What the UAE’s new insolvency framework means for entrepreneurs

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In 2009, it took a MENA company 3.5 years on average to go through the insolvency process, with a value erosion rate of 14 percent.

In December 2009, the Dubai government issued Decree 57 to facilitate court-ordered insolvency processes for the Dubai World family. Its first test case, the 2012 restructuring plan on the part of Drydocks World (a subsidiary of Dubai World), was hailed as a precedent and a solid case study of modernizing the United Arab Emirates’ insolvency framework.

In the recovery years that followed, debtors fearful of criminal proceedings against defaults continued to skip town.

In September 2016, a new bankruptcy law, Law No. 9,  was published in the UAE’s official legal gazette. The prospect of its coming into effect by the end of that year was welcomed by the market’s business stakeholders, as the UAE ranked 99th in 2016, and 104th in 2017 on the World Bank’s Ease of Doing Business Resolving Insolvency index.

What’s new?

Covering commercial trading companies that are not governed by separate insolvency regimes – essentially, UAE SMEs with the exception of those registered under DIFC and ADGM – the law paves the way for insolvency proceedings in cases of debt exceeding AED 100,000 (just over US $27,000) and unpaid for more than 30 days. It includes measures for preventative composition, financial restructuring, the raising of new funds, and the liquidation of debt-laden companies.

Older legal insolvency provisions offered untested arrangements for protective composition and restructuring. The new law’s strong suit is in the decriminalization of the time period of bounced checks for insolvent companies undergoing court-mandated restructuring, and, on a macro level, a more ordered timetable and structure for salvaging companies in dire financial straits.

Theoretically, debtors who have begun for bankruptcy or other proceedings within 30 days of being considered insolvent are protected from criminal penalties or creditor claims raised against them. Should they exceed this time period, or in cases of liquidation - an entirely separate process -  within 45 days of defaulting, the law also entails provisions that subject them to legal action by creditors for negligent bankruptcy, including imprisonment up to a period of two years. However, this cannot be generalized as it will eventually boil down to the court's decision as to the severity of the penalties.

Richard Catling, senior associate at Al Tamimi & Company, noted that, in the past, bankruptcy law provisions were typically “spread across multiple sources [...] and they were rarely used, mainly because they were not really understood.” The result? “There was not really an insolvency regime in the UAE,” and equally, a need for a business-friendly environment where creditors would need to take a hit on their exposure.

And this is precisely where roadblocks could arise.

The new law’s strong suit is in the decriminalization
of the time period of bounced checks. (Image via Stockvault)

Which way will the pendulum swing?
Criminal sanctions for bounced checks have historically served to allay the concerns of unsecured creditors.
The new law does not typically apply to secured creditors – namely banks, which hedge against default risk with securities. Unless they relinquish their securities, banks do not hold voting rights in the restructuring process, only collateral. In tandem,
the mortgage of movables law, published in the official legal gazette in December 2016, oscillates between allowing more flexibility for lenders in taking over diverse company assets and placing greater limitations on the nature of those assets.

The pendulum can swing either way, but so far it has gone in the creditors’ direction. For debtors dealing with unsecured creditors, it is not entirely clear whether or not the decriminalization of bounced checks would apply to, for instance, post-dated checks.

According to the UAE Banks Federation (UBF), among the top challenges facing entrepreneurs attempting to secure financing in the UAE are ‘insufficient securities’ and ‘weak governance.’

Creditors might think that “the company is trying to pull a fast one” under the protection of the new law, as Adrian Low, partner at law firm Clyde & Co., put it. But they should equally reason that having to deal with restructuring is preferable to contending with absconding debtors.  

The court...and its discontents

Ideally, debtors need an ironclad guarantee that they can resolve sticky financial situations through the law – not out of court, and the earlier, the better. In the absence of a legal framework, debtors had been resorting to agreements outside of the law, and often, remotely, to restructure finances and settle disputes with creditors.

Under the new law, third-party bankruptcy trustees are empowered by a broader scope of authority; but their appointment works to the advantage of debtors only during protective composition stages. At any later stages, such appointments would be at the discretion of creditors.

Bankruptcy trustees would also curb the court’s involvement in an otherwise court-intensive process. That’s a good thing, providing judges are trained and experts available. The UAE’s Ministry of Finance is currently training judges for restructuring processes.

The upshot of it all

As Law No. 9 shapes up, a new bankruptcy framework will provide a more solid alternative, and in many instances a lifeline, for entrepreneurs struggling with cash flow.

In a startup ecosystem marred by aversion to risk-taking, UAE entrepreneurs will feel that they have more skin in the market. The law so far is of little relevance to self-funded, seed, or early-stage entrepreneurs that report to institutional investors or VCs, but it will ease the process of winding them up should shareholders collectively agree on the viability – or lack thereof – of their companies if and when creditors are involved.

SMEs struggling with cash flow won't simply skip the country and try to remotely restructure their finances. Under legal protection, they have time to repay debt, restructure, refinance, or simply, revive their business if it holds potential.

The law is applicable to any entrepreneur
who takes unsecured credit. (Image via Pixabay)

The law is applicable to any entrepreneur who takes unsecured credit. Crowd-lending platforms in the UAE such as Beehive are also taking note of the new law. Beehive takes its cue from banks, in that it requires security checks from debtors. In that sense, the law could conceivably pose a threat to its lenders, by giving more leeway to absconders.

But Craig Moore, Beehive’s CEO, asserts that the platform’s mediator modus operandi is precisely that of the new bankruptcy framework. “We don’t really [cash in] our security checks, [but rather] try to work with businesses; because it’s not in our investors’ interest to try to push businesses into bankruptcy.”

Moore is a firm believer in out-of-court collaboration between creditors and debtors, but he also sees value in the law curbing creditors’ authority to “pull trade finance or overdraft lines” and essentially crunch SME liquidity. How it will all play out in a risk-averse market will come down to mindsets first, and legalities second.

Feature image via Stockvault.

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