are, at any time, insufficient to cover its debts.  The relevant debts for this test seem to be only debts actually due and payable, rather than contingent or prospective liabilities.  If this is the case, this is a significant limitation: the inability of the debtor to meet the totality of its financial commitments into the foreseeable future, weighed against its likely trading performance, will not be a trigger.

Cash flow test

Important new requirements have been added in respect of the cash flow test from a creditor's perspective. A creditor or group of creditors may only initiate bankruptcy proceedings where they hold ordinary (i.e. unsecured) debts of at least AED 100,000 and have issued a written demand for repayment which has not been satisfied within 30 business days.  For a smaller creditor who does not meet the AED 100,000 threshold, it may not be straightforward to identify other creditors to join in taking action, in particular as the annual accounts of most UAE companies are not publicly available.  In other jurisdictions, the trigger for a creditor application is usually lower (for example GBP750 (approximately AED3,500) in the United Kingdom).

The applicant must lodge cash or a bank guarantee of up to AED 20,000 at the court to cover the costs and expenses of considering the application. 

Potential practical consequences

Amongst the issues facing creditors in the current economic climate is debtors juggling their debts and extending payment periods.  The Law does not make it easier for creditors to tackle this type of behaviour, particularly smaller trade creditors.  Although a well-advised debtor and its management should be wary of such behaviour in light of the potential civil and criminal liability that may arise in the event of an eventual winding-up, this may not be a sufficient deterrent to a debtor which is convinced it can "trade out" of its current financial difficulties. 

Prospective and contingent creditors will also be unable to apply for a creditor led bankruptcy in the UAE regime, so for large financial institutions, where the debtor is making repayments, the banks have no official process to fall back on to force the debtor to assess its longer term prospects.

Business rescue - no US Chapter 11 equivalent

One of the aims of the Law is the promotion of a rescue culture.  To do this, the Law includes both a "preventive composition" process (where a debtor is in financial difficulty but not insolvent) and a "restructuring scheme" (as part of a bankruptcy procedure).  Notably, however, both processes are subject to the scrutiny and control of the court. 

The Law does not include a statutory process to facilitate consensual settlement between a debtor and its creditors, similar to the US Chapter 11 process, which, although court supervised, does not require court approval.  Informal consensual restructurings are not prohibited, however, and initiatives such as the mini-insolvency law (see above) may well continue. 

One drawback to using an informal out-of-court process in the UAE (in contrast to Chapter 11 and the court processes in the Law) is the lack of a moratorium on claims against the debtor and its assets, to give the debtor "breathing space" to reach agreement with its creditors.  A debtor must rely on creditor agreement to not pursue claims, although it is not usually practical to reach such an agreement with all creditors.  As a result, there is a risk that one of those other creditors, such as a small trade creditor, may apply to court for an insolvency process against the debtor and defeat the consensual arrangement.  Under the Law, the high AED100,000 threshold and notification requirements for creditor-led bankruptcy proceedings (see above) should restrict the ability of smaller creditors to derail such a process.  This may be seen to benefit not just businesses, but also larger lenders such as banks, who have more to lose on a liquidation, in circumstances where there is still a viable business.                                  

The Law provides for the establishment of a new "Financial Restructuring Committee".  It is hoped that this Committee may introduce further measures to support consensual restructurings in the UAE in the future.

Business rescue – role and rights of creditors

The procedures for both the preventive composition and the restructuring scheme under the Law are largely similar to the processes currently available under the Commercial Code.  There are, however, several differences of note from a creditor's perspective:

  • Publications in English:  notices required by the Law, including invitations to creditors to file their claims, are now required to be published in local newspapers in English as well as Arabic.  We have seen a similar move towards requiring publications in English in the new Commercial Companies Law 2015.  This is a helpful development for international creditors. 
  • Lists of creditors: currently, the trustee for a composition or scheme is required to lodge a list of creditors with the court.  There is a new requirement in the Law for a breakdown of the debts to be published in the newspapers.  Creditors may not appreciate their exposure being publicly revealed in this manner.
  • Creditor classes and voting thresholds:  currently, any composition or scheme requires the approval of a majority in number of ordinary creditors, provided that the majority represents at least two-thirds of the debts, and creditors cannot vote in respect of their secured interests.  Under the Commercial Code, however, in preventive compositions non-attending creditors and their debts are not counted in determining whether these majorities have been reached.  This will no longer be the case under the Law, where the majorities apply in respect of all admitted ordinary creditors and their debts.  This gives a blocking power to smaller creditors who are more likely to be absent, if they form a majority in number.
  • Bond holders: under the Commercial Code, where a company has issued bonds of an amount in excess of 20 per cent. of its total debt, or where the composition or scheme will alter the rights of the bonds, the approval of the bond holders as a separate class is required.  This requirement has not been carried over in the Law, although the court may appoint a committee of bond holders to review and comment on the composition or scheme.
  • Recovery rate for a preventive composition: the Commercial Code expressly requires any preventive composition plan to provide for settlement of not less than 50 per cent. of the debt.  This requirement does not appear in the Law, so it will be up to the requisite majority of ordinary creditors to determine what is acceptable in the circumstances.
  • Extensions: unlike the Commercial Code, the Law provides for a composition or scheme to be extended beyond three or five years, respectively, for a further three years with creditor approval.  This adds helpful flexibility.
  • Moratorium: as mentioned above, once the court has agreed to initiate proceedings either for protective composition or a restructuring scheme, a moratorium applies to prevent claims against the debtor.  Whilst under the Commercial Code, secured creditors may bring or continue court proceedings in relation to the specific assets over which they hold a security interest, under the Law, secured creditors will have to seek the court's permission to initiate enforcement proceedings.
  • Secured assets: as mentioned above, agreement to a composition or scheme is a right given to only unsecured creditors.  Secured creditors must still waive their security interests if they wish to vote in respect of a composition or scheme. 
  • Disposal of assets:  as part of a composition or scheme, the trustee is entitled to sell assets.  To the extent that any such assets are subject to security, a debtor may propose alternative security of equal value to a creditor and if the creditor rejects this proposal the court may nevertheless order it.  If any secured assets are sold, the proceeds will be distributed to the creditors secured by the asset first.
  • Set-off and netting: under the Commercial Code, set-off and netting arrangements are enforceable on a bankruptcy to the extent that the rights and obligations of the parties are considered to be "connected".  A connection will arise if the right and obligation arise from a single cause or if they are comprised by a "current account".  The Law does not include such a requirement.  Any proposed set-off or netting arrangements should be set out in the proposal for the composition or scheme, and the court will have discretion to approve such arrangements regardless of whether they are sufficiently "connected".
  • New money: the court may, at the request of the debtor or the trustee, allow the debtor to obtain new finance as part of a composition or scheme, which will have priority over any existing ordinary debts.  Such new finance may be secured either on unsecured assets of the debtor, or on assets already subject to security (ranking behind existing security unless the relevant secured creditor agrees otherwise).  This is very helpful to enable consolidation of existing debt and reducing the number of creditors.
  • Rent debts: one of the more significant outgoings for businesses may be rental payments on commercial premises.  As with the Commercial Code, the Law contains specific provisions which deal with the rights and obligations of the debtor and the landlord creditor.  In particular, in a restructuring process, the trustee may terminate the lease early with 45 business days' notice (or a shorter period if specified in the lease) and the premises may be sub-let with court approval, even if sub-letting is prohibited in the lease.  The landlord may also terminate the lease early, either with court approval if the rent guarantee is no longer sufficient, or if the rent has not been paid for at least three months in the period of the restructuring process.  The landlord does not have a right under the Law to terminate for non-payment of rent before a restructuring process commences, although a well drafted lease may provide for this contractually. 
  • Recovery of assets: as under the Commercial Code, provisions are included to allow the recovery of goods held by the debtor on behalf of another, for example pursuant to a retention of title, factoring, hire purchase or other form of quasi-security arrangements.

Priority of debts on liquidation

The Law clarifies how the rights of creditors rank on liquidation.  The list of priorities is as follows (and, within each class, claims rank equally):

  1. Secured creditors to the extent of their security.Reasonable fees and expenses incurred in the sale of the relevant assets are deducted before distribution.Any shortfall in the value of the asset ranks as an ordinary debt
  2. Costs and expenses incurred in respect of the liquidation process, such as court fees and the fees of the trustee and experts
  3. Unpaid end of service gratuity, wages and salaries of employees of the debtor (not including allowances, bonuses etc.), in total not exceeding a maximum of 3 months' salary.The court may permit the payment of salaries for a period of not more than 30 days
  4. Judgment debts
  5. Amounts due to governmental bodies
  6. Fees, costs and expenses which arise in connection with the provision of goods and services to continue the business of the debtor after proceedings have been initiated.

Conclusion

The aim of the Law is the promotion of a "rescue culture" in the UAE, leading to fewer "skips", more restructurings and, ideally, higher recovery rates for all creditors.  Its success will depend on whether, in practice, debtors initiate the statutory procedures, and how effective the UAE courts and experts are in implementing them.  Appointing appropriately skilled trustees and experts is also key, which will depend on the level of fees they are permitted to charge for their services.  So, whilst the Law is a move in the right overall direction for creditors, the infrastructure to support the Law will also need to develop.

New UAE Bankruptcy Law – how are creditors protected?

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.

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