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Company Law

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DIFFERENT TYPES OF BUSINESS ORGANISATIONS

There are different types of business organizations or business associations.

These range from small, individually owned businesses to large multi-national

corporations. There are at least three categories of business organization in the

UAE excluding the free zones (e.g. D.I.F.C Zone)

Company Partnership Sole trader

Private company Public company Limited liability company Partnership limited in/by/with shares

General partnership Limited partnership

Sole trader business

UAE Sole Trader Formation

A sole trader is a structure in which a business is owned by one person, acting

under their own name or using a 'trading name'. This person is fully liable for the

company's debts and contracts and there is no distinction in law between the

business and their own personal wealth i.e. unlimited liability. He is

liable/responsible to the extent of his own personal assets for the business's

debts. This means that their personal possessions are at risk. It is a “sole”

proprietorship in the sense that the owner has no partners. This is the most

straightforward structure for a business.

Basically it means the business decisions are being made by one person. Of

course, it doesn’t necessarily mean that the business has only one worker. The

sole trader can employ others to do any or all of the work in the business. Being

a sole trader is the simplest way to get started in business. Once you have

informed the government agencies of your intentions to go self-employed, you

can start trading right away (subject to any specific licenses you might require in

your line of work).

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An Establishment, or Sole Proprietorship, is a simple structure whereby an

individual is issued a trade license in their own name, permitting them to trade

or conduct business activity on their own account. The sole proprietor is held

personally liable to the full extent for all assets and liabilities incurred by the

business.

Mainly, it is only UAE nationals and nationals of GCC countries (subject to certain

conditions) who are permitted to form establishments in UAE. However, in

recent years, a practice has evolved whereby a UAE national obtains a license for

an establishment and leases it to an expatriate(s) for an annual fee. These

expatriates, then, take on all management functions of the business and retain

all profits. This type of Arrangement, though common, is not recommended as it

is fundamentally unlawful and problems may arise if the business relationship

between the parties breaks down.

Certain foreigners in selected fields may form sole proprietorships if they reside

in the UAE. This is also referred to as “Professional Firm”. These include

professional consultants in:

A) medical services,

b) engineering fields,

c) the legal profession,

d) computer services,

f) artisan activities and similar services.

A professional firm of foreign sole proprietor is required to appoint a local

service agent. The local service agent must be a UAE national, but he has no

direct involvement in the business and is paid a lump sum and/or percentage of

profits or turnover. The role of the local service agent is to assist in obtaining

licenses, visas, labor cards, etc.

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Partnership

1. General Partnership:

General partnerships are between two or more partners who are jointly or

severally liable to the extent of their personal assets for all of the liabilities of

the partnership. The name of a general partnership should consist of the names

of all of its partners or may be restricted to the name of one of its partners with

words to indicate the existence of a partnership, or it may have a special trade

name.

There is no prescribed capital requirement for general partnerships and no

negotiable shares are permitted to be issued due to the personal nature of the

company. Similarly, assignment of a partner’s share without the consent of all

partners is not permissible and any contract to the contrary is deemed to be

void. The names of the person(s) who will manage the company is required to be

set out in the company’s Memorandum of Association and decisions in a general

partnership have to be unanimous unless the memorandum provides otherwise,

in which case, the management is carried out in accordance with such

provisions. All the partners of a general partnership have to be UAE nationals.

Memorandum of Association: is a written constitution that governs or regulates

both the company’s (or firm’s) relations with the outside world and its internal

affairs.

Resolutions: this is the method by which companies or firms decide what they

are going to do. When decision has to be reached at a meeting the manger or

chairman will ask the members to vote on a resolution. In a general partnership

have to be unanimous unless the memorandum provides otherwise. For

example, memorandum of Association may allow resolutions to be passed by a

simple majority i.e. 50% + 1.

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(Article 42) The Memorandum of Association of a general partnership shall

contain the following:

a. Name and purpose of the company.

B. The company's registered office and the branches thereof.

C. The capital and shares undertaken by each partner whether paid in cash or in

kind, the estimated value of these shares, subscription method and due dates.

D. Date of establishment, and expiry, if any.

E. Management of the company and names of authorized signatories and the

extent of their respective powers.

F. Commencement, and expiry, dates of the company's financial year.

G. Rate of distribution of the profit and loss.

(Article 45/3)

Unless the Memorandum of Association allows for a majority of votes, general

partnerships shall adopt resolutions made by unanimous voted the partners'

unanimous votes, and unless otherwise stipulated in the Memorandum of

Association, "majority" shall mean numerical majority of votes. Resolutions

pertaining to the amendment of the Memorandum of Association shall be valid

only in taken by the partners' unanimous votes.

Features of Partnerships

a. The ordinary rules of contract apply between partners, for example, the

partnership is voidable if induced by misrepresentation, and it is void if

formed for an illegal purpose.

b. Partners are known collectively as a ‘firm’. The name under which they

carry on business is the ‘firm name’.

c. The actions of one partner can bind the whole firm.

d. Partners are jointly liable for ALL the partnership’s debts - They do NOT

have limited liability.

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e. Death, insanity, retirement or bankruptcy of any partner automatically

dissolves the entire partnership, (unless otherwise provided). For

example, a partner has the power to withdraw and dissolve the

partnership. The surviving, or remaining, partners have the right to

continue a partnership after its dissolution. When a partnership is

continued, the old partnership is continued, the old partnership is

dissolved, and a new partnership is created.

Advantages

(1) Ease of formation – no written agreement or registration required.

(2) Greater privacy - minimum of state regulation

(3) All partners have a right to participate in management of the business

Disadvantages

(1) No separate legal personality. This means that the business is the same as the

owners. Debts owed by the firm are deemed to be owed by the members. Wrongs

done by the firm are deemed to be done by the members.

(2) No limited liability. Partners fully liable for firm’s debts. This means there is no

limit to the partners’ liability. Any debt owed by the firm could be satisfied from

the personal fortunes of the partners.

(3) Difficulties of finance. More difficult to raise loans; floating charge not available

to use as security.

(4) No perpetual succession. A partnership is dissolved on

departure/bankruptcy/death of a single partner and then wound up.

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2. Limited Partnership:

This type of entity is constituted by general or active partners and limited or

sleeping partners. General or active partners take an active part in the

management of the company and are jointly liable to third parties to the extent

of their personal assets for all of the liabilities of the partnership, while sleeping

partners do not interfere in the management of the company against third

parties and their liability is limited to the extent of their share capital in the

partnership. Limited or sleeping partners may however take part in the internal

administration of the firm to the extent permitted by the Memorandum of

Association. A limited partner’s name cannot be mentioned as part of the name

of the firm.

A limited partner may be held liable personally to third parties if he holds

himself out as a general partner and third parties are induced to believe so.

Internal decisions in a limited partnership are valid only by unanimous consent

unless otherwise provided in the Memorandum of Association. Only UAE

nationals may be active partners, however, limited partners may be non UAE

nationals. Limited partnerships are prohibited to issue negotiable shares in the

form of instruments. There is no minimum capital requirement.

COMPANIES

Companies are the most advanced form of business organisation. A company

comes into existence by a process known as incorporation.

Definition of ‘Company.’

An artificial legal person i.e. a personality created by incorporation rather than

by birth.

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Upon incorporation, a company becomes a body corporate and assumes a separate

identity in law distinct from those of its members. Even though the company is

owned by its members, it is regarded as different from those members. The law in

a sense throws a veil between the company and its members/shareholder.

Formation of Companies

The process of formation of companies is generally referred to as incorporation.

Companies formed in accordance with the registration procedure stipulated by the

Companies Act are referred to as registered companies. Most companies now are

registered companies and we shall concentrate on such companies.

Registration of Companies

The documents needed for registration of companies are:

(a) A copy of Memorandum and Articles of Association. This is a formal document

stating the subscribers of the company and number of shares they have taken in

the company.

(b) An application for registration. The application must contain the following

particulars:

- A statement containing particulars of the first directors and secretary of the

company and their residential and service addresses. This statement must

be signed by or on behalf of the subscribers to the memorandum. It must

also contain consent by each of the persons named in it as director or

secretary to act in the relevant capacity. A private company need not have a

secretary. The shareholders have the power to appoint and remove

directors but at this stage the company does not have shareholders and this

explains why the founding members/ subscribers have the power to

appoint the first directors. However, subsequent directors will be

appointed by the shareholders.

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- The company’s proposed name

- Statement of intended location of the company’s registered office

- The type of company

- A statement of capital and initial shareholding – This is a statement as to the

amount of share capital the company proposes to start business with. Only

companies limited by shares are required to provide this statement. The

statement should include the total amount of the share capital, its division

into smaller units, the classes of shares and number of shares in each class

and the rights attached to each class of shares, the number of shares taken

by each subscriber, and the amount paid and owed on each share.

All these documents would then be submitted to the Registrar of Companies. Once

the necessary documents have been lodged and the registrar is satisfied with

them, the registrar of issues a certificate of incorporation. The certificate will

contain the name of the company, the date of registration, type of company, and

the situation of the company’s registered office. The certificate of incorporation is

conclusive evidence that the requirements of the Companies Act have been

complied with, and that the association is a company authorised to be registered

and is duly registered under the law.

Classes of shares:

a. Ordinary shares: These are the most common. They carry no special

rights. Dividends are payable to ordinary shareholders after the

preference shareholders have been paid.

b. Preference shares: They carry special rights in relation to dividends. A

preference share confers the right to receive a specified

amount/percentage of dividends before any dividends are paid for other

ordinary shares. The right to dividends is deemed to be “cumulative”.

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This means that if dividends are not paid in any year, they are carried

forward to the following year.

c. Redeemable shares: these are shares issued on the understanding that

they could be bought back by the company at a fixed date or when the

company desires. They give temporary membership and are used to raise

capital when needed. In other words, redeemable shares are used to raise

short-term funds without intending to make the holders permanent

member of the company.

Classification of companies as Private companies or Public companies

The main characteristics of a public company are as follows:

1. The capital is represented by negotiable shares publicly subscribed to

with provision for rights issues;

2. The minimum capital requirement is UAE Dirham 30,000,000 and a

minimum of 5 founding members are required to subscribe to a minimum

of 30% and a maximum of 70% of the share capital of the company.

3. The management vests in a Board of Directors consisting of a minimum of

three and a maximum of 11 persons, the chairman being a UAE national;

4. The liability of its members or shareholders is limited to the extent of

their respective share value.

5. There is indefinite duration and separate legal personality;

6. The shares are freely transferable provided always that 51% of the shares

are held by GCC nationals.

7. They are allowed to offer their shares for sale to the general public.

The main characteristics of a private company are as follows:

1. They are not allowed to offer their shares for sale to the general public.

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2. The minimum capital requirement is UAE Dirham 5,000,000.

3. The management vests in a Board of Directors consisting of a minimum of

three and a maximum of 11 persons, the chairman being a UAE national;

4. The liability of its members or shareholders is limited to the extent of their

respective share value.

5. There is indefinite duration and separate legal personality;

6. This type of company is constituted by at least TWO founding members and

maximum of 200 who fully subscribe to the company’s capital between

themselves.

Advantages of incorporation

The following features/characteristics of incorporation should be noted:

(1) Incorporated companies enjoy separate legal personality different from that of

the members.

(2) Members enjoy limited liability for the company’s debts (for limited

companies). This means the members are liable to pay only the amount

outstanding on their shares, or in the case of a guarantee company, the amount

they had undertaken to pay on liquidation.

(3) Companies are easier to finance; they attract more loans and can use floating

charges

(4) Companies have unlimited capacity for growth. A small company can become a

large conglomerate

(5) A company has perpetual succession. This means the members may come and

go but the company could theoretically live forever.

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Disadvantages of incorporation

(1) Detailed state regulation means that incorporated companies do not have as

much privacy as partnerships or sole proprietorships. Companies, especially public

ones, have to file notices of its decisions and annual returns of its activities with the

Registrar of Companies. The Companies Act provides a compulsory framework,

which all companies must comply with.

(2) Formation of companies involves some formalities and expense in comparison

to sole proprietorship or partnership.

(3) For a company to cease to exist it must be formally wound up and then

dissolved. Partnerships and sole businesses do not have to follow such formalities

before ceasing business.

(4) Owners of companies may lose control of the business to outsiders who invest

money in the company. Companies may also be taken over by other companies

against the wishes of some owners.

Limited Liability Companies (LLC):

Limited liability companies must have at one and not more than fifty partners. Each

partner is liable to the extent of his share capital. LLC must be owned 51% by the

UAE nationals or 100% by GCC nationals. In other words, should there be a foreign

(Jordanian, US, British...etc) partner, then at least 51% of the LLC must be owned by

UAE nationals. The company is prohibited from issuing negotiable share

certificates; carrying on the business of insurance, banking and investment of

funds; resorting to public subscription for raising its capital and accepting deposits

or taking loans from the public.

The shares of the company should be divided into equal shares. Partners enjoy a

right of pre-emption in respect of shares to be transferred by any partner of the

company to third parties. If any partner wishes to transfer his shares to a third

party the existing partners have the right within thirty days of receiving notice, to

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purchase the shares offered for sale at a mutually agreed price. If no price can be

agreed, the company’s auditor must value the shares and existing partners may

purchase the shares at that price. If the existing partners do not elect to purchase

the shares offered for sale within the period of thirty days from receipt of notice,

the partner offering to sell the shares is free to sell them to third parties.

In August 2009, the UAE President, His Highness Sheikh Khalifa bin Zayed Al

Nahyan, issued a decree amending certain provisions of the UAE Commercial

Companies Law Federal Law 8 of 1984 (CCL) with respect to reducing the capital

required to form new businesses. Previously, a new limited liability company (LLC)

was required to have share capital of at least AED300,000 in Dubai and a minimum

of AED150,000 in the other Emirates. The amendment now enables partners in LLCs

to determine what they consider to be sufficient capital requirements for

establishing their company.

The LLC must have at least one manager (no maximum is prescribed by the NEW

UAE COMPANY LAW 2015) who may be appointed under the Memorandum of

Association or by a separate agreement. The manager(s) may be an expatriate and

maintain full authority to manage the affairs of the company.

If there is more than one manager the Memorandum of Association may provide

for the formation of a Board of Directors and may specify the method of operation

of the board and the majority required for passing its resolutions. If the number of

the partners in the company exceeds seven, supervision of the company must be

entrusted to a Board of Supervisors from at least three of the partners.

I explained earlier that company's constitution (memorandum and articles of

association) is a contract between all the members (shareholders) of the company.

One objective/aim of this constitution is to protect shareholders' rights (right to

vote, right to attend meetings, right to receive dividends etc...). However, some

shareholders still prefer to enter into another agreement between themselves

called "side agreements" or "shareholders' agreements" to protect their rights. A

question arises here: why would shareholder enter into another agreement? Isn't

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the company's constitution adequate to protect shareholders' rights? One simple

answer is that some shareholders are looking for more security and that is why

they prefer to enter into side agreement (they want to get better protection). A

detailed answer as to why shareholders prefer to enter into such agreements is

shown below.

Two main reasons why shareholders in the UAE enter into a shareholders'

agreement:

1. To protect minority shareholders

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.

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So, minority shareholders can protect themselves by insisting upon a

shareholder's agreement (sometimes called a "minority protection agreement")1

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, 95%, 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;

Altering or amending the company's constitution.

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 154 of the CCL, in the absence of express provisions in the

company's articles of association, requires prior shareholder approval to the

1 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.

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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

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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.

2. To circumvent or avoid the ownership requirement (51/49) specified in the UAE

COMPANY LAW

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.

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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.

Formal Requirements

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

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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 79 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.

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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.

"Side Agreements"

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

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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.

So, in view of the Companies Law requirement to have a minimum 51% of the

shares in UAE companies owned by UAE nationals, the foreign shareholder will

often have entered into a “side agreement” with the UAE shareholder.

The side agreement probably provides for the following:

Only the foreign shareholder has contributed to the share capital of

the company and accordingly owns all the share capital of the

company.

The foreign shareholder is the sole owner of all the assets and the

trade name of the company and is the actual agent with respect to

distribution agreements and commercial agencies of the company.

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The UAE shareholder is the custodian and trustee with regard to the

51% shares registered in his name.

The UAE shareholder will waive/give up any shares held by him in

the share capital of the company in case of liquidation of the

company (whether in the form of in kind dividends or public

auction proceedings or amicably).

The entire profits and losses in the company will be earned/borne

by the foreign shareholder except for an agreed percentage of the

net profits of the company (agreed percentage).

The UAE shareholder will not claim any right to the profits

generated by the company except for the agreed percentage.

The UAE shareholder acts only as the local sponsor for the company

to obtain and renew the licences, visas and work permits relating to

the company and its employees.

The UAE shareholder is entitled to an annual fixed fee (fixed fee) at

the beginning of each financial year for acting as the local sponsor

for the company in addition to the agreed percentage.

The UAE shareholder is entitled to 10% interest on undistributed

amounts of the agreed percentage at the end of the financial year,

to the extent that the company did not distribute profits in the

relevant financial year.

The foreign shareholder, represented by an individual, is appointed

as the manager of the company.

I explained earlier that one aim of a shareholders' agreement is to circumvent

the ownership requirement specified in the UAE Company law and that such

agreement is null and void. But what if a dispute occurs between the UAE

shareholder/partner and the foreign partner/shareholder? On one hand, the

company's constitution shows the UAE partner owns 51% of the company's share

capital. On the other hand, the side agreement either shows that the UAE

partner has not actually contributed to the company's share capital (zero

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contribution) or that he has contributed to less than the limit specified by the

UAE Company law (e.g. 15% of the company's share capital). In such cases, we

have two contradicting documents namely the company's constitution and the

shareholder's agreement. So, which document/agreement will prevail over the

other one? In Dubai courts, judges are willing to enforce and recognize side

agreements but they will liquidate the company (bring the company's life to an

end). However, Abu Dhabi judges, as shown below, have recently declined to

enforce and recognize side agreement.

Abu Dhabi Court’s approach - Side Agreements and their enforceability

In a dispute between a UAE investor and a foreign investor, the parties disputed

over whether a side agreement or the official Memorandum of Association

(MOA) governed their relationship. The UAE investor insisted that the official

MOA is the valid document whereas the foreign investor argued that the side

agreement states that the foreign investor has a greater percentage in shares

and that the side agreement is the valid/ applicable agreement to govern the

relationship between the two parties.

As outlined in the previous article, the matter had been decided in favour of the

UAE investor at the first instance and appeal levels, however the foreign

investor appealed further to the Supreme Court.

In its judgment, the Supreme Court held that the side agreement can be

established by any means of evidence and allowed the parties to hear testimony

of witnesses.

When the Court of Appeal heard witnesses brought in by the foreign investor

and rejected the claim, the parties appealed again to the Supreme Court. The

Supreme Court considered the evidence and decided that there was enough

evidence to prove the existence of the side agreement and subsequently

directed the Court of Appeal to look into this. Upon review of the evidence, the

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Court of Appeal issued its judgment confirming the existence of the side

agreement.

The UAE investor appealed for the third time to the Supreme Court contesting

the validity of the side agreement and it is this appeal which is the subject

matter of this update.

This recent judgment handed down by the Federal Supreme Court demonstrates

a unique position on the issue of side agreements and the removal of a partner

in a company. The judgment sheds light on the validity and enforceability of side

agreements in the context of a 49/51 UAE limited liability company. The

judgment also addressed a very important issue on whether the majority

shareholder can request the court to remove any of his partners/shareholders

and the grounds for such request. The case is discussed in detail below.

Background

A dispute arose in relation to a limited liability company in Abu Dhabi between a

UAE shareholder (owning 51 % of the shares), an Omani shareholder (owning 24 %

of the shares) and a US company (owning 25 %). An action was filed by the UAE

shareholder requesting confirmation of its entitlement to 51 % of the profits

according to the shareholder’s agreement. The UAE shareholder also requested

the court to issue judgment for the withdrawal of the Omani shareholder on the

basis that the Omani shareholder had not been cooperative and caused loss to

the company as a result of his lack of cooperation. The Omani shareholder

argued that the partners in the company signed a side agreement and entered

into an arrangement whereby the UAE partner would own 37.5 % of the shares,

the Omani partner would also have 37.5 % and 25% was owned by the US

Company.

Court of First Instance

The matter progressed before the Court of First Instance and the court issued

judgment in favour of the UAE partner on the basis of the official documents

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(the Memorandum of Association) which confirmed that he was the owner of

51% of the shares of the company. The court however rejected the request of the

UAE partner to expel the Omani partner.

Federal Court of Appeal

Both the UAE and Omani partners appealed further against the judgment and

the Court of Appeal rejected both appeals and upheld the lower judgment.

Federal Supreme Court

Both parties appealed further to the Federal Supreme Court. The Federal

Supreme Court ruling highlighted two important issues:

Side agreements

The general principle in UAE Evidence law is that a written contract can only be

contradicted by written evidence, except where the opponent waives his right

to documentary evidence or where there is an agreement to defraud the law.

When the fraud exception to the general principle applies, the party against

whom the fraud was made can use all means of evidence including testimony of

witnesses to prove that the official agreement is not genuine vis-à-vis the side

agreement.

Withdrawal of the Omani shareholder

The UAE shareholder requested the court to dismiss the Omani shareholder as a

result of the losses he caused the company to incur. The Court of First Instance

refused to accept the UAE shareholder’s request on the basis of articles 37, 47

and 63 of the Commercial Companies Code. These articles mandate that a

numerical majority is required and in these circumstances, only one shareholder

out of three requested the dismissal. This was followed by the Court of Appeal

however this was reversed by the Federal Supreme Court (as discussed below).

Federal Supreme Court

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The Federal Supreme Court decided that what is legally required is the majority

of shares rather than a majority of the partners and accordingly a shareholder

owning a majority of the shares could request the court to dismiss a partner

based on sufficient reasons to justify the request. As the UAE shareholder owned

51% of the shares he could request the dismissal of the Omani entity on the basis

of the following articles:

Article 677 of the civil code provides:

(1) It shall be permissible for a majority of the partners to apply for a judicial

order dismissing any partner if they adduce serious reasons justifying the

dismissal.

(2) It shall likewise be permissible for any partner to apply for a judicial order

that he cease to be a partner in the company if the company is of defined

duration, and he provides reasonable grounds for such application.

(3) In both of the foregoing events the provisions of Article 675 (2) shall apply to

the share of the dismissed or withdrawing partner, and such share shall be

assessed in accordance with its value on the date the claim was brought.

Article 675 (2) provides that ‘it shall likewise be permissible for an agreement to

be made to continue the company as between the remainder of the partners if

one of them dies or is placed under a legal restriction or becomes bankrupt or

withdraws, and in those events such partner or his heirs shall be entitled only to

his share in the assets of the company…’

In light of the above, the Federal Supreme Court overruled the Court of Appeal

judgment and remanded the case again to the Court of Appeal to look into the

appeal and consider the directions of the Supreme Court.

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The Court of Appeal

Upon re-trial, the Court of Appeal gave the Omani shareholder the opportunity

to call witnesses to prove his side agreement. However, the case was dismissed

for lack of evidence confirming ownership of the UAE partner for 51% of the

shares. The court also dismissed the appeal filed by the UAE partner to remove

the Omani partner on the basis of lack of evidence to support such request.

Both parties appealed again to the Supreme Court. The Omani shareholder

argued that it has submitted sufficient evidence to establish the side agreement

but argued that the Court of Appeal neglected this issue. The UAE shareholder

filed its appeal insisting on its request to remove the Omani shareholder.

Federal Supreme Court

The Federal Supreme Court confirmed that the Court of Appeal neglected to

look at evidence confirming the Omani’s shareholding. The Court of Appeal did

not address the side agreement which contains a clause (Article 20 of the

contract) Article 20 of the side agreement states that “Each of the parties

acknowledges that they hold shares equally in the company.” The profits and

losses of the firm were distributed equally under Clause 20. This is in addition to

various other documents which prove that the profits and losses were

distributed equally between the two companies and not based on the official

51/49% shareholding of the UAE Company.

The Federal Supreme Court, however, rejected the appeal filed by the UAE

shareholder on the basis that there was no evidence to support its request to

remove the Omani shareholder.

The Supreme Court therefore overruled the Court of Appeal judgment for the

second time and returned the case back for retrial to look into the documents

and arguments raised by the Omani shareholder in support of the side

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agreement.

As a result of this judgment the request of the UAE partner to expel the Omani

partner became final and the only issue that remained to be addressed by the

Court of Appeal was the issue of the side agreement as argued by the Omani

partner.

The Court of Appeal Judgment –upon retrial

As a result, the Court of Appeal heard the case again (for the third time) in order

to decide whether or not there are sufficient documents to establish the

existence of the side agreement/arrangement as argued by the Omani partner.

Upon reviewing all the documents submitted by the Omani partner, the court

concluded that there is sufficient evidence to establish the existence of the side

agreement between the parties (and that the shares have been distributed on

the basis of 37.5% to the UAE and Omani partners and 25% to the US Company).

Comment

In this case, it was clear that the shareholders of the company could continue the

company’s business on the basis of the side agreement. In the event that one of

the parties wanted to dissolve the company, a separate court judgment would

be needed to dissolve the company on the basis that the company lacked the

required legal corporate structure as the UAE partner’s shares had been

declared to be less than 51%, however the partners may need to decide whether

or not their interest are better served by living with the side agreement and

continue with the company or dissolve it.

LATEST SUPREME COURT JUDGMENT

The Supreme Court ruled on this matter for the third time and in this latest

judgment, the Supreme Court decided very differently to the last decision and

declared that the offical MOA as registered with the authorities is the valid

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agreement that governs the relationship between the parties and not the side

agreement.

The Supreme Court relied on Articles 8, 10 and 11 of the Commercial Companies

Law (CCL) and held that it is imperative for all agreements relating to

commercial companies to be in writing, notarised and registered in the

Companies Commercial Register so as to comply with the requirements of the

CCL and that all amendments to the company documents (i.e. Memorandum of

Association) must also be duly notarised and registered in the same manner as

the MOA.

In this case, the Supreme Court concluded that as the side agreement was not

notarised or registered in the Companies Commmercial Register, it is therefore

null and void.

Reminder of the facts of the case:

A dispute arose in relation to a limited liability company in Abu Dhabi between a

UAE shareholder and an Omani shareholder over the ownership of the actual

shareholding in a limited liability company. Legal action was commenced by the

UAE shareholder requesting confirmation of its entitlement to 51% of the shares,

assets and profits of the company according to the official memorandum of

association (MOA) of the company as officially registered and declared with the

competent authorities. The Omani shareholder, however, claimed that it owned

more than it’s registered shares (as reflected in the side agreement).

COMMENTS ON THE JUDGMENT

1. It is apparent that this Union Supreme Court judgment contrasts with the

previous two judgments by the same court (in the same dispute) which

previously decided that side agreements are not null and void if they were not

notarised or registered pursuant to Articles 8,10 and 11 of the CCL. The court in

the former two rulings held that the parties can even hear witnesses to prove

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this matter. The court also held that the side agreement can be concluded from

various documents and not necessarily from a single written agreement and that

such agreement is valid even without notarisation.

2. The new ruling is therefore a material change from the Supreme court’s

former rulings on the issue of side agreements. As side agreements are not

official agreements, they cannot be notarised or registered in the Commercial

Register.

3. The main purpose of the side agreement is that it is binding between the

two parties only and concealed from the Commercial Register. This purpose

would not be achieved if there was a requirement to notarise it or file it with the

Commercial Register. This has been confirmed by the Supreme Court itself in

former rulings. The side agreement also includes provisions that cannot be

notarised or accepted by the official authorities such as the shareholding

percentage which is usually different from the official documents.

4. It is to be noted that this latest judgment did not address the effect of

Article 395 of the Civil Code. Article 395 provides that: “If the contracting parties

conceal a true contract with an apparent contract, the true contract will be the

effective one as between the contracting parties and a special successor.” If Article

395 had been addressed by the Supreme Court, it is possible that the court would

have produced a different result.

5. It should also be highlighted here that although this judgment addressed

the issue of the validity of the nominee agreement with regard to the official

MOA, it has not however, adressed the issue of whether the rights of the parties

under the MOA should be liquidated as a result of the invalid nominee

agreement.

6. The judgment also did not address the issue of the date the invalidity

occurs i.e. whether it is from the inception of the company or from the date of

the judgment.

7. In view of the above judgment and the previous Supreme Court decisions

on the same matter, it should be noted that the courts in future cases, will not

necessarily decide that all side agreements are null and void. Each case will be

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decided on a case by case basis and the arguments raised above (in paragraphs

3, 4, 5 and 6) may also appear in separate matters in the future.

Capitalisation of UAE companies

As a general rule, companies in the UAE must have a minimum national

shareholding of 51 per cent. Companies based in the free zones are not caught by

such ownership restrictions - although their ability to do business in the UAE

outside the free zone is restricted.

The most common forms of corporate vehicle in the UAE are limited liability

company (LLC) and joint stock company (public and private), with LLCs tending

to be the more commonly used vehicle for international investors establishing

joint venture operations.

As well as differences relating to board representation and governance

generally, the other clear distinction between the company forms is the

minimum share capital required. A Private JSC requires a minimum share capital

of AED5 million (AED 30 million for a Public JSC) and an LLC has historically

required a minimum of just AED150,000 in Abu Dhabi and AED300,000 in Dubai.

However, the minimum amount for LLCs has now been removed, although the

authorities will expect the LLC to be established with a sufficient level of capital

to conduct its proposed activities (there are no guidelines as to how this will be

assessed). Certain sectors also impose additional or higher levels of capital.

Both LLCs and JSCs must allocate 10 per cent of their net profits each year to a

statutory reserve, but this allocation can be suspended if the reserve reaches an

amount equal to 50 per cent or more of the company’s total equity share capital.

There has accordingly been a preference for shareholders of highly capitalised

UAE companies to put shareholder funds in by way of loan (as opposed to

shares), thereby avoiding the need to reserve more than necessary – an

approach assisted by the absence of any thin capitalisation rules in the UAE.

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Partnership Limited With Shares:

A partnership limited with shares is a company formed by general partners who

are jointly liable to the extent of their personal assets and participating partners

who only participate in the capital and are jointly liable with the general partners

only to the extent of their shares in the capital of the company. All general

partners must be UAE nationals whereas participating partners may be non-UAE

nationals. The capital of a partnership limited with shares must be divided into

negotiable shares of equal value.

The names of the general partners must be part of the name of the partnership. If

the name of a participating partner is mentioned, with his knowledge, as part of

the partnership name, such a partner becomes liable towards third parties.

The capital of the company must not be less than UAE Dirhams 500,000. The

management of the partnership is entrusted to one or more general partners

under the Memorandum of Association. A participating partner may not, even with

consent of the general partners, deal with third parties. He may, however, be

actively involved in the internal management of the company within the limits laid

down in the Memorandum of Association. Every partnership limited with shares

must have a Board of Supervisors consisting of at least three members from

amongst the participating partners or others. The board of supervisors does not

take part in the day to day management of the company but performs a

supervisory function and may request managers to present reports of their

management and examine the company’s books and documents.

Free Zones in the UAE

In recent years, the UAE has become host to many free zones which offer

foreign investors numerous benefits such as 100 per cent foreign ownership (in

contrast to the 51 per cent minimum national shareholding mentioned above),

guaranteed tax free status, a one-stop-shop of support services (including

licensing and visa sponsorship procedures) and other advantages such as high

33

technology facilities and services and real estate infrastructure. In most free

zones it is possible to establish either a branch or representative office of a

foreign company or to establish a limited liability company.

There are numerous free zones in the UAE - each has its own geographic

boundaries and regulations and most have been established to accommodate

certain types of activity (such as media, education, manufacturing and financial

activities).

A free zone company is generally excluded from operating in the UAE outside of

the free zone in which it is incorporated. Despite their physical locations, free

zones are generally considered to be offshore jurisdictions and entities

operating from such zones are not permitted to carry out their activities onshore

in the UAE. Therefore, if a free zone company wants to conduct business in the

UAE outside of the free zone in which it is registered, it will in theory need to

enter into an agreement with a local agent or distributor in the UAE or establish

a formal presence, such as a branch office, onshore.

However, in a recent development, HH Sheikh Mohammed bin Rashid Al

Maktoum, Vice President and Prime Minister of the UAE and Ruler of Dubai has

issued a new licensing law which, amongst other things, provides that, in

coordination with the free zone authorities, the Dubai Department of Economic

Development may authorise free zone entities to practice their activities

onshore in Dubai. Although a welcome move, no additional clarification has been

given as to the circumstances in which such authorisation will be granted and

the conditions which must be complied with - the full effects and

implementation of the new law therefore remain to be seen.

THE NEW UAE COMMERCIAL COMPANIES LAW: A COMPARATIVE VIEW

The new Companies Law (“New Law”) as approved by the Federal National

Council introduces some incremental reforms to the existing Companies Law

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(“Existing Law”), but mostly maintains the fundamental framework and features

of the old provisions.

Whilst the New Law introduces some new concepts and approaches, most of the

essential features of the Existing Law are maintained. Despite media

speculation, the New Law applies the same conservative approach in relation to

foreign ownership restrictions under the Existing Law, so foreign investors are

limited to 49%. Also, the New Law does not allow sell-downs in IPO deals.

By the same token, the majority of board seats, including the chairman of the

board, of public joint stock companies must be held by UAE nationals. Founders

of public joint stock companies continue to be restricted by a lockup period of

two years under the New Law, which defeats sell-down exist options in IPOs.

Also, the New Law has not reformed the governance of limited liability

companies through introducing a proper board of directors’ structure, but has

maintained the old form of governance by “managers”. However, the restriction

on the number of managers under the Existing Law (namely five managers) has

been lifted under the New Law.

On the other hand, the New Law introduces some new concepts. For example,

the New Law:

allows for sole-shareholder companies, in limited liability companies;

addresses employees’ incentive share schemes;

enables shareholders in pubic joint stock companies to sell their

preemption rights (rights issue);

facilitates strategic share placements by public joint stock companies

within pre-emptive complications;

prohibits financial assistance (in line with the international market

practice);

enables the legal pledge of quotas in limited liability companies. Some

other reforms are discussed below in details.

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This note aims to shed some light on the main differences between the New Law

and the Existing Law, the fresh concepts enacted under the New Law, and to

highlight the practical impact of these differences.

This note follows the same sequence of the New Law.

Detailed Views

General Rules:

1. Article 5 – Free Zone Companies – Free zone companies are exempted from

the application of the New Law. However, it is to be noted that article 5 states

that there will be a Cabinet decree that will set out the conditions which should

be followed in registering free zones companies in case these companies wish to

operate onshore or outside the borders of the free zone in question.

2. Article 6 – Corporate Governance – The New Law provides that private joint

stock companies will be subject to corporate governance rules provided that

such companies are composed of more than 75 shareholders. A ministerial

decree setting out the applicable corporate governance rules will be issued in

due course. The expected corporate governance rules will include financial

penalties on board members, managers and auditors of any defaulting company.

3. Article 8 – The Concept of “sole founder” – The New law provides for the

first time the concept of having a company with a sole founder. This applies on

limited liability companies.

4. Article 10 – Local Ownership – The New Law continues to follow a

conservative approach in respect of local ownership restrictions, so companies

must be owned 51% by the UAE nationals or 100% by GCC nationals (LLC

COMPANIES).

5. Article 24 – Exclusion of Liability – The New Law introduces an explicit

clause stipulating that any provision in the articles of the company allowing the

company or any of its subsidiaries to agree to exclude any person from their

current or previous liability towards the company will be void. However, this

36

article does not address the provisions that may be agreed upon between the

shareholders in separate shareholders agreement (in particular between

nominees and beneficial owners) whereby one of the shareholders is excluded

from liability. Unexpectedly, this clause prohibits the exclusion of liability in

general without limiting the exclusion to liability arising out of gross negligence

or willful misconduct, as provided under the Civil Code.

6. Article 26 – Companies Accounting Books – New obligations are imposed

on companies to retain their accounting books for a period of not less than five

years from the end of each financial year. This is a new requirement under the

New Law that is not provided for under the old Law. This provision comes in line

with similar requirements in other Middle Eastern jurisdictions. Also, companies

may retain electronic versions of their documents provided that these

documents will be saved in compliance with a decree to be issued by the

Minister.

7. Article 28 – Financial Year – Each financial year may not exceed 18 months

and should not be less than six months. This clause will have an impact on

calculating the lockup period in public and private joint stock companies, as it

will shorten the two/one financial year(s) required with respect to the founders

of public/private joint stock companies. Likewise, it will affect the timeline

required to convert a limited liability company to a public joint stock company as

provided for under article 275 of the New Law.

8. Article 32 – offering of shares to public – This article explicitly prohibits any

company (either in one of the free zones or onshore) from making any

advertisements or marketing to invite general public to subscribe in shares

without obtaining the prior approval of SCA. Under the Existing Law, there is no

explicit provision prohibiting such practices, but rather it is a matter of practice

and unwritten rules followed by SCA.

9. Article 36 – Retention of Documents - Similar to article 26 referred to

above, article 36 provides that the Minister will issue a decree setting out the

time limit for companies to retain corporate documents.

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Rules Governing Limited Liability Companies

1. Article 71 – Sole ownership –Article 8 provides that a limited liability company

may be established by one natural or corporate person. This approach follows

free zone regulations which allow the incorporation of a free zone

establishment (FZE), which originally is a common law concept. Under the old

Law, limited liability companies may only be established by a minimum of two

founders and a maximum of fifty. The maximum limit of fifty partners still

applies under the New Law.

2. Article 79 – Pledge of Quotas (shares) - The New Law provides that limited

liability quotas (or shareholdings) may be pledged. The old company Law is

silent in respect of pledge of quotas, and so it is questionable whether quotas

can be pledged legally. This new development will assist raising of debt finance

by owners of limited liability companies and will enhance the security package

that can be offered to the financiers. Pledge of quotas will add another level of

comfort to beneficial owners of quotas (foreign investors) in respect of their

shareholding relationship local registered owners (nominee).

3. Article 80 – Preemption Rights – preemption rights are still mandatory by

operation to law under the New Law, as is the case under the old Law.

4. Article 83 – Company’s Managers – Under the New Law, companies may

appoint one or more managers without setting out a maximum number of

managers. Under the old Law, the maximum number of mangers is five.

5. Article 86 – Competition – Under the New Law, manager(s) of a company may

not be allowed to operate any business in competition with the business of the

company in question. Defaulting manager(s) will be discharged and compensate

the company accordingly. This matter is not addressed under the Existing Law.

6. Article 93 – Invitations to General Assemblies– Invitations to general

assemblies need to be sent out 15 days before the date of the meeting or less

than 15 days if all partners agree. Under the old Law, the notice period required

is 21 days which may not be abridged.

38

7. Article 96 – Quorum for General Assemblies – Under the New Law, general

assemblies will not be valid unless attended by partners owning 75% of the

capital of the company. If the quorum is not satisfied in the first meeting, the

second meeting shall be called for within 14 days from the first meeting, which

shall not be valid unless attended by partners owning 50% of the capital of the

company. If the quorum is not satisfied in the second meeting, a third meeting

shall be called for after the lapse of 30 days from the date of the second

meeting, which shall be valid regardless the quorum attended such meeting. This

means that the existing difficulties in achieving quorum general assemblies for

public joint stock companies at the first attempt have been magnified by the

New Law. Resolutions of general assemblies shall only be valid if approved by

partners owning at least 50% of the capital of the company. Under the old Law,

general assemblies may only be valid unless attended by partners owning 50% of

the capital of the company. If the quorum is not satisfied in the first meeting, a

second meeting shall be called for within 21 days from the first meeting, which

shall be valid regardless of the quorum attended such meeting. Also under the

old law, any amendment to the articles of the company requires the approval of

partners owning at least 75% of the capital of the company. However, under the

new law, amendment to the articles of the company requires the approval of

partners holding at least 75% of the votes represented at the general assembly

meeting.

8. Article 103 – reference to joint stock companies rules – Article 103 of the New

Law refers to the rules governing joint stock companies with respect to any

matter which is not addressed under the rules of limited liability companies.

Such reference is not provided for under the old Law.

Rules Governing Public Joint Stock Companies (“PJSC”)

1. Article 107 – Number of founders - PJSC may be established by a minimum of

five founders. Under the Existing Law, PJSC requires a minimum of 10 founders.

This article will facilitate the constitution of PJSC, in particular in the set up

phase before offering the company’s shares to public.

39

2. Article 112 - Founders’ committee – The New Law provides that founders

committee shall be composed of three members without setting out a maximum

limit. Under the old Law, founders committee should be between three to five

members.

3. Article 117 – Founders’ ownership – The New Law provides that founders may

own a minimum of 30% and a maximum of 70% of the capital of the

company. Under the Existing Law, founder may own a minimum of 20% and a

maximum of 45% of the capital of the company. This article will have an impact

in relation to encouraging investors to promote an IPO without facing the risk of

losing their control of their business, as they are allowed to own up to 70% of the

company and offer 30% to public. This will also promote IPOs for companies that

have good financial standing and do not require additional capital inflows which

are high compared to their pre-existing issued capital. Unfortunately, the New

Law does not facilitate or permit sell-downs by existing shareholders, an avenue

already available in most developed markets. Such a reform would have greatly

encouraged new IPO transactions.

4. Article 123 – Underwriters – For the first time in the UAE the New Law

recognizes the role of underwriters. Under the old Law, underwriting activity is

not addressed. There will be a ministerial decree regulating the underwriting

activities to subscribe for unsubscribed shares and resell them again in the stock

market. The facilitators of underwriting could enable the IPO market to flourish

and attract leading global financial institutions to act as underwriters and

develop the UAE capital market.

5. Article 124 - Subscription period – Subscription period opens for a period of a

minimum of 10 days and a maximum of 30 days. Under the old Law, the

subscription period opens for a period of a minimum of 10 days and a maximum

of 90 days.

6. Article 129 – Book Building - The New Law refers explicitly to a book

building mechanism in relation to the pricing of newly issued IPO shares. The

detailed regulations governing and regulating book building will be issued later.

Pricing is to be determined at the discretion of the issuer and the banks at a

40

valuation that is acceptable to investors, the issuer and the selling

shareholder(s).

7. Article 131 – Constitutional General Assembly – Under the old Law,

constitutional general assembly requires the attendance of shareholders owning

at least 75% of the capital. However, the New Law provides that the

constitutional general assembly shall be valid if attended by shareholders

representing 50% of the capital of the company. This article comes as an attempt

to facilitate and expedite the process for incorporation.

8. Article 143 – The Composition of the Board of Directors – Board of directors

under the New Law should be composed of a minimum of three members and a

maximum of 11. Under the old Law, board of directors should be composed of a

minimum of three members and a maximum of 15.

9. Article 144 – Election of Board Members/Expert board members – The New

Law provides for cumulative voting at any election of board members.

Cumulative voting is not provided for under the old Law, but rather it was under

the applicable Corporate Governance rules. The voting mechanics will allow each

shareholder to distribute voting powers amongst various board candidates. This

should increase the chances of minority shareholders achieving board

representations. The Existing Law also allows the general assembly to appoint

“expert” board members who are not shareholders provided that the total

number of “expert” board members may not exceed one third of the total

number of the board of directors.

10. Article 151 – Nationality of Board Members – The requirement under the

Existing Law that the majority of board members and the chairman should be

UAE local nationals continues to apply under the New Law.

11. Article 156 – Board Meetings - Under the New Law, the board of directors

shall meet at least four times a year. Such requirement is not provided under the

Existing Law. This is something that has been dealt with separately under the

Corporate Governance rules.

12. Article 170 – Voidance of resolutions - Any resolution not in compliance with

the provisions of the New Law, or adopted without consideration to the

41

company’s interests in favor of a particular group of shareholders, causing

damage to them or providing a private benefit to the members of the board of

directors or to third parties may be revoked. Proceedings for annulment are

time barred on the expiry of 60 days from the date of adopting the resolution

contested. Under the old Law, the applicable prescription period is one year.

13. Article 172 - Invitations General Assemblies– General assembly invitations

need to be sent out 15 days before the date of the meeting or less than 15 days if

95% of the shareholders agree. Under the old Law, the notice period required is

21 days and cannot be abridged.

14. Article 193 – Issued and Authorized capital – The New Law provides that the

issued capital of PJSC shall be not less than AED 30 million. In addition, the

company may decide to have an authorized capital which may not exceed twice

the value of the issued capital. Authorized capital is defined as the maximum

number of shares that the company is authorized by the constitution

(memorandum and articles of association) to issue. More specifically, under the

old Law, the concept of “authorized” capital is not addressed. A new set of rules

have be issued to allow companies to increase its issued capital within its

authorized capital. By way of explanation, the authorized capital is not more

than a notional concept which has no financial implications or effect. In other

jurisdictions, it only allows the board of directors of joint stock companies to

increase the issued capital within the limits of the authorized capital by a board

resolution instead of having an extraordinary general assembly resolution

(shareholders' consent is not required). So the difference between authorised

capital and issued capital is analogous to the difference between an approved

loan facility and a partially drawn approved loan facility. For example, if the

authorized capital of a company is AED 120 million and its issued capital is AED 50

million. The board members of such company can increase the issued capital

with any amounts until they reach the ceiling of AED 120 million with a board of

directors resolution only instead of holding an extraordinary general assembly

(shareholders' consent is not required). Any increase of capital in excess of the

120 million (authorized capital) should be pursuant to a resolution from the

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extraordinary general assembly of the company; shareholders' consent is

required. So, if the AED 120 million authorized capital has been fully exhausted

by the company's directors, they will not be able to issue a single share/stoke

above the AED 120 million authorized capital without seeking the permission of

shareholders. Therefore, the authorized capital is merely to facilitate procedural

matters associated with capital increases. In the UAE, there will be a ministerial

decree that will set out the procedures by which the issued capital can be

increased within the authorized capital. As for the issued capital, the Companies

law allows the shareholders to pay 25% only of the issued capital of a company

upon its incorporation and the remaining 75% should be completed within 5

years. For example, if the issued capital of a company is AED 40 million, the

shareholder of this company can pay AED 10 million on the date of incorporation

and the remaining AED 30 thousand (75%) over five years.The general assembly

has the right to authorize the board of directors to execute the capital increase

resolution, provided that the board will execute the capital increase resolution

no later than one year from the date of the general assembly’s resolution.

Under the Existing Law, the board of directors has five years to implement any

capital increase resolution of the general assembly.

15. Article 193 – Board’s Authorization - The general assembly has the right to

authorize the board of directors to execute the capital increase resolution,

provided that the board will execute the capital increase resolution no later than

one year from the date of the general assembly’s resolution. Under the old Law,

the board of directors has a period of five years to execute the capital increase

resolution of the general assembly.

16. Article 197 - Sale of Entitlements to Rights Issue – Shareholders have

preemption rights to subscribe for their company’s capital increase (Rights

Issue). Under the New Law, shareholders are allowed to sell their entitlements

under the rights issue to other existing shareholders or to third parties. Under

the Existing Law, this is not possible.

17. Article 207 – Nominal Value of the Share – The New Law provides that the

nominal value of the share is to be paid within three years from the date of

43

incorporation. Under the Existing Law, the nominal value of the share is to be

paid within five years from the date of incorporation.

18. Article 215 – Restrictions on the Transfer of Shares – The founders’ lockup

period of two years provided for under the Existing Law remains the same under

the New Law.

19. Article 222 – Financial Assistance – The New Law prohibits companies from

providing financial assistance to assist one of its shareholders to subscribe or

buy its shares or bonds. The rationale for the prohibition is that the capital of the

company will not be protected if the company assumes financial risk in a

transaction relating to its own shares.

20. Articles 223/224 – Strategic Investor – The New Law allows companies to

increase its capital and allot the newly issued shares to a Strategic Investor

without applying the preemption rights of the existing shareholders to

subscribe for the capital increase in question. A strategic partner is defined as a

partner whose contribution to the company provides technical, operational or

marketing support for the benefit of the company. Furthermore, the strategic

partner is required to have activities that are similar or supplementary to the

activities of the company and have issued two years of financial statements. The

additional conditions relating to such an issue are: (1) a presentation by the

board of directors to the general assembly of the benefits from the entry of the

strategic partner; and (2) a special resolution approved by shareholders holding

at least 75 percent of the votes represented at the general assembly

meeting. This is a new development that is not addressed under the Existing

Law.

21. Article 225 – Debt Capitalization – The New Law explicitly states that a

company may convert its debt to equity/shares; in other words, swap debts for

shares in the company. This is not addressed under the Existing Law. The new

law allows companies to capitalize its cash debts without a pre-emptive offer to

existing shareholders, subject to certain conditions. The conditions relating to

such an issue are: (1) a presentation by the board of directors to the general

assembly meeting of the necessity for the capitalization of debts; and (2) a

44

special resolution approved by shareholders holding at least 75% of the votes

represented at the general assembly meeting.

22. Article 226 – Employees Share Scheme – The New Law explicitly addresses

the possibility of issuing employees incentive share scheme. SCA shall issue a

decree regulating employees share scheme. The old Law does not address this

issue.

Rules Governing Private Joint Stock Companies (“PrJSC”)

1. Article 255/256 – Private Joint Stock Companies – Under the New Law, a

number of not less than two founding members may incorporate a PrJSC. The

founding members will fully subscribe to the capital, which must not be less

than 5 million Dirhams. The old Law provides a number of not less than three

founding members may incorporate a private joint stock company with a capital

not be less than two million Dirhams. Under the New Law, PrJSC may also be

incorporated by two founders and not more than 200 shareholders.

2. Article 264 – Lockup Period – Under the New Law, there is a lockup period of

one financial year from the date of incorporation. Under the Existing Law, the

lockup period is for two financial years.

3. Articles 266/269/272 – Introduction of New Corporate Status – The New Law

sets out a new set of rules that governs new corporate legal structures such as,

holding companies and subsidiaries. In addition, it addresses investment funds

for the first time. A new set of rules and decrees will be issued to regularize

these new legal structures.

4. Penalties Chapter - A new penalties chapter has been introduced by the New

Law which is more extensive than the existing chapter under the Existing Law.

Corporate Personality principle

Upon incorporation, a company becomes a body corporate and assumes a separate

identity in law distinct from those of its members (i.e. shareholders and directors).

45

Even though the company is owned by its members, it is regarded as different

from those members. The law in a sense throws a veil between the company and

its members/shareholder. The company is capable of acquiring its own rights,

duties and obligations. It is able to do most things a natural person could do. The

House of Lords formally established the principle of corporate personality in the

case of Salomon v Salomon & Co Ltd (1897) AC 22.

The facts of the case are as follows: Mr. Salomon ran a successful sole business.

Later he formed a company called Salomon and Co. Ltd. and transferred the

business to the company. He sold his interest in the business to the company partly

in cash and partly in debentures (Secured loan). The other members of the

company were Mr. Salomon’s wife and his five children to whom he allotted one

share each. Subsequently, the company ran into financial difficulties and was to be

liquidated despite the efforts of Mr. Salomon to keep it afloat. The argument was

whether Mr. Salomon was entitled to recover the value of his debentures and

whether he was liable personally for the company’s indebtedness to its unsecured

creditors. The High Court and the Court of Appeal found against Mr. Salomon,

holding that the company should be treated as an agent, alias, or trustee of Mr.

Salomon. An appeal was made to the House of Lords.

Held: That upon registration, the company became separate from Mr. Salomon

who could not be regarded as the company’s agent. Mr. Salomon was therefore

entitled to recover the value of his debenture in the same manner as any secured

creditor. He was also not liable personally to the other creditors. As Lord Halsbury

said:

Once the company is legally incorporated, it must be treated like any other

independent person with rights and liabilities appropriate to itself, and that

the motives of those who took part in the promotion of the company are

absolutely irrelevant in discussing what those rights and liabilities are

46

Even though this principle may in some instances lead to hash results, it is firmly

entrenched in company law as a fundamental principle.

Effects of corporate personality

Because a company a company has a personality, which is separate from the

personality of its members, it means:

(1) Company properties are owned by the company itself and not by the members

Macaura v Northern Assurance Co [1925] AC 619 (insurance) M ran a sole business as

a timber merchant. He had also insured the properties of the business against fire.

He later incorporated a company in which he had a majority shareholding and

transferred the business to it. He did not transfer the insurance policy to the new

company. The properties of the company were destroyed be fire and M sought to

recover from the insurance company.

Held: that he could not recover from the insurance company since the property

covered by the policy belonged to the company, which had no insurance.

(2) Business operations are deemed to be conducted by the company and not by its

members. This is so even though the members or officers appointed by them run

the company’s affairs.

(3) The company’s contractual rights and duties are not those of its members – The

company is able to sign contracts in its own name and the benefits and obligations

arising from them belong to the company and not to the members.

(4) The controller of the company could be its employee - In Lee v Lees Air Farming

Ltd [1961] AC 12, the majority shareholder of the company who was also a director,

was held to be an employee of the company for the purposes of an insurance

contract. And in Secretary of State v Bottrill [1999] BCC 177, it was held that a sole

shareholder/director of a company was to be regarded as an employee of the

47

company for the purposes of recovering a redundancy payment under an

employment contract.

(5) Perpetual succession - Members of a company may come and go but the

company may live on in perpetuity. The death or bankruptcy of a member of a

company does not affect the life of the company. This contrasts with the position

in partnerships which collapses on the death or bankruptcy of a partner

(6) The company can only sue or be sued in its own name - This means a company

can take legal action under its own name and legal action can be taken against the

company using the company name.

(7) It is the company which may go into insolvency. Shareholders are NOT liable

for the company’s debts. If the company becomes insolvent all they lose is the

money they used to buy their shares (and nothing else).

(8) The debts are the debts of the company and not of the shareholders whose

only obligation is to contribute to the company’s assets such amount as is due on

their shares.

Lifting the veil of incorporation

International investors are often concerned about the extent to which

shareholders in UAE companies may be exposed and are keen to understand

whether UAE law recognises the principle of the “corporate veil” by supporting

a doctrine of limited liability for shareholders.

This principle is reflected in the UAE Commercial Companies Law (CCL), under

Articles 105 and 71 which state that:

Article 105 - “Any company whose capital is divided into negotiable shares of

equal value shall be considered a public joint-stock company and a partner

therein shall be liable only to the extent of his capital share.”

48

Article 71 - “A limited liability company is an association of a maximum number

of fifty and minimum of two partners. Each of them shall be liable only to the

extent of his share in the capital, and the partners’ shares are not made in the

form of negotiable instruments.”

As is the case in many other jurisdictions, there are certain exceptions that

would render this protection inapplicable, including articles 72 and 75 of the CCL.

For example, article 72 provides that if shareholders, who are also directors,

neglect to state that the company is a limited liability company or to state the

company’s share capital next to its name in papers issued by the company then

they will be jointly liable to the extent of their personal assets towards the

company’s debts.

However, a decision by the Dubai Court of Cassation on this issue has indicated

that the court takes a strict approach in favour of the corporate veil. The court

said that – in order for a shareholder to be personally liable for the companies’

obligations under article 72 – the claimant had to demonstrate that the failure by

the shareholder to comply with the provisions of article 219 was the main, actual,

direct and inevitable reason due to which the claimant suffered damages and not

due to other reasons related to the company itself, such as winding up or

insolvency for reasons beyond the control of the shareholder. Yet another

decision required an element of bad faith on the part of the relevant

shareholder.

It is possible and indeed simple for unscrupulous and fraudulent people to abuse

the principle of incorporation and separate legal personality. For example people

may form a company not for the purpose of doing any genuine business but in

order to defraud creditors. When found out, such people might argue that the

company they used, and not themselves, was responsible for the fraud. If the

corporate personality principle were applied to the later, the fraudsters would go

free to enjoy their loot. Or people might register a company in order to do deals,

49

which they were otherwise forbidden from doing; or in order to back out of a

legitimate deal; or in order to defraud the Inland Revenue, etc.

The policy of the law is that a legal principle must not be used as an instrument for

fraud or wrongdoing. In certain situations, therefore, the court will ignore the

separate identity or corporate veil of a company to identify and deal with those

behind it. In such circumstances those behind the company would attract personal

responsibility. This is called lifting the veil of incorporation. The importance of

lifting the corporate veil in appropriate cases could be seen from the fact that

companies are artificial persons and therefore not able to do anything themselves.

People behind the veil of incorporation must not therefore be allowed to abuse the

corporate principle. The ability of the courts to lift or pierce the corporate veil is

designed to preserve the integrity of incorporation. The instances where the

corporate veil would be lifted have not been rigidly or conclusively set. The veil

could be lifted by the courts on the basis of precedent and/or public policy. It could

also be lifted by statute.

Note: that the corporate personality is a fundamental principle and that the

corporate veil would not be lifted lightly. The following are examples of

circumstances where the corporate might be and has been lifted.

Paramount public interest or national emergency

Sham or façade companies

Group of Companies

Fraudulent Trading and Wrongful Trading

Evasion of legal obligations

Abuse of legal procedure

Fraudulent Trading

Trading

Wrongful Trading

Civil Liability

Criminal Liability

50

(A) Paramount public interest or national emergency. The veil could be lifted in the

interest of the public or the nation.

Daimler Co. v Continental Tyre Co Ltd [1916] 2 AC 307 (alien enemy) The claimants

(Continental Tyre Co. Ltd), was owed some money by the defendants (Daimler Co.)

under a contract during WW1. The UK was at war with Germany at that time. Both

companies were registered in the UK. It happened that the members of CTC Ltd.

Were German nationals. The claimants sought a court order to enforce the

payment of the debt. Held (HL): That the court could not sanction the payment of

the debt since the owners of the claimant company were enemy nationals at a time

the nation was at war.

(b) Sham or façade companies: the courts have been prepared to lift the veil of

incorporation where it is deemed that the company has been used as sham or a

façade to hide another, dishonest purpose For example:

1. Evasion of legal obligations. The corporate structure cannot be used as an

instrument to escape a binding legal or contractual responsibility.

Gilford Motor Co v Horne [1933] Ch. 935 (restrictive covenant) The claimants

employed Horne, who undertook in his contract not to canvass or solicit the

customers of the claimants if he left their employment. Upon leaving the

claimant’s employment, however, H formed a company with his wife and the

company went about soliciting the customers of the claimants. Held: That the

claimants were entitled to enforce the agreement against H and his company; that

the company was a sham or alias of the H.

Jones v Lipman [1962] 1 All ER 442 (specific performance) The defendant (L)

entered into a contract to sell land to the claimant (J). L however sold the land to

another person. To avoid specific performance of the contract with J, L formed a

new company and transferred the land to it. Held: That the L and his company were

51

bound to perform the contract with J. The company to which he purported to

transfer the land was a sham, a cover to escape his contractual obligation.

In Trustor AB v Smallbone [2001] almost $39m had gone missing from the

claimant company with $20m ending up in a company, I Ltd, which was

essentially a front for S, the managing director of the claimant company. In

order to pursue a claim against S for the $20m, the claimant company needed to

pierce (or lift) the corporate veil to establish that receipt by I Ltd was receipt by

S. The court found that I Ltd was a device used for the receipt of the claimant

company’s money which had been misapplied by S in what the court described

as inexcusable breaches of his duties as a director of the claimant company. As

the veil would be pierced (lifted) in this case, S had no defence to the claim that

he had received the $20m.

Also, in Gencor ACP Ltd v Dalby [2000], a director in breach of his fiduciary duty

had profited personally by diverting to himself business opportunities which

came to him as a director of the company. On an action being brought to hold

him liable to account for those profits, he tried to argue that he had not profited

personally – the proceeds had been paid direct to an offshore company wholly

owned and controlled by the director. The court found that the company had no

staff or business and its only function was to receive these profits. In essence,

the court said, it was no more than the director’s offshore bank account.

2. Abuse of legal procedure. The corporate structure should not be used to

undermine the provisions of the law.

Re Bugle Press [1961] Ch. 270 - The majority shareholders in BP (90%) tried to use

their power to force the holder of the remaining 10% of the company’s shares to

sell their shares. Under the Companies Act, where there is a take-over bid for a

company and holders of 90% of the shares agree to it, the bidding company can

compulsorily purchase the shares of the unwilling members. The 2 major

shareholders in BP formed a company and used it to launch a take-over bid and

compulsory purchase of the minority shares. Held: That the bidding company was

52

the same as the major shareholders of BP. The bid was therefore a fraudulent

attempt to forcefully take the shares of the minority shareholder of the company.

(C) Group of Companies: In the same way as a person can own a company and be

separate from it by means of the doctrine of corporate personality, so can

another company and it is increasingly common for one company (known as

holding company) to set up another (known as a subsidiary company) to take

advantage of the principle of limited liability (See articles 226-269 of the UAE

COMPANY LAW). A holding company is a company that owns at least 51% of the

shares in another company called subsidiary company. A lot of business activities

(whether domestic or multinational) are undertaken through a group structure.

In a group the parent is the owner (controlling shareholder) of the subsidiaries.

A successful company faced with a risky business venture may choose to

incorporate a separate company to exploit the opportunity safe in the

knowledge that, should it fail, only the assets of the subsidiary company can be

used to satisfy its debts, leaving the holding company safe. In this way, it is not

uncommon for large groups of companies to be owned by the same parent or

holding company.

Despite this legitimate use of corporate personality to reduce risk, the courts

have been prepared to ignore the corporate veil and treat the holding company

and subsidiary companies as one and the same. However, this is only under very

particular circumstances. Usually the companies in a group have their own

separate legal personalities, particularly if the subsidiary company leases its own

premises, employs its own staff and people, earns profits, pays its own taxes,

has its own separate bank account, has its own creditors and debtors, and finally

carry on activities on its own account as principal. If this is not the case, then

both the parent and subsidiary companies may be treated as a single economic

entity.

Smith, Stone & Knight Ltd v Birmingham Corporation [1939]

53

Facts: SSK, a paper manufacturing company, acquired a waste paper business

and registered it as a subsidiary company. The parent company held all the

shares except five, each of which was held by its creditors. The profits of the

new company were treated as profits of the parent company, which exercised

total control over the activities of the subsidiary company. When the local

authority exercised its powers of compulsory purchase to take the land occupied

by the subsidiary company, the parent company claimed compensation for

disruption to its business. However, the council argued that the proper claimant

was the subsidiary company, which was a separate legal entity.

The facts in this case concerned the amount of compensation payable on

compulsory acquisition of certain land by a local authority. To maximize the level

of compensation, the holding company argued that it and the subsidiary

company should all be treated as a single entity.

The court held that as the subsidiary company was not operating on its own

behalf but rather on behalf of the parent company, the parent company was

able to claim compensation.

Adams v Cape Industries plc [1990]

Cape, an English company, mined asbestos which it sold through a subsidiary

company in the UK and another in the USA. The US Company was sued by a

number of former employees for injuries arising from exposure to its asbestos

but, as the company had disposed of its assets in the USA, only a successful

action against the UK parent company would secure damages for the claimants.

Therefore, it was necessary for the court to look in detail at the relationship

between the English parent company and the American subsidiary to see

whether the subsidiary was carrying on its own business or the business of the

English parent company.

The court found that it was indisputable that at the very least a substantial part

of the business carried on by the subsidiary at all material times was in every

sense its own business. It leased premises, employed people and carried on

54

activities on its own account as principle. It earned profits, paid its taxes and had

its own debtors and creditors. The court concluded that the business carried on

was carried on by the subsidiary on its own account. The subsidiary was not a

wholly-owned subsidiary but an independently-owned company. While the

English company had provided funding for it, it carried on business on its own

account and not as agent for the English company. Therefore, the English

parent company was not required to contribute to the US subsidiary’s debts as

there is no agency relationship between both. Each company should be treated

as a single entity.

(D) Fraudulent Trading and Wrongful Trading:

When a company goes into insolvent liquidation (i.e. when it is liquidated

because of inability to meet its debts or obligations), it may be necessary to

consider whether officers of the company, especially directors, have by their

actions, contributed to the company's liquidation. If the directors have

contributed to the company's liquidation, they will be facing one of two charges:

they will either be accused of wrongful trading or accused of fraudulent trading.

They (i.e. directors) cannot be accused of both (i.e. wrongful trading and

fraudulent trading). If they have contributed to the company's liquidation, they

(i.e. directors) will be punished (imprisonment & fine) and will be required to

contribute to the company's debts from their own personal assets (so the veil of

incorporation will be lifted). There are different provisions for bringing errant

company directors to account upon winding up. We shall be concerned here

with the provisions on fraudulent and wrongful trading.

1. Fraudulent Trading (Fraudulent bankruptcy)

Meaning of fraudulent trading

Generally fraud means dishonestly obtaining a material advantage by unfair or

wrongful means. Fraudulent trading occurs where directors or other officers of

a company engage in trading with intent to defraud creditors of their company,

any other creditors, or for any fraudulent purpose. In other words, directors will

55

defraud (commit fraud against) others in the name of the company and keep the

profit for themselves. In doing so, directors will maximize the company's

financial losses eventually the company will be put into insolvent liquidation. It

implies that the directors or officers dishonestly engage in and obtain benefits

from a transaction without intending to pay for them or with intent to cheat the

other parties to the transaction.

There are criminal and civil liabilities for directors or other officers of a company

who engage in fraudulent trading.

A) Criminal liability for fraudulent trading

The UAE Penal Code as well as the UAE COMMERCIAL code provide as

follows:

(1) If any business of a company is carried on with intent to defraud creditors

of the company or creditors of any other person, or for any fraudulent

purpose, every person who was knowingly a party to the carrying on of

the business in that manner is liable to imprisonment or fine, or both.

(2) This applies whether or not the company has been, or is in the course of

being wound up.

In other words, if in the course of the winding up (i.e. liquidation) of the

company it appears to the judge that any business of the company has been

conducted with intent to defraud creditors of the company, then those directors

are liable to imprisonment or fine, or both.

This provision is intended to combat corporate crime. An offence is committed if

the business of a company was carried on with intent to defraud creditors of the

company, creditors of any other person, or for any fraudulent purpose.

- Any fraud against any creditors in the course of the company's business

are covered by this provision

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- Dishonesty element must be established in order for the offence to be

committed. Recklessness, unreasonableness or negligence is not

sufficient to establish an offence.

- There must be real moral blame in accordance with current notions of

fair-trading among ordinary and honest people.

- The person concerned must realize, by those standards, that he was being

dishonest. If the director or officer participated in the business without

knowing that it was intended to defraud a creditor, he would not be

liable.

Knowledge implies the person concerned:

- Knows the nature and intent of the business at the time of the

transaction, or

- Deliberately turns a blind eye to relevant information or facts which

indicate fraud, or

- Was recklessly indifferent or careless as to the facts

- Negligence is not enough

Who are creditors?

Creditors of a company include suppliers of goods or services and lenders of

money to the company. It does not matter whether the debts are payable

immediately or at a future time.

What amounts to fraudulent trading?

What amounts to fraudulent trading is a question of fact depending on the

circumstances of each case but it must involve dishonesty and moral blame.

Examples of fraudulent trading:

- Obtaining goods on credit without intending to pay for them

- Receiving large deposits from customers without intending to supply

them with the goods

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- Obtaining loans from lenders by false accounting/documentation

- Defrauding the Inland Revenue Service

There is no need for a line of fraudulent transactions. The offence may be

committed even if only one creditor is defrauded as long as the intent is present.

In Morphites v. Bernasconi (2003), it was held that the defrauding of a single

creditor by single transaction could properly be described as the carrying on of a

business with intent to defraud creditors.

What may not amount to fraudulent trading?

- The fact that a company continued to do business while insolvent is not

enough to establish fraud. The directors may be trading with the hope of

turning the company's fortunes around. Failure to turn the company

around does not, without more, amount to fraud. Note the "sunshine

test":

"There is nothing to say that directors who genuinely believe that the

clouds will roll away and the sunshine of prosperity will shine upon them

again and disperse the fog of their depression are not entitled to incur

credit to help them get over the bad time. – Per Buckley J in Re White and

Osmond (Parkstone) Ltd (1960)"

- Making a bad but honest commercial judgment to continue trading while

insolvent is therefore not evidence of fraud

- Playing some creditors ahead of others is not fraudulent even though this

means inability to pay other creditors in full.

Persons liable under UAE Penal Code

The section covers "every person who was knowingly a party to the carrying on

of the business with intent to defraud". Therefore it covers anybody who

knowingly took active part in the business , including:

- Directors

- Officers having managerial control

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- Third parties and financers who facilitate the fraudulent business

- Creditors who knowingly receive money made from fraudulent trading

Persons not liable:

- Ordinary employees

- A company secretary who does administrative work even though he

failed to give expected advice – Re Maidstone Building Provisions Ltd

(1971).

Trial and punishment

- Maximum punishment for the offence is 10 years imprisonment and/or

fine

- A director convicted for fraudulent trading may be disqualified from

acting as a company director.

B) Civil Liability for Fraudulent Trading – UAE Company Code

Provisions for civil liability for fraudulent trading is made under UAE Company

Law. The essence of the provision is that the courts can order a director or

officer who took part in fraudulent trading to contribute money to a company's

losses. This provision is not intended for punishment. So the judge will lift the

veil of incorporation. Directors will no longer enjoy a limited liability; they will

be responsible to the extent of their own personal assets for all of the

company's debts.

UAE Company Law and commercial code provide:

(1) If in the course of winding up (i.e. liquidation) of a company it appears that

any business of the company has been carried on with intent to defraud

creditors of the company or creditors of any other person, or for any fraudulent

purpose, the following has effect.

(2) The court, on the application of the application of the liquidator may declare

that any persons who were knowingly parties to the carrying on of the business

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in the manner above-mentioned are to be liable to make such contributions (if

any) to the company's assets as the court thinks proper.

Note: The provisions are similar to that under UAE Penal Code discussed above in

that before somebody can be made liable, fraud and knowledge must be proved

as in the criminal case

Differences:

- These provisions can only be invoked during winding up of a company.

- Only the liquidator of a company can apply for a court order.

- The persons found to be knowingly involved in the fraudulent trading can

only be ordered to contribute money to the assets of the company to

help in paying its creditors. The amount to be contributed is to be

determined by the court.

- Contributions by the directors or officers concerned is compensatory not

punitive. Therefore it should not exceed the amount of losses incurred

due to the fraudulent trading.

2. Wrongful Trading (negligent bankruptcy)– UAE Company Code and commercial

code

Because of the difficulty in establishing fraud in cases involving fraudulent

trading, there arose a need for a simpler method of assigning liability to

directors when a company goes into insolvent liquidation. The concept of

wrongful trading was introduced to take care of that.

Under UAE Company law and commercial code , if a director at some point

before the commencement of the winding up of the company knew or should

realized that the company cannot avoid insolvent liquidation but continued to

trade, then he risks having to contribute to the company's looses. In other

words, the court may order a director (including a shadow director) to

contribute money to the LOSSES of a company being wound up (liquidated). So

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the judge will lift the veil of incorporation. Directors will no longer enjoy a

limited liability; they will be responsible to the extent of their own personal

assets for all of the company's debts.

- The application for a court order can only be made by the liquidator of

the company

The provision applies where:

- A company goes into insolvent liquidation, and

- A director of the company knew or ought to have concluded that there

was no prospect of the company avoiding insolvent liquidation, and

- The director did not take every step that ought to have been taken to

minimize losses to the company's creditors.

In determining whether a director knew or ought to have known that the

company cannot avoid insolvent liquidation, and whether he took every step to

minimize the losses of the creditors, the standard to be used is that of a

reasonably diligent person:

- Having the general knowledge, skill, and experience of a person carrying

out the function of a director (objective test), and

- Having the general knowledge, skill and experience of the particular

director (subjective test).

In other words, in determining whether or not a director has acted negligently

the judge will use both the objective (reasonable man test and the subjective

test).

Objective test: the judge will ask the following question, would a reasonable

director who possesses reasonable knowledge, skill and experience manage the

company the same as the concerned director if the answer is yes, then the

director will not be found to be negligent and judge will have apply the other

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test namely subjective test. Here, the judge will look at the concerned director's

personal knowledge, length of experience and skills. So, would a director who

possesses such knowledge, experience and skills manage the company the same

way as the concerned director if the answer is no, then director will be found to

be negligent. The judge will lift the veil of incorporation and require the director

to contribute to the company's losses from his own personal assets.

So a director is expected, under this provision to possess reasonable knowledge,

skill and experience. If a director lacks these, he would still be judged by the

standard of a reasonably competent director. And if he possesses a high level of

skill, experience and knowledge the standard will be raised accordingly. This is

the two-fold objective and subjective test.

NOTE: Unlike fraudulent trading, there is no need to prove that the company or

director concerned did business with intent to defraud creditors. What is to be

proved is that the director had not taken every step necessary to safeguard the

interest of creditors. It is therefore easier to prove wrongful trading than

fraudulent trading.

In Re DKG Contractor Ltd. (1990), the company had a contract to do some work. A

director carried out the work himself with his own equipment and workers

while the company provided the materials. All money due to the company was

pad to the director. In the last 10 months of its life the company was insolvent

but within this period, a further sum of £400,000 was paid to the director. The

liquidator applied to the court to recover this money. It was held that the

director was liable for wrongful trading since creditors are entitled to have the

company's assets kept intact.

Consequences of a finding of liability:

Where a director is found liable for wrongful trading:

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- The court will order him to contribute money to the assets of the

company. The amount of contribution he could be asked to make is to be

decided by the court.

- The contribution is designed to compensate for the loss suffered by the

company/directors and not to punish the director.

- The director may also be disqualified from taking a directorship in

another company.

UAE Example

Directors liability

The new law contains provisions setting out the liability of the company and that

of its directors. It contains clarifications relating to directors' liabilities such as

the liability of the manager of an LLC:

Article 88 explicitly states that the director of an LLC shall be personally

liable to the company, partners and third parties for any fraudulent act

that occurs as a result of their negligent or fraudulent management. The

manager of an LLC will also be liable for any loss or expense incurred due

to the improper use of their powers in contravention of any applicable

laws, the articles of incorporation of the company, their employment

contract or their gross errors.

Article 90 further states that the manager shall not, without the consent

of the general assembly, get involved in or undertake deals that compete

with the company. They also cannot manage any other company that is in

direct competition with the current company.

18 April 2011, the Dubai Courts delivered a stirring and momentous judgment that

effectually lifted the 'veil of incorporation' of an LLC and found the shareholders

culpable and liable in their personal capacity.

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Structure of the lawsuit

The case was filed jointly and severally against the following four defendants:

First Defendant: Dubai based Limited Liability Company;

Second Defendant: Company's Head of Trade, sued in his personal capacity and

in his capacity as a partner of the First Defendant;

Third Defendant: the wife of second defendant, sued in her personal capacity

and in her capacity as the Managing Director of the Company;

Fourth Defendant: the local shareholder, sued in his personal capacity and in his

capacity as a 51% shareholder of the First Defendant.

Facts:

The Claimants were two U.S based individuals who were allured by the First

Defendant to invest large amounts of money in a currency trading platform i.e.

the Company. The two Claimants together in mid of 2010 transferred a large sum

of money to the First Defendant's bank account. The Claimants were promised

monthly interim reports as to the returns made each month.

At the end of May 2010, the Second and Third Defendant issued a report falsely

declaring a profit return of 34.28 % on the Claimants money and induced the

Claimants to transfer more funds in order to make better investment returns,

the Claimants relied on the report issued by the Defendants and transferred

additional funds to the First Defendant.

It was not much later that the Claimants discovered the falsity of the claims

made by the second and third defendant. It was discovered that the First

Defendant was not even licensed to trade in currencies

Merits of the Claimants' case:

TLG sued the first, second and third defendant on grounds fraudulent

misrepresentation of its business activities, illegally procuring the Claimants

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money, carrying out a sham business and using the Company as a mere facade

for concealing its fraudulent activities.

The fourth defendant was the majority shareholder and was sued on grounds of

being a necessary accomplice to this scheme. The fourth defendant had access to

the first defendant's bank statements, accounting records, bookkeeping, annual

statement of accounts and budgets and therefore was aware or ought to have

been aware of the actions of the first, second and the third defendants. We

argued on behalf of the Claimant, that the fourth defendant was preoccupied by

the personal wealth made to him by the first, second and third defendant and

was illicitly enriched at the expense of the Claimant. After establishing the facts

of the case the Claimant's plea to the Court was to treat the receipt of funds by

the First Defendant as a receipt of funds by the second, third and fourth

defendant in their personal capacity as well as in their capacity as the

shareholders of the first defendant on grounds that the second and third

defendant were using the Company as a facade to carry out improper acts and

therefore the interest of justice demanded such a result.

Defense raised by the defendants:

The defendant's counsel argued that the case ought to be rejected on grounds of

the second and third defendant having no capacity to be sued. The Defendant's

counsel acknowledged the transfer of funds to the bank account of the First

Defendant but denied the reasons for the transfer of such amounts and asked

for the case to be rejected due to lack of evidence of the grounds on the basis of

which the case was being filed against the second, third and fourth in their

personal capacity and therefore the case should be rejected. The Defendant's

counsel relied on Case 187/2009 in order to support its contention.

Judgment

The Court held that subject to the provisions of Article 380 of the Commercial

transactions law, and Article 51, 52 and 53 of the law of evidence. As approved by

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appeal case No. 234/2009 a bank transfer is a process whereby certain monies

are paid from one account to another based on a written request.

The Court further ruled that as the second and third defendants are shareholders

of the first defendant and they refused to return the money which the first

defendant had procured without any true and lawful reason, they have been

unjustly enriched at the expense of the Claimants. Therefore, in a bold and

sweeping judgment, the Court held that the Defendants ought to be jointly

compelled to refund the entire sum of money to the Claimants.

The Court also awarded a nine (9) percent annual commercial interest and all the

legal costs, expenses including the cost of legal representation.

Conclusion

This judgment ought to be considered as a welcome step towards the

development of law in this area. The dangers associated with the concept of

limitation of liability of companies are no less significant than the reasons

behind the existence of this concept. An active and vibrant judiciary breathes life

into legislative order, fills the necessary gaps that transpire upon the application

of such laws and makes these laws apt to real situations.

Five years ago, a similar case was indeed filed before the Dubai Courts, whereby

the Claimant attempted to sue the partners in their personal capacity. At that

time the system was more rigid and less willing to adapt to the emerging issues

being face by a legal system which is still in its infancy and therefore, the Court

refused to accept the matter and the Claimant was not even afforded a first

hearing.

This bold and sweeping judgment from the Court of First Instance is a ray of

hope, a possibility that persistence in this system will pay off, and bring the UAE

legal system in line with the rest of the developed legal systems in the world.

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1. Union Station Associates of New London (USANL) was a limited partnership

formed under the laws of Connecticut. Allen M. Schultz, Anderson Nolter

Associates, and the Lepton Trust were limited partners. The limited partners did

not take part in the management of the partnership. The National Railroad

Passenger Association (NRPA) entered into an agreement to lease part of a

railroad facility from USANL. NRPA sued USANL for allegedly breaching the lease

and also named the limited partners as defendants. Are the limited partners

liable? National Railroad Passenger Association v. Union Station Associates of New

London, 643 F.Supp. 192, Web 1986 U.S. Dist. Lexis 22190 (United States District

Court for the District of Colombia)

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2. Virginia Partners, Ltd. (Virginia Partners), a limited partnership organized

under the laws of Florida, conducted business in Kentucky. Robert Day was

tortuously injured in Garrard Country, Kentucky, by a negligent act of Virginia

Partners. At the time of the accident, Day was a bystander observing acid being

injected into an abandoned oil well by Virginia Partners. The injury occurred

when a polyvinyl chloride (PVC) valve failed, causing a hose to rupture from its

fitting and spray nitric acid on Day, severely injuring him. Day sued Virginia

Partners and its limited partners to recover damages. Are the limited partners

liable?

3. Joseph M. Billy was an employee of the USM Corporation (USM), a publicly

held corporation. Billy was at work when a 4,600-pound ram from a vertical

boring mill broke loose and crushed him to death. Billy's widow brought suit

against USM, alleging that the accident was caused by certain defects in the

manufacture and design of the vertical boring mill and the two moving parts

directly involved in the accident, a metal lifting arm and the 4,600-pound arm. If

Mrs. Billy's suit is successful, can the shareholders of USM be held personally

liable for any judgment against USM? Billy v. consolidated Machine Tool. Corp., 51

N.Y2d 152, 412 N.Y.S.2d 879, Web 1980 N.Y. Lexis 2638 (Court of Appeals of New

York)

4. Commonwealth Edison Co. (Commonwealth Edison), through its

underwriters, sold 1 million shares of preferred stock at an offering price of $100

per share. Commonwealth Edison wanted to issue the stock with a dividend rate

of 9.26 percent, but its major underwriter, First Boston Corporation (First

Boston), advised that a rate of 9.44 percent should be paid. According to First

Boston, a shortage of investment funds existed, and a higher dividend rate was

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necessary for a successful stock issue. Commonwealth Edison's management

was never happy with the high dividend rate being paid on this preferred stock.

Nine months later, Commonwealth Edison's vice chairman was quoted in the

report of the annual meeting of the corporation as saying "we were

disappointed at the 9.44 percent dividend rate on the preferred stock we sold

last August, but we expect to refinance it when market conditions make it

feasible." Commonwealth Edison, pursuant to the terms under which the stock

was sold, bought back the 1 million shares of preferred stock at a price of $110

per share. What type of preferred stock is this? The Franklin Life Insurance

Company v. commonwealth Edison Company, 451 F.Supp. 602, Web 1978 U.S. Dist.

Lexis 17604 (United States District Court for the Southern District of Illinois)

5. REIS, Inc., owns, constructs, and manages 25 shopping malls throughout the

United States and Canada. REIS is concerned that the failure of any one mall will

be a substantial financial loss that will cause the entire business to fail. What

parent-subsidiary structure do you recommend RIES, Inc., create to solve the

liability risks of operating 25 malls? What roles will the parent corporation

undertake after the subsidiary structure has been established? List the dos or

don'ts that will help prevent a piercing of the veils between the subsidiaries and

between the parent company and its subsidiaries.

6. M. R. Watters was the majority shareholder of several closely held

corporations, including Wildhorn Ranch, Inc. (Wildhorn). All these businesses

were run out of Watters’s home in Rocky Ford, Colorado. Wildhorn operated a

resort called the Wildhorn Ranch Resort in Teller County, Clolrado. Although

Watters claimed that the ranch was owned by the corporation, the deed for the

property listed Watters as the owner. Watters paid little attention to corporate

69

formalities, holding corporate meetings at his house, never taking minutes of

those meetings, and paying the debts of one corporation with the assets of

another. During August 1986, two guests of Wildhorn Ranch Resort drowned

while operating a paddleboat at the ranch. The family of the deceased guests

sued for damages. Can Watters be held personally liable? Geringer v Wildhorn

Ranch, Inc., 706 F.Supp. 1442, Web 1988 U. S. Dist. Lexis 15701

7. Piercing the Corporate Veil M. R. Watters was the majority shareholder of

several closely held corporations, including Wildhorn Ranch, Inc. (Wildhorn). All

these businesses were run out of Watters’s home in Rocky Ford, Colorado. in

Teller County, Colorado. Although Watters claimed that the ranch was owned by

the corporation, the deed for the property listed Watters as the owner. Watters

paid little attention to corporate formalities, holding corporate meetings at his

house, never taking minutes of these meetings, and paying the debts of one

corporation with the assets of another. During August 1986, two guests of

Wildhorn Ranch Resort drowned while operating a paddleboat at the ranch. The

family of the deceased guests sued for damages. Can Watters be held personally

liable?

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71

Loan Capital

A company has the power to finance its business and activities. Since a company

has legal personality, it can enter into contracts, including loan contracts, in its

own name. Borrowing money is a very important part of corporate life as it

provides needed funds for business activities. The power of a limited company

to borrow is exercised by the board of directors.

Why borrow?

- Shareholders may prefer the use of borrowing if the company is

confident of a return greater than the cost of those borrowings, but high

borrowings (particularly variable rate) increase risk. Moreover,

- Borrowing would be a better option if a company’s shares are not

attractive to existing or potential investors

- Borrowing also has the advantage of allowing present shareholders to

keep control over the company.

- Disadvantages are the absolute obligation to pay interest and the

problem of the variable rate squeeze (interest rates rise as demand falls)

Debentures: A debenture is any document issued by a company acknowledging

or evidencing its indebtedness to a creditor and the terms of that indebtedness.

In practice, the debenture would be a formal legal document under the

company’s official seal. The document is called a ‘debenture’ (i.e. a written

acknowledgment that the company owes that person money, and will pay the

debt plus interest at a time specified by the person).

Some characteristics of a debenture (e.g. Bonds):

- A debenture is transferable like shares

- At times a debenture may be converted into shares

- Debenture holders are not members of the company.

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- A private company cannot offer debentures to the public. A public

company may offer debenture to the public.

Charges:

When a company borrows money or issue a debenture, it is usual for it to use a

part of its properties or asserts to secure the loan so that if it fails to repay the

loan or interests on it, the creditor could take the property. A charge is one such

security.

A charge is therefore a form of security given by a company for money

borrowed by it. It is a form of mortgage. A legal charge is created in writing by a

formal deed (i.e. document under seal) of legal mortgage or legal charge. To be

valid, a charge over a company’s assets must be registered with the registrar of

companies.

Unsecured debentures: these are loans made to the company where the lender

does not take any security.

Secured debentures: these are loans made to the company where the lender

takes a security for the loan. The security will normally be in the form of a

charge over the company’s property or assets. There are two types of charges a

lender can take. These are:

1. Fixed charges: a fixed charge is a charge on a specific asset or assets

owned by the company. A key requirement for a fixed charge is that the

control of the asset passes to the lender and therefore the company

cannot deal with that asset without the permission of the lender. If such

property is sold by the company without the consent of the chargee,

charge follows the property to the buyer. In other words, the buyer takes

property subject to the charge provided the charge has been registered.

If the charge was not registered, the buyer would not be bound by it

unless he has notice of the charge at the time he bought it. So a fixed or

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specific charge is a charge on specific and identifiable assets of a

company. Such fixed assets include land, buildings, plants or equipment.

2. Floating charges: a floating charge is not attached to a specific asset.

Instead it floats over the entire assets of the company. With a floating

charge the company keeps control of the asset and is therefore able to

user the assets without asking the permission of the lender. 2

The crucial character of a floating charge is that the charge remains dormant

until the company ceases to be a going concern (i.e. until the company stops

being solvent), or until the chargee intervenes. This process called

crystallization. In other words, before crystallization, the company can use the

property in its business as if there was no charge on it. Thus, the charge is said to

float. Crystallization occurs when the company fails to meet its obligations

under the charge agreement and the creditor decides to call in the assets. When

crystallization occurs, the charge becomes a fixed equitable charge attaching to

the class of assets concerned.

It is also a character of a floating charge that the charge takes the charged

assets in the condition in which they are at the time of crystallization. Because

the company can use the charged assets in its business, the precise assets and

their real value cannot be accurately ascertained until crystallization. It is

2 Under UAE law, there is no concept of a floating charge The law in the UAE does not allow for

the creation of a security interest, whether by mortgage or pledge, over future assets that were

not in existence at the time the security interest was created. A pledged item must be able to be

sold and therefore (i) must exist at the time of the contract, (ii) must have a monetary value and

(iii) must be capable of being delivered. Consequently, a security interest under UAE Law can only

be created over assets that are ascertained and identifiable at the time of creating such interest

and may not, subject to certain exceptions, be created over assets that change from time to time.

Therefore, future assets are not able to be captured, nor is a ‘floating’ pledge possible. This does

make it difficult to take security over book debts and stock in trade. In the context of working

capital facilities, as an alternative to taking a charge over current assets, bankers in the UAE may

secure facilities by taking a pledge over machinery or a registered mortgage over immovable

property.

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possible for the assets to appreciate, depreciate, or rise and fall in value with

time and usage.

Sometimes a charge includes an automatic crystallization clause, which normally

relates to the following: either that the charge is made to crystallize on the

happening of a certain event provided for in the charge (without the need for

any further action) or the charge is stated to crystallize on the service of a notice

of crystallization on the company. This means that crystallization can occur

automatically without any other creditors being aware of it, and put the

crystallized charge in a more favorable position vis a vis other chargee.

Crystallization may occur:

- If an agreed crystallization event occurs (e.g. if the company defaults in

payment of interests).

- If the company is liquidated.

- If the company ceases doing business prior to winding up.

- If the company uses assets other than in the normal course of its

business.

Differences between floating charges and fixed charges:

a. A fixed charge will usually be taken over a specific asset while a floating

charge is usually taken over the entire assets of the company.

b. A fixed charge requires the lender to have control of the asset, but

floating charge allows the company to keep control of the asset.

c. If the company becomes insolvent and is unable to pay all its debts the

fixed charge gets paid first and the floating charge only gets paid after all

the fixed charges have been paid.

Priority of charges:

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A fixed charge takes priority over a floating charge even if the floating charge

was created before the fixed charge.

A fixed charge will take priority over any fixed charges after it – priority is

decided according to the time of creation of the charge.

Any fixed registered charge takes priority over a registered uncrystallized

floating charge. Once the floating charge has crystallized then it will take

priority over any later fixed equitable charge.

Advantages of a fixed charge:

1. The charged assets cannot be sold or disposed of without the consent of the

chargee.

2. A fixed charge takes priority over a floating charge where a property is

secured by both types of charge.

3. It may be easier to secure a loan by a fixed charge because of the greater

assurance to creditors of the security.

4. The company may also get better rates of interest from their creditors with a

fixed charge.

Disadvantages of a fixed charge:

1. A fixed charge ties down the charged assets. This means the company cannot

deal with or dispose of the property without prior consent of the charge

(lender). The company cannot create another charge on the property without

such permission. For example, a company may use a house worth $5 million to

secure a debt of $3 million. The company may wish to borrow another $1 million

with the same property but would not be able to do so if the first creditor

refuses to give permission.

2. If the value of the secured assets depreciate, so does the amount the creditors

could recover from it.

Advantages of a floating charge:

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1. A floating charge allows the company to deploy the charged assets in the

normal course of its business. Thus the charge, unlike fixed charge, does not tie

down the charged assets.

Disadvantages of a floating charge:

1. it is lower in priority to a fixed charge, this factor and the fact it could be used

or disposed in the normal course of the borrower’s business may make it less

attractive to creditors, and therefore may incur higher interests.

A charge must be registered with the Registrar of companies within 21 days of its

creation. The company is obliged to provide the Registrar with this information

but it is also possible for the person interested in the registration to register it.

The Registrar will then issue a certificate of registration and include details as to

its particulars. This is because where a charge is not registered, it will be invalid

and it will not allow the creditor to have the right to dispose of the assets to

which the charge was to relate. This does not mean that the creditor would be

unable to bring an action against the company on the debt owed, but he would

lose the security that the charge provides. Remember, a creditor without charge

over assts is an unsecured creditor, and on the basis of the company being

wound up and unable to settle its debts, this creditor will join the rest in

attempting to obtain the money it is owed. A secured creditor will have a greater

opportunity and priority to have debts owed satisfied.

If the charges have been correctly registered, they rank in priority as follows. A

fixed charge will rank higher than existing floating charges. The next level of

charge is a floating charge. Preferential creditors take priority over the holders

of floating charges, but over fixed charges. Preferential creditors include

employees who are owed wages and any loan taken to pay the employees’

wages. The company will also have to pay any holiday pay due to employees and

any loans from third parties taken for the purpose of paying such costs.

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Securities in the UAE

Commercial (business) mortgage

Mortgage

Pledge

Commercial mortgage

A business mortgage is a mortgage of movable assets of an entity. It can only be

created in favour of banks or other financial institutions. Provision for use of a

commercial mortgage is set out in the UAE Commercial Code. A commercial

mortgage may be registered over a “business premises” which includes all

tangible and intangible assets deemed necessary for commercial activity.

Tangible assets are specified in the Commercial Code and cover items such as

goods, equipment or machinery; and intangible assets such as customers,

goodwill, trade name, right to let, patents and licences, and so on. A list of all

existing moveable assets of the company is normally included in the mortgage

specifying the assets which are to be mortgaged. At the very minimum, UAE law

provides that a commercial mortgage should cover the trade name, the leased

premises, customer contact details and goodwill.

So, a business mortgage is a mortgage of movable assets of an entity. It can only

be created in favour of banks or other financial institutions.

A business mortgage covers (Commercial Code):

.All of a company’s tangible movable property comprising:

.goods;

.stores;

.machinery; and

.tools.

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.All of a company’s intangible movable property, such as:

.contract rights;

.goodwill;

.trade name;

.intellectual property; and

.license rights.

Commercial mortgages can only be mortgaged to banks and finance companies,

and only as a form of security that can be registered. They must be notarised and

registered to be “perfected” (completed). Perfection is done by way of

registration in the Commercial Register of the relevant Emirate (for example the

Commercial Mortgage Register is maintained by the Department of Economic

Development in Dubai and Abu Dhabi or the Fujairah Municipality in Fujairah. All

parties’ contractual and legal obligations under a commercial mortgage are

continuous, and both parties should be aware of their ongoing obligations to

ensure the mortgage is fully perfected and enforceable according to the terms

of the financing documentation.

So one can say that commercial mortgages can generally be viewed as an

umbrella mortgage under which various types of moveable assets can be

mortgaged. Unlike in other jurisdictions, a floating charge over all and any

assets, current or future, is not possible under UAE law. Instead, piecemeal

security over specific assets has to be taken.

A commercial mortgage is a relatively cumbersome form of security and it is not

recommended for use with construction finance or traders as requires all assets

of the company, including the incorporeal, to be mortgaged.

There is specific provision in the Commercial Code which provides that a

commercial mortgage may only be mortgaged to banks and financing

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institutions, therefore it is not possible for another company or individual to

take this form of security in a financing transaction.

Renewals and periodic reviews

Parties’ contractual and legal obligations under a commercial mortgage are

continuous and do not end upon a successful registration. A commercial

mortgage is intended to cover the term of the loan and, in order to remain a

perfected and enforceable security it must be renewed and upgraded

throughout its life span.

The Commercial Code provides that a commercial mortgage, once registered,

shall only secure a priority right for five years. Registration in the Commercial

Register must be renewed before the expiry of the fifth anniversary or the

priority provided by this form of security is lost and the mortgage will be

deemed to have been cancelled.

Renewal in the Commercial Register is normally negotiated between the parties

at the outset and provision can be made whereby the bank can opt to renew the

mortgage without notice to the company.

Regardless of which party effects the renewal, both parties should be aware of

the consequences of non-renewal. Failure to maintain a properly perfected

security is normally deemed to be a breach of the financing documentation and

the company risks a technical default should it fail to keep its commercial

mortgage registrations up to date. The banks also have some responsibility in

keeping an eye on the registration dates of its commercial mortgage to ensure

that security duly perfected at all times and is enforceable for the full term of

the loan.

Periodic review of the secured assets’ value throughout the term of the loan is a

common feature of a commercial mortgage. Under a commercial mortgage the

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company is required to mortgage all its existing identifiable moveable assets.

Where the company acquires further assets during the period of lending, it will

be required to execute, notarise and register addenda to the filed commercial

mortgage with the Commercial Register, specifying the additional assets and

their values.

In conclusion, in order for a commercial moegage agreement to be valid and effective, a business mortgage must be:

1. In writing. 2. Executed before a public notary. 3. Registered in the Commercial Register. Once registered, the mortgage is

valid for five years.

Notice of the mortgage must be published in an Arabic daily newspaper two

weeks before registration.

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ortgageM

A mortgage is defined in the Civil Code as a contract by which a creditor acquires

the right to be satisfied from the proceeds of the sale of the mortgaged real

estate in priority to unsecured creditors and other secured creditors of the

debtor. To have effect, a mortgage must be registered. The time of registration

of the mortgage determines priority among mortgages over the same real

estate. Real estate constitutes land and permanent structure on land that cannot

be moved without suffering damage or alteration. Real estate does not include

fixtures on land (even if the fixture cannot be moved or detached without

damaging it).

In addition to the above, mortgages can be granted over:

.Vehicles.

.Vessels.

.Aircraft.

Security over vehicles is effected by way of registration of a mortgage with the

relevant Traffic Department. There is an absence of clear written law on this

topic, however, in general all dispositions and ownership interests over vehicles

must be registered. Accordingly, the borrowing party still retains the legal

ownership of the vehicles, such ownership being subject to the mortgage.

Vessel mortgages in the UAE are created pursuant to the UAE Commercial

Maritime Law No. 26 for the year 1981 and amendments as per law No. 11 for the

year 1988 (the “Maritime Law”). The Maritime Law permits the mortgage of a

vessel if its total tonnage exceeds ten tons. The vessel being mortgaged in the

UAE should be registered with the National Transport Authority, in other words,

the vessel should maintain a UAE flag.

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Financing the purchase or lease of aircraft is common in the UAE where such

aircraft are being acquired or leased by private operators or airlines. In relation

to private operators or high net worth individuals acquiring a single aircraft, the

financing structure usually includes a term loan coupled with an aircraft

mortgage registered at the General Civil Aviation Authority (GCAA). Once the

mortgage is perfected, the GCAA will issue a certificate of registration

confirming the details of the owner/mortgagor, the operator (if the operator is a

separate entity) and the financing bank as mortgagee.

Finally, only mortgages registered with the Land Department (which of course

means that the property right to be mortgaged must be registered with the

Land Department) on the real estate register or the interim register will be

considered valid. If on the interim register, at the time of transfer of title to the

real estate register, all mortgages and other interests noted on the interim

register will automatically be transferred to and registered on the real estate

register. The ranking of the mortgage is determined by the time of registration,

with a serial number allocated on registration with the Land Department.

Accordingly, in Dubai, only registered mortgages are recognized.

In terms of enforcement, the Mortgage Law states that any clause in a mortgage

contract stipulating that when the borrower fails to pay the mortgage debt

within the specified period, the lender shall have title to the mortgaged

property or can sell the mortgaged property without taking the enforcement

steps required under law (ie self help), shall be considered as void. This

provision, read together with the execution proceedings on mortgaged property

foreclosure, provide for a streamlined Court driven procedure on default by the

borrower. The enforcement steps are as follows:

In the event of default in payment of the debt when due, the lender must

provide the borrower 30 days written notice through the Notary Public

before commencing execution proceedings.

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If within the 30 day period, the borrower fails to pay the sums due, the

execution judge shall, upon request of the lender order an attachment

against the mortgaged property so that it can be sold by a public auction in

accordance with the applicable procedures of the Land Department.

A mortgage must be registered against the property in order to enforce such

mortgage. If a mortgage is not registered, it will not be valid and cannot be

enforced. This is not to say the mortgage is void, however it will not create an

enforceable security with a priority right over other creditors.

Therefore, lenders who are financing against the security of an unregistered

property in Abu Dhabi generally rely on a conditional assignment of the

borrower’s sale and purchase agreement or lease agreement (as applicable)

with step-in rights in the event of default under the loan. This is sometimes

combined with an unregistered mortgage. Such interest(s) are noted on the

internal register maintained by the relevant developer.

On enforcement, assuming a lender does not have a registered mortgage, the

likely avenues will be perfection of the conditional assignment with the

cooperation of the developer, or a claim against the property (which would

simply be a civil claim as an unsecured creditor). In either case, the provisions of

the UAE Civil Code will apply.

In conclusion, mortgages over real property,Vehicles, Vessels and Aircraft must

be both:

1. In writing. 2. Registered with the appropriate real estate authority in each Emirate.

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Commercial or business Pledge

A commercial pledge is a pledge over movable property. A commercial pledge

can be created over:

.Movable plant (tools, equipments, goods) and machinery.

.Receivables (i.e. a right to payment under a contract).

.Negotiable instruments (shares/stokes).

A pledge would be relevant in case of unregistered moveable assets, being

assets which are not of a permanently fixed nature (i.e. assets which can be

removed without damaging or alerting its structure, physical appearance or

surroundings). Simply put, moveable assets are assets which do not comprise

real property (i.e. land) or any structure permanently affixed to the land. In

cases where the asset subject to the asset financing can be specifically defined

and ownership interests therein are not capable of being legally mortgaged, the

pledge is a more appropriate form of security. The requirements for perfection

of the pledge are set out below:

(i) The Pledge should be executed in a written form and time certain.

A pledge over movables is ineffective against non-contracting parties unless an

instrument showing the debt and the property held in pledge together with the

transfer of possession to a pledgee is made.

Since there is no registration of pledged movable assets in the UAE, the signing

of a pledge agreement in a notarised document serves as a document that fixes

the time of signature of the pledge agreement and thereby confirms priority

over other unsecured and subsequent secured creditors. Notarisation is the

recognised and accepted practice to create time certainty.

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(ii) The pledged assets must be in existence and be identified.

The Civil Code in general, requires that the subject of a pledge is identifiable at

the time of the contract. Therefore, future assets are not able to be captured,

nor is a ‘floating’ pledge possible.

(iii) The secured party must take custody of the pledged assets.

The Civil Code and Commercial Code both require that custody of the pledged

assets should either be held jointly or by the creditor or by a neutral third party.

Therefore, if the lenders do not intend to have physical possession over the

pledged asset, it would be required that the pledge agreement provides that the

custody of the pledged asset should be transferred to a third party “Bailee”. If

the borrower is a company (as with most financial institutions’ facility

agreements) the pledge agreement may appoint the general manager of the

borrower (in his personal capacity) as a Bailee.

LLC and share pledge

Investors frequently ask whether it is possible to pledge the shares of a limited

liability company incorporated under the Federal Law No. 8 of 1984 concerning

Commercial Companies (Companies Law), (UAE LLC) following a relatively

recent announcement by the Dubai Department of Economic Development

(DED) in which the DED indicated a willingness to record such pledges. We

highlight that while a share pledge over the shares in a UAE LLC is contemplated

under applicable UAE law, in practice, there are certain procedural challenges

and issues that need to be addressed to be able to implement and register a

share pledge.

In brief:

While a share pledge over the shares in a UAE LLC is contemplated

under applicable UAE law, in practice, there are certain procedural

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challenges and issues that need to be addressed to be able to

implement and register a share pledge.

The practical problem faced with the concept of “possession of a

pledged item” is that there is no requirement under the Companies

Law for a UAE LLC to issue share certificates.

The majority of the free zone authorities in the UAE issue share

certificates for companies incorporated in such free zones and

certain free zone authorities also permit creating a security

interest or a pledge over shares of companies registered in the

relevant free zone.

Under the old company law while share pledges were expressly permitted in

respect of private and public joint stock companies under the Companies Law,

there was no such provision with respect to a UAE LLC, although the Civil Code

and the Commercial Code do contemplate the concept of a share pledge as

outlined below. Under the new company law, Article 79 states that partners are

allowed to pledge their shares to a third party. Article 79 – Pledge of Quotas

(shares) - The New Law provides that limited liability quotas (or shareholdings)

may be pledged. The old company Law is silent in respect of pledge of quotas,

and so it is questionable whether quotas can be pledged legally. This new

development will assist raising of debt finance by owners of limited liability

companies and will enhance the security package that can be offered to the

financiers. Pledge of quotas will add another level of comfort to beneficial

owners of quotas (foreign investors) in respect of their shareholding

relationship local registered owners (nominee).

Federal Law No. 18 of 1983 concerning Commercial Transactions (Commercial

Code) clearly contemplates the existence of a pledge and sets out the definition

of a commercial pledge as being “a pledge relating to movable property as

security for a commercial debt.” The concept of “moveable property” is further

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set out in Federal Law No. 5 of 1985 concerning Civil Transactions (Civil Code),

which together with the above provisions of the Commercial Code, would

indicate that the shares of a UAE LLC are considered to be “moveable property”.

Therefore, in principle, such shares should be able to be the subject of a pledge.

However, in practice, the registration and perfection of share pledges over

shares in a UAE LLC and the mechanism to achieve this have not been developed.

The Commercial Code essentially provides that a pledged item should either pass

from a pledgor to a pledgee, be held by a third party or remain in their joint

possession. The practical problem faced with the concept of “possession of a

pledged item” is that there is no requirement under the Companies Law for a

UAE LLC to issue share certificates. Therefore, it is not clear how the

requirement of “possession” under the Commercial Code can be achieved in the

absence of share certificates, or alternatively, a deed or similar document that

represents title to the pledged shares.

Although the DED has indicated that it is possible to register a pledge over

shares in a UAE LLC in Dubai as described above, the mechanism for registering

and perfecting such pledges remains unclear. In seeking clarification on this, the

DED has verbally advised that any pledge over shares in a UAE LLC will be subject

to the approval of the legal department at the DED.

It is also important to note that under the Commercial Code, a pledgee may not

automatically “step in” and sell the pledged item when it seeks to enforce the

pledge. The Commercial Code states that where the pledgor fails to pay the debt

secured by the pledge on the maturity date the pledgee must petition a

competent court to authorise the pledge to sell the pledged item.

The position with respect to share pledges in free zones is slightly different. The

majority of the free zone authorities in the UAE issue share certificates for

companies incorporated in such free zones and certain free zone authorities also

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permit creating a security interest or a pledge over shares of companies

registered in the relevant free zone.

Effective security

Effective security, in simple terms, is the process of ensuring that a bank’s risks

on its lending are sufficiently covered and that in the event of default or in the

worst case in the event of winding up, a bank is assured of getting its funds

back. The aim of security is to attain a priority ranking in the list of creditors of

the borrower upon dissolution.

There are various types of security documents and not all are equal. Some

require registration to perfect them and others do not. Free Zone areas in

particular have their own rules and regulations in relation to the registration of

security documents and it is beyond the scope of this article to discuss each of

those in detail.

The majority of types of UAE security documents are set out in the table below

along with a synopsis of the main issues surrounding each.

Document Type Registrable?

Dual

Language

Required

Notarisation

Required?

Guarantees

(Bank/Corporate/Personal) No

Not a

prerequisite

Not a

prerequisite

Issues: UAE legislation contemplates a guarantee by way of suretyship only.

There is a time period for enforcement.

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Document Type Registrable?

Dual

Language

Required

Notarisation

Required?

Land Mortgages

Yes. Registration is

required to ensure

perfection and

therefore priority

rights upon winding

up.

Yes Yes

Issues: Land Mortgages must be considered on a case by case basis as there are a

myriad of legal issues arising with this form of security particularly in relation to

title and location of the property and the power and authority of each party.

Document Type Registrable?

Dual

Language

Required

Notarisation

Required?

Commercial Mortgages

Yes. Registration is

required to ensure

perfection and

therefore priority

rights upon winding

up.

Yes Yes

Issues: This is a cumbersome umbrella mortgage under which various types and

classes of assets are mortgaged. Registration fees are in some Emirates

uncapped and based on the value of the underlying debt.

Document Type Registrable? Dual Notarisation

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Language

Required

Required?

Security Assignments No Not a

prerequisite

Not a

prerequisite

Issues: Perfection is by way of Notice of and Acknowledgment and Consent of

Assignment by each counterparty to the agreement. Issues arise on the

practicalities of securing perfection.

Document Type Registrable?

Dual

Language

Required

Notarisation

Required?

Share Pledge

Yes. Registration of

the Share Pledge in

the company's

register is required

Not a

prerequisite

Not a

prerequisite

Issues: Perfection is by way of execution by the parties, by notarisation, by

delivery of the share certificate to the bank annotated with a notice of the

pledge of the shares to the bank, and by registration of the pledge in the

company’s share register. Possession is the crucial element in this security

document.

Document Type Registrable?

Dual

Language

Required

Notarisation

Required?

Account Pledge No Not a Not a

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prerequisite prerequisite

Issues: The Account Pledge is considered perfected upon the bank at which this

account is held consenting to the transferee’s interest over the account. There is

no tested legal practice in the UAE for pledging rights to funds held in bank

accounts which can be relied upon. There is no concept of a floating charge

under UAE law.

Document Type Registrable?

Dual

Language

Required

Notarisation

Required?

Pledge over Moveables No Not a

prerequisite

Not a

prerequisite

Issues: For a valid pledge to exist, there must be delivery by the pledgor to the

pledgee (or to a third party nominated by the parties) of actual or constructive

possession and control of the pledged items. The issues arising pertain to

possession.

Document Type Registrable?

Dual

Language

Required

Notarisation

Required?

Special Security Power of

Attorney No Yes Yes

Issues: Special Security Powers of Attorney are normally expressed to be

irrevocable by the grantors, but they may nevertheless be revoked by mutual

agreement of the parties and by operation of law.

Strategies for managing security?

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Admittedly it is often difficult to assess what type of security to request from a

borrower. The UAE does not have a sophisticated system to enable searches

against companies to be easily carried out to ascertain if there is prior registered

security and where security is not registrable banks have to take assurances on

face value from the borrower that shares, assets or accounts have not already

been secured to other lenders.

Ultimately the security package will depend upon what assets the borrower has

to offer and this will vary from case to case. However, in all cases a risk profile

assessment must be undertaken to ascertain and manage the security and risk

exposure.

Regardless of the type of security available, it is imperative in order to safeguard

the bank’s position that whatever security package is put in place, it is properly

implemented and perfected and that due attention is given to the powers and

authorities of all parties executing the documents.

Assignments in the United Arab Emirates

What are Property Assignments?

An Assignment is a legal sales transaction whereby the Original Purchaser (the

"Assignor") of a property sells, and thereby transfers, their rights and

obligations under the original contract to a new Purchaser (the "Assignee"). An

Assignment takes place from the time an original Agreement For Sale has

occurred between the Developer (the "Vendor") and the Original Purchaser, and

PRIOR to Completion of the Property.

Imagine that one is stepping into the shoes of the Original Purchaser for a fee in

order to purchase the desired property.

The "Assignee" assumes all of the "Assignor's" duties and obligations under the

original Agreement of Sale. These rights and obligations are stated in the

original Agreement of Sale and include terms such as deposits, included items,

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Completion date and required disclosure statements. Upon Completion, the

"Assignee" is granted the Title to the real property.

An Assignment is legally permitted unless otherwise expressed in writing. An

Assignment fee may be charged by the Developer and is normally a cost borne

by the "Assignor" (the Original Purchaser).

Remember, the Developer is the legal owner of the interest in the real property

until a legal transfer of Title has occurred upon Completion. In all cases, written

consent from the Developer (the "Vendor") will be required for an Assignment

transaction.

Example of a Property Assignment

To simplify, an example of an Assignment transaction is provided below:

Mary (the "Assignor") entered into an agreement to purchase an apartment for

$200,000 from the Developer (the "Vendor") as a 'Pre-Sale'. As part of the

Agreement For Sale, she paid a total deposit of 25% = $50,000.

Six months later and prior to Completion of the apartment, Mary decides to sell,

and thereby transfer, her contractual rights and obligations to purchase the

apartment for $28,000.

Fred (the "Assignee") missed his chance to purchase an apartment when the

Developer was 'pre-selling'. The building is now sold out. He wants to purchase

Mary's rights and obligations for her asking price of $28,000.

Fred pays to Mary $28,000 PLUS replacement of her deposit of $50,000 which

equals a total of $78,000.

When the building is Complete, Fred owes the "Vendor" (the Developer) the

balance of the Agreement For Sale which is $150,000 (being the original price

less the original deposit).

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Assignment of rights and obligations (i.e. receivables)

assignment under UAE law is the transfer of certain obligations or rights from

one party to another. In the UAE, assignments are often used as a security

arrangement under which a party (the assignor) who is entitled to receive

certain benefits (arising from a contract, payment arrangement or receivables),

assigns those benefits to a financial institution as security for a financing

arrangement.

It is important not to confuse the elements of a UAE assignment with its

common law counterpart. Being a civil law jurisdiction, assignments in the UAE

are subject to certain peculiarities and have different implications. For example,

the UAE does not recognize the concept of a floating charge, and technically

does not distinguish between an assignment by way of security and an absolute

assignment. Under a UAE assignment, the assignor relinquishes all its rights in

respect of the assigned property from the outset (albeit that perfection, in

respect of the third party, may be deferred). Hence, even the term assignment

by way of security may be a misnomer.

It is also important to note that the UAE does not maintain a public companies

register in which records relating to security (including assignments) are kept

and made available to the public. While implications of these are too extensive

to be discussed in this article, this generally means that the assignee must make

a commercial decision on whether it is comfortable that the assignor has not

assigned, and will not assign, the subject matter to any other third party other

than the assignee.

The laws of the UAE in relation to assignments are not fully developed. The UAE

Civil Code only prescribes for an assignment of debts/obligations, but is silent on

the procedural aspect of an assignment of rights. From a banking/lending

perspective, an assignment of rights has commercial value as security, and this is

what will be discussed in this part.

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Since an assignment of rights is not expressly covered under the UAE Civil Code,

one would therefore have to be guided by UAE case law to ascertain the position

of an assignment of rights. While the Civil Code provides that an assignment of

debts/obligations require the consent of third parties, the courts in Abu Dhabi

and Dubai have had differing views on whether third party consent is required in

relation to assignment of rights, or whether third party notification will suffice.

Although it is best to err on the side of caution and obtain third party consent

for all assignments, this may sometimes prove to be administratively difficult.

The courts have also applied different criteria in establishing whether consent

may be implied from the action of the third party.

It is also essential that the assignee take possession of or control over the

assigned rights, especially in relation to the assignment of receivables. This is a

common step that is often overlooked.

Legal Framework

Within the UAE the doctrine of stare decisis does not exist and legal precedent is

not binding on the courts, thus there exists no legal context whereby the courts

should abide by precedence or rules established by prior decisions. The absence

of this doctrine can often cause some confusion in the assignment of rights

within the UAE courts. Although the assignment of rights is not regulated within

the UAE and the laws do not have any provisions specifically for the assignment

of rights, its rules and regulations are generally formulated from comparative

law and existing common practices and commentary. In this class we will discuss

the issue of assignment of rights and considers the conditions in which this

concept is recognised under UAE Law.

Of all the U.A.E. laws, the Civil Code and Commercial Code are the most

pertinent in addressing the issue of assignment of rights, albeit indirectly. The

Civil Code is a broad law which includes general rules organising all “civil”

transactions. The Commercial Code includes specific rules relating to

commercial/business matters. Being of more specific orientation, the

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Commercial Code is usually referred to first for the interpretation of commercial

contracts, however, if the Commercial Code is silent on a matter, the Civil Code’s

provisions will apply.

It should be noted that the Civil Code is accompanied by a detailed explanatory

commentary and although this commentary does not form part of the Civil Code,

it is treated by the UAE courts as an authoritative guide to the intention of the

legislator.

Most importantly, as noted above, the doctrine of stare decisis does not exist in

the U.A.E. (i.e. in other words, legal precedent is not binding on the courts).

Therefore, although it is difficult to predict the manner in which a court may

interpret a given case, the decisions of the highest Federal Court and the Federal

Supreme Court will have persuasive effect on cases heard in the lower courts.

However, without the doctrine of stare decisis, contradicting judgments muddy

the waters of an area of law (the assignment of rights) that is already less than

developed.

Does the concept of assignment of individual rights arising from a legal

relationship exist under the laws of Dubai/ U.A.E.? For example, is it accepted

under the laws of Dubai/ U.A.E. that a right to payment of a monetary sum

arising from a contract may be assigned (or transferred) by the creditor to a

third party?

The provisions of the Civil Code relate to the assignments of debts and not the

assignments of rights. As a result, with regards to the assignment of the right of

recovery, the U.A.E. laws do not include any provisions specifically regarding the

assignments of rights. However, the validity of such transactions may be

pleaded on grounds of general principles which emanate from existing

commercial common practices, decided cases and comparative law.

In the Dubai Court of Cassation Case No. 188/2006 issued on 13 March 2007, the

court was guided by the provisions of Civil Code relating to the assignment of

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debts/obligations in determining the validity of an assignment of a right. The

court held that an assignment of right takes place by agreement between the

assignor and the assignee as against the obligor. An assignment in that respect is

a contract between the assignor and the assignee, which must satisfy all of the

necessary elements including consent, subject matter and cause.

In further recognition of the assignment of rights, the Dubai Court of Cassation

Case No. 323/1991, regarded the assignment of rights as permissible transactions

as there are no provisions to the contrary in the law in force. There are many

other cases from the Dubai Court of Cassation which reiterate this view.

That being said, given the absence of a separate legal regime for an assignment

of rights under UAE law, UAE Courts have decided cases on assignment of rights

based on existing commercial common practices and comparative law. In the

following Dubai Court of Cassation case, the Courts are guided by the provisions

of the UAE Civil Code relating to ‘assignment of debts / obligations’ in

determining the validity of an ‘assignment of right’.

Dubai Court of Cassation Case No. 188/2006

Issued on 13th March 2007

Claim

A civil action was filed before the Dubai Court of First Instance by a commercial

bank (the “Bank”) against a corporate borrower (the “Borrower”) for non-

payment of the latter’s obligations under a term loan facility.

Facts of the Case

The Bank granted a term loan facility for the amount of AED7,469,602.09 to the

Borrower under the terms of a facility agreement (“Facility Agreement”).

Subsequently, the Borrower defaulted on its installment payments. This

prompted the Bank to declare an acceleration event pursuant to the terms of the

Facility Agreement and making the full amount of the loan immediately due and

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payable. The Borrower was served a notice of acceleration but failed to settle

the outstanding amount of the loan.

Hence, an action was filed in the Court of First Instance for collection.

Court of First Instance

The Court of First Instance ruled in favour of the Bank and ordered the Borrower

to settle the full outstanding amount plus interests from due date until actual

receipt of payment, together with costs and minimal advocate’s fees.

The Borrower consequently appealed the decision to the Court of Appeal.

Court of Appeal

On appeal, the Borrower argued, inter alia, that the Court of First Instance failed

to determine the correct amount outstanding under the Facility Agreement.

The Borrower alleged that the Court of First Instance failed to appreciate that

the right of the Borrower to receive payments under a contract in relation to a

certain project (“Receivables”) was assigned in favour of the Bank. It was

claimed by the Borrower that since the Bank had been assigned the right over

the Receivables, the amounts pertaining to the said Receivables should have

been deducted from the outstanding amount of the loan. Further, it was

asserted that the amount of Receivables assigned to the Bank was reflected on

the Borrower’s book of accounts and, therefore, should have been considered

by the Court of First Instance when it rendered its decision as to the judgment

amount.

The Court of Appeal did not find merit in the allegations and upheld the decision

of the lower court in toto, hence, the Borrower brought the action to the Court

of Cassation.

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Court of Cassation

The Court of Cassation ruled that no assignment of right had been perfected

between the parties.

The Court held that an assignment of right takes place by agreement between

the obligee (assignor) and another party to whom the obligee transfers its right

(assignee) as against the obligor. An assignment in that respect is a contract

between the assignor and the assignee, which must satisfy all of the necessary

elements including consent, subject matter and cause.

It is settled law that in order for a contract to be concluded, there must be a

corresponding offer and acceptance, and the link between them. What is meant

by an offer is an offer whereby the person who makes it conclusively expresses

his intention to enter into a specific contract, in such a way that if it is

accompanied by acceptance, the contract will be concluded. The exchange of

offer and acceptance should indicate mutual consent of the parties.

The Court referred to Article 1109 (1) of the Civil Code which requires consent of

the parties for an assignment to be valid.

Article 1109 (1) states that:

“In order for an assignment to be valid, there must be consent of the transferor

and the transferee, and the creditor.”

In this case the Court held that whilst there was an intention on the part of the

Borrower to assign its rights over the Receivables, the consent of the Bank (as

assignee) to the assignment was not present.

The Court held further that in order for an assignment to be valid the

requirement of Article 1113 of the Civil Code should be met.

Article 1113 provides that:

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“In addition to the general conditions, the following conditions must also be

satisfied in order for an assignment to be valid:

a. It must be completed and dependent on no condition other than an

appropriate or customary condition, nor must any future contract be dependent

on it;

b. The performance thereof must not be deferred to an unknown future date;

c. It must be limited in time to a specific time limit;

d. The property transferred must be a known debt which is capable of being

satisfied;

e. The property transferred to the transferee in a restricted transfer must be a

debt or specific property which cannot be compounded, and both types of

property must be equal in type, amount and description; and

f. It must not involve any conditional or substantial additional consideration in

favour of any of the parties, and the assignment shall be unaffected by such

additional consideration agreed upon after the assignment was made, and it

shall not be payable.”

The Court held that in order for an assignment of right to be valid, the subject

matter of the right should be specified as to type and amount. In addition to the

general conditions, the property assigned must be a debt of known amount, and

capable of being substituted. This means that the subject matter of the

assignment, which is the property assigned, must be particularised as to type

and amount. Where the property consists of money, it must be of a specified

amount, failing which the assignment is void.

Assuming that there had been a valid assignment of right, the Court ruled that

there was no proof that payments were indeed made by the third party

contractor (being the counterparty to the original contract) to the Bank.

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In light of the above, the Court of Cassation upheld the findings of the lower

courts in dismissing the claim of the Borrower that an assignment of right had

been granted in favour of the Bank as security for the obligations under the

Facility Agreement.

The Court of Cassation in the foregoing case made a significant point in relation

to Article 1113(d) of the UAE Civil Code as applied to assignment of rights. For an

assignment of right to be valid and enforceable, the type and quantity of the

assigned right (arising from a contract; payment obligations or receivables)

should be certain and identifiable, and where the assigned right relates to a sum

of money, the amount should be fixed at the time of execution of the

assignment agreement. The same is equally applicable where the right being

assigned relates to receivables at some future date.

With the foregoing decision, it should be noted that where the right consists of a

sum of money, certainty in the subject matter of the assignment lies not only

upon the relevant contract (under which such right is being assigned) being

identifiable, but also for that sum of money to be fixed at the time of perfecting

the assignment.

In taking an assignment of right as a form of security, parties should bear in

mind the important components constituting a valid assignment in the UAE

including the present position on the matter as clarified by this case.

Can a right be assigned under the laws of Dubai/ U.A.E by mere agreement

between the assignor and the assignee, without the consent of the obligor?

As the U.A.E. Law does not govern the assignment of rights directly, it also does

not address its requirements.

The U.A.E. courts have taken different approaches in respect of the requirement

for the consent of the obligor, however, the current legal position seems to be

that in this form of assignment, the consent of the obligor is not necessary,

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although he should at least have notice of the transaction, if it is to be asserted

against him.

The Dubai Court of Cassation Case No. 323/1991 issued on 23 May 1992, as

referenced above to establish the recognition of the assignments of rights under

U.A.E. law, went on to state that the same may be concluded with the consent of

the assignor and the assignee only, without any need of the obligor’s consent.

The court further stated that the obligor should however have notice of the

assignment if it is to be binding on him, and that such notice may be proved by

all means of evidence. According to this view, the mere knowledge of the

obligor is held to be sufficient.

In support of this view, the Dubai Cassation Court Case No. 34 of 1999 issued on 1

May 1999, held than an assignment of rights is deemed valid and binding once it

is agreed by the assignor and the assignee and that there is no requirement for

the obligor to agree to the assignment but his knowledge of the assignment is

required.

There are several other cases which also support this widely held view that an

assignment of a right is constituted by the agreement of an assignor and

assignee only, but for the agreement to be valid towards the obligor, he should

be aware of it, i.e. have notice.

However, it would be prudent to mention that there is an opposing and more

conservative view as established by the Dubai Court of Cassation Case No.

188/2006 issued on 13 March 2007, referred to above.. In this case, the court

referred to the assignment of debts provisions in the Civil Code and specifically

Article 1109(1) which requires consent of all the parties (assignor, assignee and

creditor) for an assignment to be valid. Therefore, the court utilised the

provisions as applicable to the assignment of debts to the assignment of rights

to produce a more cautious approach to defining the requirements for

assignments of rights.

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The court further held that in order for an assignment to be valid, the

requirements of Article 1113 of the Civil Code must also be met. In summary the

court relied on this Article and held that for an assignment of right to be valid

and enforceable the type and quantity of the assigned right (arising from a

contract, payment obligations or receivables) should be certain and identifiable

and where the assigned right relates to a sum of money, the amount should be

fixed at the time of execution of the assignment agreement. The court went on

to state that where the right consists of a sum of money, certainty in the subject

matter of the assignment lies not only upon the relevant contract (under which

such right is being assigned) being identifiable, but also for that sum of money

to be fixed at the time of perfecting the assignment.

Notwithstanding this more conservative view as espoused in Case No. 188/2006,

it is generally accepted practice that judges currently distinguish between the

assignment of debts and assignments of rights, and will consequently not rely

on the assignment of debts provisions as contained in the Civil Code when

adjudicating on the assignment of rights. Therefore, the current trend, with the

caveat that there is no binding system of precedent, is that the only requirement

is for the consent of both the assignor and assignee, without the need of the

consent of the obligor, although he should be notified of the assignment.

In brief:

Within U.A.E. laws, the Civil Code and Commercial Code are the most

pertinent in addressing the issue of assignment of rights, albeit indirectly.

The provisions of the Civil Code relate to the assignments of debts and

not the assignments of rights. The U.A.E. laws do not include any

provisions specifically regarding the assignments of rights.

The Dubai Court of Cassation has previously held that an assignment of

right takes place by agreement between the assignor and the assignee as

against the obligor, which must satisfy all of the necessary elements

including consent, subject matter and cause.

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Although the U.A.E. courts have taken different approaches in respect of

the requirement for the consent of the obligor, the current legal position

seems to be that the consent of the obligor is not necessary, although he

should at least have notice of the transaction, if it is to be asserted

against him.

It is generally accepted practice that judges currently distinguish between

the assignment of debts and assignments of rights, and will consequently

not rely on the assignment of debts provisions as contained in the Civil

Code when adjudicating on the assignment of rights.

If an assignment clause is unclear, the articles above from the Civil Code

must be applied in order to deduce its true meaning, for which the

intentions of the parties is paramount.

Case Question

1. Orion Painters Ltd has raised $30,000 in loan capital by borrowing from

Bartlett Bank, John, Paul and William. Orion Painters Ltd borrowed $15,000 from

Bartlett Bank, and has taken a floating charge over Orion Painters’ office

buildings. This happened in November 2006.

Orion Painters Ltd borrowed $5000 from John, and for this loan John took a

fixed charge over Orion Painters’ motor can. This happened in October 2006.

Orion Painters Ltd borrowed $5000 from Paul, and for this loan Paul took a

floating charge over Orion Painters’ stock of brushes and paints. This happened

in March 2006.

Orion Painters Ltd borrowed $5000 form William, and for this William took a

floating charge over Orion Painters’ stock of brushes and paints. This happened

in July 2006.

Orion Painters Ltd is now insolvent, and will have to be liquidated. There is a risk

that there will not be enough money to pay all its creditors. Advise Bartlett

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Bank, John, Paul and William of the priority in which they will be paid (i.e. who

will be paid first, second, third, fourth, etc…)

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Maintenance of Company Capital

Money raised by a company from the issue or allotment of its shares are

referred to as the capital of the company. This capital must be maintained by the

company and not dissipated unlawfully. This means that the company can only

use the capital in ways permitted by the Company Law. In order to maintain a

company’s capital several rules have been made. Company’s capital need to be

maintained essentially in order to have money available for the settlement of a

company’s creditors upon insolvency or liquidation. The rules on capital

maintenance are strict for both public and private companies. Some of the rules

involve:

1. Acquisition by a company of own shares:

A company is forbidden from acquiring its own shares. If a company purports to

buy its own shares, that purchase is void and the company and the officers

responsible would be committing an offence. Shares must be paid for and the

payment forms part of the capital of the company. If a company buys its own

shares, no new money would be received for those shares and the capital of the

company would be diminished to the value of that purchase.

Exception - Article 219 of the UAE Company Law:

This article examines the concept of share buybacks, applicable law in the UAE,

and the potential to exploit share buybacks under existing market conditions.

Share buybacks are an attractive option in an unpredictable market. If a listed

company has surplus funds it does not need for its operations, it may either use

those funds to expand its operations or distribute them to its shareholders. One

avenue for distributing funds to shareholders is to make a share buyback, under

which the company buys back some of its own shares from its existing

shareholders in an open market and then cancels the shares purchased.

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This liberates cash for shareholders seeking an exit, and gives committed

shareholders a larger slice of the pie for no outlay on their part.

Article 219 of the Commercial Companies Law (CCL) allows public joint stock

companies to buy back a maximum of 10% of their shares for the purpose of

selling them if the market value of their shares falls below their book value,

provided that certain conditions are satisfied. The conditions seem to relate only

to publicly listed companies, so there appears no avenue for limited liability

companies to buy back their own shares.

Under Article 219, it is a precondition for a buyback that the market value of the

company’s shares is lower than the book value.

The term “book value” has not been defined in the CCL. However, according to

the definition provided by the Securities and Commodities Authority (SCA), it

appears that the term book value would reflect the shareholders’ equity as

reflected in the last audited financial statement (a company’s total assets minus

its total liabilities) divided by the number of shares on issue.

The conditions stipulated in Article 219 of CCL, among others, include the prior

approval of the SCA and the availability of excess liquidity to the company to

meet the purchase operation. A special resolution supported by a statement of

solvency signed by its directors. The statement would affirm that the company

would be able to pay all its debts within 12 months of the reduction. It is an

offence to make a false or misleading statement of solvency. The companies are

not allowed to use their capital or their legal reserve to meet their buyback

purchase obligations.

According to Article 219, if the buyback shares are not resold (with the resale

taking place within a maximum of two years from the last buyback), the shares

will be cancelled.

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Where a company’s board and the management both believe that there is a

major shortfall between current market value and the long-term enterprise

value of a company’s shares and the company enjoys adequate liquidity, a share

buyback should be considered. The most commonly given reason for buybacks

is that the board perceives the company’s shares to be undervalued.

The answers to the following questions drive the attractiveness of a buyback

plan:

• Whether a company has surplus working capital

• Whether the buyback price is below the long-term enterprise value

Shareholders who need cash will benefit from the buyback liquidity and the

value of the remaining shareholdings will increase if the market value of the

shares truly sits below the long-term enterprise value.

A share buyback can, therefore, transfer wealth from shareholders anxious to

exit in favour of committed shareholders. When a company buys back its own

shares, it reduces the number of shares held resulting in an increase of profits

and assets-backing per share. However, any increase in the company’s gearing

resulting from the cash payout must be reflected in the final equation.

Other potential benefits of share buybacks arise from their potential to “sell”

the company and its future plans to the market. A buyback announcement, its

terms and the way it is implemented all convey signals about the company’s

financial position, prospects and plans. The announcement of a share buyback

can indicate that the management is so confident of the company’s prospects

that it believes the best investment it can make is to buy back its own shares.

This can force the market to re-rate the company.

Buybacks may, however, backfire if investors interpret it as an admission that

the company cannot identify attractive new opportunities. However, if

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conducted properly, a share buyback can deliver shareholder value like no other

corporate action or process.

2. Payment of dividends:

This must only be made from distributable profits. Payment from capital would

be an illegal return of capital to the shareholders. A company’s profit available

for distribution are its accumulated, realized profits which has not previously

been utilized by distribution or capitalization, lee its accumulated, realized

losses, which was not previously been written off in a duly made reduction or

reorganization of capital.

So, even if a company makes a healthy profit this year, it has accumulated

realized losses carried forward from the previous year, those have to be met

before a dividend can be paid.

3. Redemption of redeemable share:

These shares may only be redeemed from distributable profits or from the

proceeds of a fresh share issue.

4. Issue of shares at a discount:

Each share in a company has a determined value. For example, a company may

value its shares at $1.00 each. This called the nominal value. Where the shares are

issued at less than the nominal value, they are said to be issued at a discount. If

anybody is allotted shares at a discount, he is liable to pay the balance plus

interest at the going rate.

Shares may however be issued at a premium. A premium is the difference

between the nominal value of a share and its selling price. If a $1.00 share is old

for $1.50, there is a premium of 50p. A company may issue its shares at a

premium. If a company issues shares at a premium, the premium has to be

transferred to a special account called the share premium account.

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Members’ Meetings

A meeting of a company’s members is called a general assembly meeting.

The general assembly Meeting is held once every year.

Matters to be discussed at the general assembly Meetings include:

(a) The company’s annual audited account;

(b) The directors’ and auditors’ annual report

(c) The election or re-election of directors,

(d) The appointment or re-appointment of auditors,

(e) The payment of directors’ and auditors’ fees

(f) Such businesses as proposed by the directors or members.

(g) alteration of articles of association,

(h)voluntary winding up

(i) reduction of share capital,

(j) selling the company's real estate and properties.

The general assembly Meeting may be convened when:

(a) The Board of Directors consider it necessary. But they must act bona fide (in

good faith) and in the interest of the company as a whole.

(b) Members of a company holding 20% or more of the paid-up shares or voting

rights demand the meeting. If the directors fail to convene the meeting within 15

days, the members concerned may convene it themselves

Chairman - General meetings are presided over by the company chairman. The

articles of association will normally make provisions for the appointment of a

chairman – usually one of the members of the Board of Directors. Where the

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chairman is unavailable, the directors shall nominate another director to be the

chairman. Where there is no chairman or director, the members at a general

meeting may elect anyone among themselves to be the chairman of the

meeting. The chairman is responsible for the proper conduct meetings.

In order for a meeting to validly transacted, two conditions must be satisfied:

1. Quorum for meetings

Quorum refers to the minimum number of people who must be present at a

meeting to make it regular and valid. The quorum for meetings is normally

stated in the articles of association of a company. A meeting held without the

required quorum would be null and void.

Under the New UAE Company Law, general assemblies for a limited liability

company will not be valid unless attended by partners owning 75% of the capital

of the company. If the quorum is not satisfied in the first meeting, the second

meeting shall be called for within 14 days from the first meeting, which shall not

be valid unless attended by partners owning 50% of the capital of the company.

If the quorum is not satisfied in the second meeting, a third meeting shall be

called for after the lapse of 30 days from the date of the second meeting, which

shall be valid regardless the quorum attended such meeting

Under the New UAE Company Law, general assemblies for private and public

companies will not be valid unless attended by partners owning 50% of the

capital of the company. If the quorum is not satisfied in the first meeting, the

second meeting shall be called for within 15 days from the first meeting, which

shall be valid regardless the quorum attended such meeting

2. Notice of Meetings

-Before the decision of general meeting will be considered valid and binding,

every member and every director entitled to attend the meeting must be given

sufficient notice of the meeting.

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-The notice of meeting shall contain the date, venue, and the nature of matters

to be discussed at the meeting.

-The length of notice shall be 15 days for a general assembly meeting of a private,

public and limited liability company.

Resolutions

Company decisions are passed by way of resolutions. There are now three types

of resolutions recognised by the Companies Act – the ordinary resolution,

special resolution and written resolution. Resolutions may be passed at general

meetings or without the need for general meetings. Ordinary and special

resolutions require a general meeting. Written resolution does not require a

general meeting.

a) Ordinary Resolution

This is a decision by a simple majority (at least 51%) of members present and

voting at a general meeting. This means that the necessary majority is counted

from the shareholders who actually attend the meeting and cast their votes. For

example, if a company has hundred members and only fifty attend a general

meeting, the simple majority shall be twenty-six. Provided all members entitled

to vote at a meeting have been duly invited, they are bound by the decisions of

those who attend the meeting. Unless the articles of association or the

Company’s Act stipulate a larger majority, decisions at a general meeting should

be adopted by ordinary resolution.

Matters requiring ordinary resolutions include the appointment and removal of

directors. They are also used for the appointment and removal of auditors.

b) Special Resolution

This requires at least 75% vote of members present and voting at a general

meeting. Usually decisions of serious matters are done by way of special

resolution. If a matter is to be proposed as a special resolution, the notice of

meeting must state the text of the proposed resolution and the intention to

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propose it as a special resolution. This is necessary to allow members study the

proposal and decide which way to vote.

Matters requiring special resolutions include alteration of articles of association,

voluntary winding up, and reduction of share capital, selling the company's real

estate and properties.

c) Written Resolutions (only exist in the free zone not in the seven Emirates)

A free zone company may take decisions by way of written resolution. This is a

resolution signed by the members without the need for a general meeting.

Written resolutions are designed to make decision-making easier for companies.

Members of a company or the Board of Directors may propose a resolution as a

written resolution. A class of shareholders may also use written resolutions. The

proposal of the resolution must contain a text of the resolution and the method of

assenting to the proposal and must be circulated to all eligible members along with

any statement in support. A written resolution may be passed by a simple majority

or special majority as may be stipulated in the articles.

Any decision may be passed as written resolution unless it would be vexatious,

frivolous, or contrary to the Companies Act or the company’s’ constitution.

However, directors and auditors of a company cannot be removed by written

resolution before the end of their tenure because of the requirement self-

defence.

Registration of Resolutions

Because a company’s documents are public documents which can be viewed by

anybody, when a company passes a resolution, the effect may be to change the

contents of a document already filed at the Companies’ House. The effect may also

be to introduce a new element in the company. The old document may therefore

give a misleading picture about the company to creditors, investors, and

customers. There is therefore need to keep the registrar of companies informed of

important changes in companies’ affairs or documents. Accordingly, under the

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Companies Act a company must file with the registrar of companies a copy of any

special resolution passed by it within 15 days. Any subsequent articles of the

company must include the new resolution

Voting at meetings

Decisions at a general meeting are reached by the votes of the members present.

The vote may be by assenting to a written resolution, by show of hands or by poll.

(a) By assenting to written resolution – For a private company and using a

written resolution, every member has one vote. If the company has a

share capital each member has one vote per share

(b) By show of hands – In this case all members present have one vote each

notwithstanding the number of shares they have in the company. Every

member is however entitled to demand a vote by poll.

(c) By Poll – This means voting according to the number of shares held by

each member. Each member is entitled to one vote per share or in case of

stock.

Voting by poll benefits the larger shareholders and ensures that those with

majority shareholding effectively control the company. A company cannot

remove the right of a member to demand a vote by poll. However, a member is

not entitled to a vote by poll in respect of any shares that have not been paid for.

For example, if Y has 1000 shares in a company but has only paid for 500, his

right to poll is restricted to 500 hundred votes. If a member has not paid

anything on his shares, he will not be entitled to vote at all.

Proxies

A proxy is someone appointed to represent a member at a company general

meeting. Proxies are necessary because it is not always possible or convenient

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for a shareholder to attend a meeting in person. Besides a member may not feel

sufficiently knowledgeable in the matters for decision and may therefore

appoint someone with a better knowledge to represent him. Every member has

a right to attend the meeting in person, or to appoint a proxy to attend and vote

on his behalf. The proxy may be a member of the company or an outsider.

A member can only appoint one proxy for a meeting but in a company with a share

capital a member may appoint more than one proxy to represent the different

classes of shares or stock held by him

- A proxy is able to exercise the powers of the member who appointed him,

including the right to speak at the meeting and to vote. A proxy can now also

vote both by show of hands and by poll.

- A proxy may be elected as chairman of the meeting by a resolution

- Where a member attends a meeting after appointing a proxy, the vote of

the member and not that of the proxy should be counted.

- The articles of a company may extend the rights of a member and proxy

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Who is a director?

A director includes “any person occupying the position of director, by whatever

name called”

Classification of directors

Irrespective of how they come into their office, directors may be classed as

executive, non-executive, or alternate.

1. Executive directors are employed full time by a company and are involved in

the day-t-to-day management of the company and exercise some specific

functions. Usually they are in charge of specific departments in the company.

Examples of executive directors are the Managing director, Directors of Finance,

Marketing, personnel, etc. Normally these directors have specific contracts of

employment and these contracts normally specify the role and functions of the

particular director. The articles of association may also specify their

roles/functions. The Managing director is the most important of the executive

directors. The managing director is the chief executive officer of the company.

Other directors usually delegate their authority to the MD who can act on behalf

of the board of directors and the company. The MD can exercise such powers as

the board of directors could exercise.

The board of directors of a company may appoint somebody from among

themselves to the office of managing director and other executive officers. It is

the duty of the board of directors to appoint and remove a managing director.

The shareholders have no power to do this. However the Managing Director

would lose his office if the shareholders remove him as a director.

2. Non-executive directors are those who are not in full-time contractual

employment of the company. They do not have specific executive roles but take

part in management on a part-time basis. They sit on the board of directors of

the company and are bound by the same rules as other directors. But unlike

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executive directors, they are not usually expected to attend all board meetings.

They have a duty, however, to attend whenever they reasonably can and to keep

themselves informed of the company’s affair. Non-executive directors are

usually filled from the rank of professionals, political or public figures, or retired

former executive directors and business people. Apart from acting as a check on

executive directors, non-executives also bring clout and influence to the

company.

Appointment of directors

There are different ways of appointing directors depending on when they are

appointed. First directors, subsequent directors, and those appointed to fill

vacancies, are appointed in different ways.

First directors - Because a company must have a director or directors at

incorporation, first directors are usually named in the application for

incorporation. They are therefore appointed by the subscribers to the company’s

memorandum. In a small private company, the first directors are likely to be the

subscribers

Subsequent substantive directors - Other directors apart from the first ones are

appointed by the members/shareholders at a general meeting. The shareholders

of a company have inherent powers to appoint directors for the company. The

provisions on appointment of directors are normally made in the articles. An

ordinary resolution is needed for the appointment. The appointment may be

made to provide additional directors or to fill a vacancy. The power of members

to appoint directors must be exercised bona fide for the interest of the

company. It should not be used for ulterior purposes

- Note that a person appointed a director must consent to act as such otherwise

the appointment will not be valid.

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Qualification of directors

A person may or may not be a shareholder in the company in which he is a director.

In small private companies, most directors are also shareholders in the company. In

bigger companies and plcs, many directors, including the managing director, may

not be, and are usually not, shareholders in the company.

- There is no particular qualification needed for appointment as a director.

Literally anybody of the right age may be appointed a director, especially in

private companies. However companies are expected to appoint as directors

persons who possess the necessary skills, knowledge and experience to run the

company.

Termination of directorship

Directors’ appointment may be ended by resignation, removal or

disqualification.

1. Resignation - A director may resign his position at any time by giving notice to

the company. No specific period of notice is provided in the Companies’ Act but

the articles may provide for the necessary period of notice. A director’s contract

may also stipulate length of notice. Resignation takes effect from the date

stated on the notice. The resignation need not be accepted before it becomes

effective. In fact a company cannot refuse to accept a resignation. Where a

director resigns without giving the required notice, the company may claim

damages against him.

2. Removal by members – The members of a company have the power to remove

or dismiss a director from office at any time. The members can remove a

director before the end of their contract, and notwithstanding anything in the

articles. An ordinary resolution is required to carry out the removal. But a special

notice of intention to propose the resolution is required. The director must be

notified of the intention to remove him

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A director proposed for removal is entitled to defend himself before the

members at the general meeting before a resolution to remove him is passed.

Because of this, a director cannot be removed by written resolution. Note that a

company may not follow this procedure if its articles provide for removal of

directors in other ways.

A director removed before the end of his contract may be entitled to

compensation.

3. Disqualification - A director’s appointment may end by disqualification

following a number of events. These are:

(a) If he becomes bankrupt or makes arrangement/composition with his

creditors

(b) If he becomes of unsound mind

(c) If he fails to attend board meetings for three consecutive months without

permission

d) The court may also disqualify a director if he has been convicted of an

indictable offence connected with the management of a company, or he

has been persistently in default of the provisions of company legislation,

or has been found guilty of fraudulent or wrongful trading. In any of

these cases the disqualification period for five to fifteen years.

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The articles and Memorandum of Association as a contract: legal effect

The provisions of the articles may be enforced by the company against the

members; by the members against fellow members; and by the members against

the company. The rules of enforcement may however vary.

The articles (and memorandum) when registered bind the company and its

members in contract as if these documents had been signed as a deed by each

member and contained under-takings on the part of each member to observe

the provisions of the memorandum and articles. The main result of this statutory

contract, which is relevant mostly in terms of provisions in the articles, is that:

a) The articles constitute a contract between the company and each member. The

articles bind the company to the members to observe the provisions of the

articles since a contract cannot be one-sided. The main advantages of this to the

private company are that the articles can be drafted to contain a clause that

disputes between the company and its members as to their rights must be

referred to arbitration since this may be quicker and sometimes, but not always,

a cheaper solution than reference in the first instance to an ordinary court of

law. Also the articles may contain a pre-emption clause under which a member

who wishes to sell his or her shares must offer them first to the other members

who may purchase them at fair price as agreed by the company's auditors. This

means that outsiders cannot easily break into a family company and makes a

private company difficult, if not impossible, to take over without the agreement

of all the members. Is that he/she can, by legal process, enforce the rights given

to him/her by the articles so that he/she cannot, for example, be denied his/her

voting rights. Members of a company can enforce against the company those

obligations which may be regarded as pure membership rights, for example,

right to a declared dividend, right to attend meeting, right to vote at company

meeting, right to share certificate, right to a return of capital upon winding up

after the creditors have been paid; and right to be entered in the register of

members.

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Illustrative case law follows.

Hickman v Kent or Romney Marsh Sheep Breeders' Association [1915] 1 Ch 881

The articles of the association provided that any dispute between a member and

the company must be taken first to arbitration. H, a shareholder, who was

complaining that he had been wrongfully expelled from the company, took his

case first to the High Court. The court decided that the action could not continue

in the High Court. H was contractually bound by the articles to take the dispute

to arbitration first.

Pender v Lushington [1877] 6 Ch D 70

In this case the chairman of a meeting of members of a company refused to

accept Pender's votes, which Pender as a member was trying to exercise in a

manner contrary to the wishes of the board. The articles gave one vote for every

10 shares to the shareholders. This caused a resolution proposed by Pender to be

lost. He asked the court to grant an injunction to stop the directors acting

contrary to the resolution. The court held that an injunction should be granted.

The articles were a contract binding the company to the members.

b) The articles constitute a contract between the members and the members.

This is illustrated by the following case.

Rayfield v Hands [1958] 2 All ER 194

A clause in the articles of a company provided that: 'Every member who intends

to transfer shares shall inform the directions who will take the said shares

equally between them at fair value.' R, a member, told the defendant directors

that he wanted to sell his shares. They refused to take and pay for them, saying

that they had no liability to do so.

The court decided that the word 'will' indicated an obligation to take the shares

and the clause imposed a contractual obligation on the directors to take them.

This was nature of a collateral contract. When a member bought shares he made

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a contract with the company but also a collateral contract with the other

members to observe the provisions of the articles. Thus the members could use

each other and there was no need for the company, with whom the main

contract was made a party to the action.

Comment: Although the article placed the obligation to take shares on the

directors, the judge generously construed capacity as members. Otherwise, the

contractual aspect of the provision in the articles would not have applied. The

articles are not a contract between the company and the directors, who, in their

capacity as directors, are outsiders for this purpose (see below). The pre-

emption clause is also exceptional. Such clauses usually say that members

wishing to transfer their shares will offer them to the other members first but

that those members may purchase them. The word 'may' does not produce a

contract. It gives a choice whether to purchase or not. The requirement to make

the offer is contractual.

c) The articles do not constitute a contract with outsiders but only with the

members in respect of their rights as members. Members of a company cannot,

enforce against the company “outsider rights”. These are rights, which do not

correspond to the general rights of membership available to all shareholders of

the same class. Thus a member cannot enforce a right as a director, secretary,

solicitor etc. except in certain circumstances. It is therefore, important for an

officer/employee such as a company secretary or a finance director to have an

express contract and not have the terms of his or her appointment only in the

articles. The leadings case illustrating the difficulties which may be encountered

is Eley v Positive Government Security Life Assurance Co. (1876) 1 Ex D 88 where

the articles said that Mr Eley was to be employed, for his lifetime, as the

company's solicitor. The company ceased to employ him but it was held that he

was not entitled to damages because the articles did not constitute a contract

between him and the company except in terms of his rights as a member but not

in his capacity as solicitor. He was incidentally a member, but this made no

difference. A similar decision was reached in Browne v. La Trinidad where a

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company’s articles contained a provision that in consideration of the sale by B of

his property to the company, he would become a member of the company and

would be appointed a director for at least four years. B was removed as a

director before the stated four years. He never became a member of the

company. It was held that even if B had become a member, he could not enforce

the provision since it was an outsider right.

Exception: An outsider right may become directly enforceable if it is supported

by an independent contract.

1. George Gibbons, William Smith, and Gerald Zollar were all shareholders in GRG

Operating, Inc. (GRG). Zollar contributed $1,000 of his own funds so that the

corporation could begin to do business. In exchange for this contribution,

Gibbons and Smith both granted Zollar a signed form which stated that

“Gibbons and Smith, for a period of 10 years from the date hereof, appoint Zollar

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at their proxy”. A year after the agreement was singed, Gibbons and Smith

wanted to revoke their proxies. Can they? (Zollar v Smith, 710 S.W.2d 155, Web

1986 Tex. App. Lexis 12900 Court of Appeal of Texas)

2. In 2006 Mrs Jackson, a solicitor, negotiated a lucrative takeover bid for Zanza

Ltd. In appreciation of her work for the company Zanza Ltd., in July 2007,

appointed Mrs Jackson as their company secretary. Although Mrs Jackson

signed no contract with the company, Zanza Ltd. included in its articles a

provision that Mrs Jackson would remain their secretary for a period of 10 years.

They also gave her 2000 shares in the company. Recently however, Zanza Ltd has

been taken over by American investors who have asked Mrs Jackson to vacate

her post in favour of a new solicitor and to forfeit her shares. Mrs Jackson

believes these orders are against Zanza Ltd’s constitution and intends to

challenge them in court.

Directors’ Duties

Introduction

As we learned in the previous lecture, every company must have a director or

directors who are responsible for the management of the company. Directors

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are given discretion and freedom to manage a company the way they think fit

provided they comply with the law and the company's constitution. They are not

to be given directions or instructions by the shareholders on matters of

management. This, however, does not mean that directors of the company can

do anything they want without any checks or responsibility.

Directors are said to be in a fiduciary relationship with their company. This

means they occupy a position of trust, confidence and good faith. They hold

their positions not for their own benefit but for the benefit of the company as a

whole. Their position is similar to that between a trustee and beneficiary.

Therefore, although directors have freedom to run the company, they must do

so for the benefit of the company and not for their own personal benefit.

The law has imposed certain duties on directors to ensure they do their jobs

properly and that they do not abuse their position. Theses duties, which are

binding on directors of all descriptions, originated from Equitable and Common

Law principles, as well as from statute. And now for the first time all directors'

duties, old and new, have been codified in one enactment – the Companies Act.

The duties that arise from directors' fiduciary position are: duty to act within

their powers; duty to promote the success of the company; duty to exercise

independent judgment; duty to avoid conflict of interest; duty not to accept

benefits from third parties; duty to declare interest in any proposed/existing

transaction or arrangement.

The duty that originated from the Common Law is the duty exercise care, skill

and diligence in the performance of their duties.

Similarly, the new UAE commercial company law contains an express statement

of directors' duties. This is in stark contrast to the old company law (federal law

no. 8 of 1984) where directors' duties are scattered around various sources and,

in some cases, exist by little more than implication. Article 22 of the new

company law attempts to codify the basic duties that are owed by the directors

of all types of the company incorporated in the UAE: A person authorized to

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manage the company shall preserve its rights and extend such care as a diligent

person. Such person shall do all such acts in agreement with the objective of the

company and the powers granted to such person by virtue of an authorization

issued by the company in this respect.

1. Duty to act bona fide in the interest of the company

This is a general duty that arises from directors' fiduciary position. It means that

directors, in all they do on their companies ' behalf, must act in good faith and in

such a manner as will benefit the company as a whole. They must not act in

manner that is harmful to the interests of the company. They must not abuse

their office or use the company to benefit themselves or somebody else. This

principle is illustrated in Re W & M Roith Ltd. (1967)

Facts: One of the directors of the company was very ill. The Board of Directors of

the company signed a new service contract with the sick director in which they

agreed to pay his widow a handsome pension in the event of his death. The

director died shortly after the new contract was signed.

Held: the company was not bound by that contract because the directors have

used their power to benefit a fellow director's widow and not the company.

How do you determine a director's good faith?

In judging whether directors have acted in good faith, the test is whether they

honestly believed they were acting in the interest of the company to the best of

their knowledge and ability (subjective test). If they did, they would not be in

breach of duty even though they turn out to be wrong unless the action was

such that no reasonable person could believe it was in the interest of the

company.

Interest of creditors – If a company is insolvent, the directors must, in their

conduct, have regard to the interest of directors. They must take reasonable

care to minimize losses to the company's creditors

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Interest of employee – Company law now require directors to also take account

of the interest of employee or former employees of the company as well those

of the shareholders. The interest of shareholders should however outweigh

those of employees.

2. Duty to exercise the powers of the company for their proper purpose

This is an example of fiduciary duty. CA provides that directors must act in

accordance with their companies' constitution and must exercise the powers for

the purpose for which they were conferred. This is codification of an existing

aspect of directors' fiduciary duties. Directors must exercise their powers for the

purpose for which they were given. They cannot misuse their power to do

whatever they liked, or for any collateral purpose. If directors use their powers

use their powers for an improper or collateral purpose, they will be in breach of

duty and the transaction/act in question could be set aside.

One area where this rule is manifest is the power of directors to allot (issue)

shares in a company. This power should be exercised for the purpose of raising

money for the growth of a company. It is not be used for any ulterior or

collateral purpose. See:

Howard Smith v. Ampol Petroleum (1974)

Directors allotted new shares in order to destroy the majority control of two

shareholders who were opposed to a proposed takeover of the company. The

Board of Directors sponsored the takeover bid. It was held that the allotment

was void since it was made for a collateral purpose (changing the balance of

power), and for an improper motive.

Hogg v. Cramphorn (1967)

This case is similar to the first one. The directors allotted shares to employee

under an employee share scheme in order to fight off a take-over bid, which

they believed would not be good for the company. It was held that the allotment

was invalid.

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However where directors exercise their powers for an improper purpose, the

shareholders may decide to ratify (i.e approve) the transaction. In Hogg v.

Comphorn, the shareholders later ratified the allotments.

3. Duty to avoid conflict of interest

Another important fiduciary duty is that directors must ensure their personal

interests do not conflict with their duty as directors. This is provided in CA. This

means that directors should not involve the company in transactions in which

they stand to benefit personally. For example, if a director of a company awards

a contract to a company owned by himself or his wife or father or son, etc. this

will be a conflict of interest.

Article 90 of the new commercial company law states that the manager shall

not, without the consent of the general assembly, get involved in or undertake

deals that compete with the company. They also cannot manage any other

company that is in direct competition with the current company.

In Bray v. Ford (1896) the court held that a fiduciary (including a director) is not

entitled to make a profit or to put himself in a position where his duty and

interests conflict. See also:

Aberdeen Railway Co. v. Blaike Bros (1854)

A company entered into a contract with a firm for the supply of some goods. The

chairman of the company was also a partner in the firm supplying the articles.

It was held that there has been a breach of duty. The court stated that no one

having fiduciary duties to discharge shall be allowed to enter into engagements

in which he has, or can have, a personal interest conflicting, or which possibly

may conflict with the interest of those whom he is bound to protect.

Transvaal Lands Co. v New Belgium (Transvaal) Land and Development Co. (1914)

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Company A and company B entered into a contract. One of the directors of

company A held shares in company B on trust for someone else. It was held that

the contract was invalid because of conflict of interest as director and trustee.

The corporate opportunity doctrine

An application of the conflict of interest rule is the requirement that directors of

a company must not profit personally from corporate property, information or

opportunity in the course of their duty .This duty applies whether or not the

company would take advantage of the property, information, or opportunity. All

corporate opportunities/information/property must be utilized for the benefit of

the company. If a director uses corporate opportunity for their own interest or if

they make secret profits, they must render account of the transaction/profits to

the company. This principle is illustrated in the following cases:

Cook v. Deeks (1916)

Directors of a company became aware that a lucrative contract was about to be

awarded to the company. They resigned from the company and formed a new

one. They used the new company to get the contract for themselves. It was held

that the directors were in breach of their duty and liable to account to the

original company.

Regal Hastings v. Gulliver (1942)

The plaintiff company owned one cinema. They formed a subsidiary to buy two

more cinemas in order to tell all three together. The company could not raise all

money needed for the purchase. The directors of the plaintiff company

therefore bought personal shares in the subsidiary. They later sold these shares

at a large profit. It was held that the directors were in breach of their fiduciary

duty and should therefore account to the company for the profits.

Canadian Aero Service Ltd. O'Malley (1973) (Canadian decision)

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O and Z were directors of the plaintiff company. They were sent to Guyana by

the company to negotiate for a contract with that country's government. When

it became certain that the company would be awarded the contract, the two

directors resigned from the company and formed their own company. This new

company was awarded the contract by the Guyana government. It was held that

the directors were in breach of their duty and therefore liable to account.

Industrial Development Consultants Ltd. V. Cooley (1972)

Cooley was a director of IDC. He was approached by third party (The Eastern Gas

Board) who wished to employ him personally on a lucrative consultancy contract

without involving IDC. Cooley retired from IDC on the pretence of being ill. He

then entered a new contract with EGB. It was held that Cooley must account to

IDC for the profit he made because he became aware of the opportunity by

virtue of his position as director of IDC.

Exceptions to the corporate opportunity doctrine

(a) Where the director brings the business opportunity to the attention of

the company and the board of the directors authorizes the director to

take advantage or decides not to pursue the business on the company's

behalf, the director may not be in breach of duty if he subsequently

becomes involved in that business and makes profit – s. 175 (4) CA 2006.

This was shown in the following case:

Peso Silver Mines v. Cropper (1966) (Canadian decision)

The company's geologist advised the company to invest in certain prospecting

claim, which he considered promising. The Board of the Directors rejected the

advice. The geologist resigned and formed his own company, which bought the

claim. One of the directors of Peso became a shareholder in the new company

and made substantial profits. Peso sued him for account. It was held the director

was not breach of duty since Peso was told about the deal and they refused to

take it up.

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Note: The decision of the board must be made in good faith and the director in

question must not vote in the decision. If directors rejected the business only in

order to clear the way for them to do it themselves, they will be in breach of

duty.

(b) Where the articles allow such transactions or provide that the rule will

not apply. However the director first has to disclose his interest to the

Board of Directors.

(c) The rule should not be used as a restraint of trade. Thus a former director

may in appropriate cases make use of information and knowledge

acquired while working as a director in a company as long as departure

from the company was not motivated by a desire to pursue a particular

opportunity privately.

4. Disclosure of interest

Disclosure of interest in proposed contract: If a director finds himself interested,

directly or indirectly, in a proposed transaction or arrangement, which may

involve a conflict of interest, he required to declare his interest to the Board of

Directors before the transaction is done .

The disclosure may be done formally at a meeting or by notice, or informally by

anyhow making the other directors aware of the interest.

In Lee Panavision Ltd. V Lee Lighting Ltd (1992) a director disclosed his interest to

other directors informally without making a formal declaration at a board

meeting. It was held that there has been a disclosure as required by law.

No disclosure is necessary:

- Where the other directors are already aware of the interest, or

- Where the matter involves a director's service contract

Runciman v. Walter Runciman Plc. (1992)

The plaintiff, the executive chairman of the defendant company, was

unfairly dismissed from office. He used for damages for unfair dismissal.

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The company sought to reduce the amount of damages payable to him on

the ground that the service contract of the plaintiff and other executive

directors had been extended without the plaintiff disclosing his interest

in the extension to the Board of Directors. Because of this the companied

argued that the contract was voidable.

Held: That since it was blatantly obvious to everybody in the management

of the company that the plaintiff had an interest in his own service

contract, there was no need for formal declaration of the interest to the

Board of Directors.

Disclosure of interest in existing contract: if a director has an interest in an

existing transaction, contract or arrangement involving his company, he must

also declare the nature and extent of this interest to the board of directors as

soon as reasonably practicable.

Again the declaration may be at a meeting, by notice, or informally.

Again there is no need for disclosure where the other directors already know

about the interest or where the interest involves the director's service contract.

If the director fails to disclosure his interest in an existing contract/transaction,

he will be committing a crime for which he may be fined .

Where a company has only one director, it has been held in Neptune (Vehicle

Washing Equipment) Ltd. V. Fitzgerald (1995), that the sole director must declare

and record his interest in a meeting of the board even though he is the only

person in attendance.

5. Duty not to accept benefit from third parties

Yet another fiduciary duty is that directors must not, in the course of their

duties, accept a benefit or bribe from third parties in order to do their duties or

to refrain from doing their duties.

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This duty is intended to prevent corruption, which might compromise the

performance of directors' responsibilities.

However benefits conferred by the company or authorized by the shareholders

are not covered by this provision.

6. Duty to promote the success of the company

Directors have a duty to act in such a way as would enable their companies to be

successful. This is also a fiduciary duty. In particular, directors should in their

decisions and actions:

- Consider the long-term consequences of their action;

- Consider the interest of the company's employees;

- Foster good business relations with the company's supplier, customers

and others;

- Consider the impact of the company's activities on the environment;

- Endeavour to maintain good reputation and high standard in business;

- Treat members of the company fairly;

7. Duty to exercise independent judgment

This is another fiduciary duty. A director must exercise independent judgment in

the best interest of the company. This means he must not allow himself to be

unduly influenced in his future exercise of his discretion unless he is acting (a) in

accordance with an agreement between him and the company, or (b) in

accordance with the company's constitution. The essence of this duty is to

prevent directors from mortgaging their companies' interest to the desires of

third or from compromising their decisions. Since the directors are appointed by

the shareholders to run their company, they must exercise this mandate

personally and to the best of their ability. Outsiders, who are not answerable to

the shareholders, must not be allowed to control the board of directors.

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8. Duty of care and skill

Directors are required to exercise reasonable care, skill and diligence in their

conduct and management of the company's affairs. They would be liable in

negligence if they fail to exercise appropriate care, skill or competence.

What is the standard of care and skill required?

Originally the law did not set a particularly high standard of skill and

competence for directors. The measure of director's care and skill was first

established the case of Re City Equitable Fire Insurance Ltd. (1925).the court held

that a director might only exercise such knowledge as may be expected of a

person of his knowledge and experience, that he is not bound to give continuous

attention to the affairs of the company; and that he may delegate his duties to

other directors and officers of the company.

Now the standard of care has been made stricter. The test of directors'

competence and skill is now both objective and subjective. Under Company law

directors must act:

- With the care, skill and diligence that would be exercised by a reasonably

diligent person with the knowledge, skill and experience of any person in

the same position (objective test); and with

- The general knowledge, skill and experienced possessed by that

particular director (subjective test);

This dual test is the same test used to determine whether a director is guilty of

wrongful trading under Company law and applied in Norman v. Theodore

Goddard (1991)

Executive directors to devote their full time to company affairs

The decision in Re City Equitable Fire Insurance case that a director need not

devote his full time to the affairs of the company now applies only to non-

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executive directors who are employed on a part-time basis. Executive directors

who have full time service contracts are required to devote their full time to the

service of the company. Even non-executive directors should attend board

meetings for more than six months (without permission) is a ground for

dismissal.

Directors must supervise delegated functions

Even though directors, especially non-executive ones, may still, in appropriate

circumstances, delegate their duties to other directors, they now have a

responsibility to supervise and monitor the discharge of those duties and keep

themselves informed of their companies' businesses. In Equitable Life Assurance

Society v. Bowley (2003), it was held that a non-executive director was not

entitled to delegate his responsibilities if it meant an unquestioning dependence

on others to do his job. In Re Barings Plc (2000), it was held that the exercise of

the power of delegation does not absolve a director from the duty to supervise

the discharge of the delegated functions. It was also held that directors

collectively have a continuing duty to acquire and maintain a sufficient

knowledge and understanding of the company's business to enable them

properly to discharge their duties.

And in Dorchester Finance Co. v. Stebbing (1989), two non-executive directors of a

finance company were in the habit of signing blank cheques for the use of their

co-directors. One of the directors was chartered accountant while the other had

extensive experience in accounting. The result of the directors' actions was that

the company lost a lot of money due the misuse of the cheques by their co-

director to give irregular loans to friends and family members. It was held that

the company was entitled to sue the two non-executive directors for negligence.

Note also that for listed companies, it is now required that their directors and

senior management must collectively have appropriate expertise and

experience to manage their businesses.

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1. Lawrence Gaffney was the president and general manager of ideal tape

company (ideal). Ideal which was a subsidiary of Chelsea industries, inc.

(Chelsea) was engaged in the business of manufacturing pressure-sensitive tape.

Gaffney recruited three other idea executives to join him in starting a tap

manufacturing business. The four men remained at ideal for the two years it

took them to plan the new enterprise. During this time, they used their positions

at ideal to travel around the country to gather business ideas, recruit potential

customers, and purchase equipment for their business. At no time did they

reveal to Chelsea their intention to open a competing business. The new

business was incorporated as action manufacturing company (action). When

executive at Chelsea discovered the existence of the new venture, Gaffney and

the others resigned from Chelsea. Chelsea sued them for damages. Who wins?

2. Edward Hellenbrand ran a comedy club known as the comedy cottage in

Illinois. The business was incorporated with Hellenbrand and his wife at the

corporation’s sole shareholders. The corporation leased the premises in which

the club was located. Hellenbrand hired Jay Berk as general manager of the club.

Two years later, Berk was made vice president of the corporation and given 10

percent of its stock. Hellenbrand experienced health problems and moved to

Nevada, leaving Berk to mange the daily affairs of the business. Four years later,

the ownership of the building where the comedy cottage was located changed

hands. Shortly thereafter, the club’s lease on the premises expired. Hellenbrand

instructed berk to negotiate a new lease. Berk arranged a month-to-month lease

but had the lease agreement drawn up in his own name instead of that of the

corporation. When Hellenbrand learned of berk’s move, he fired him. Berk

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continued to lease the building in his own name and opened his own club, the

comedy company inc, there. Hellenbrand sued berk for an injunction to prevent

berk from leasing the building. Who wins? (comedy cottage v Berk 1986)

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Protection of Minority Shareholders in both England and DIFC

Shareholders who hold fewer than 50% of a company’s voting shares can be

outvoted on an ordinary resolution. Shareholders who hold 20% of the voting

shares, or fewer, cannot block a special resolution. Such minority shareholders

can find themselves in a vulnerable position if the majority shareholders elect

directors who act in concert against the majority shareholders. Often the

majority shareholders elect themselves as directors.

Introduction

In the operation of companies, the majority of the members or those who

possess majority of the shares control the company. The board of directors also

exercises considerable influence on a company. It is possible that those in

control of the company may conduct themselves or the business of the company

such a way that is beneficial to them but detrimental to the minority

shareholders or the company itself. It may also happen that those in charge of

acting on behalf of the company may refuse or fail to take action to protect the

interest of the company because they themselves are responsible for the

wrongdoing. The problem becomes more serious where the majority

shareholders are also directors of the directors.

The law has therefore provided ways in which shareholders and members,

especially the minority, can act to protect their own interest or the interest of

the company in some special circumstances. These provisions are:

- The exception to the rule in Foss v. Harbottle

- Derivative claims for directors breach of duty

- The unfair prejudice, and

- Winding up on just and equitable grounds

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Exceptions to the "Rule in Foss v. Harbottle"

The Role

First let us discuss the rule in Foss v. Harbottle. We have seen that a limited

company is a different legal person from the shareholders. A limited company

has its own rights and liabilities different from those of the shareholders. A

limited company can sue and be sued in its own name. A logical extension of this

doctrine is that if a wrong is done to a limited company be anybody, either from

outside or inside the company, the proper person to bring an action for redress

is the company itself. Individual shareholders have no right to take action on

their own behalf of the company. This known as "the rule in Foss v. Harbottle."

In the case of Foss v. Harbottle (1843) Foss and another shareholder of the

company brought an action against some directors and officers of the company

for losses suffered by the company due to the defendants' misconduct and

fraud. The defendants were alleged to have enriched themselves at the expense

of the company. It was held that the company itself could take action against the

defendants if it wished; the plaintiffs were not entitled to be bring the action;

and that since the company could confirm the actions of the defendants by

majority vote, the court could not interfere.

According to the court:

It was not, nor could it successfully be argued that it was a matter of

course for any individual members of a corporation thus to assume to

themselves the rights of suing in the name of the corporation. In law the

corporation and the aggregate members of the corporation are not the

same thing for purposes like this.

The rule in Foss v. Harbottle is based on some principles. Some of these

principles were articulated in the case of Burland v. Earle (1902). Here as in Foss v.

Harbottle, some shareholders brought an action against company directors

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challenging their conduct and certain actions taken by them. The action was

dismissed.

According to Lord Davey:

It is elementary principle that the court will not interfere with the internal

management of companies acting within their powers and in fact has no

jurisdiction to do so. Again it is clear law that in order to redress a wrong

done to the company or to recover moneys or damages alleged to be due

to the company, the action should, prima facie, be brought be the company

itself. It should be added that no mere informality or irregularity which can

be remedied by the majority will entitle the minority to sue if the act when

done regularly would be within the powers of the company and the

intention of the majority of shareholders is clear.

The reasons for the rule in Foss v. Harbottle could therefore be summarized as

follows:

1. Proper plaintiff principle – Being a separate legal person, a company is the

proper party to redress a wrong done to it. If individual shareholders are

allowed to use for corporate injuries, there may be a multiplicity of actions from

several shareholders

2. Internal management principle – A company has the power and right to run its

business and internal affairs in accordance with its constitution and internal

structure. It is not duty of the court to dictate to a company how to run its

internal affairs.

3. Ratifiability principle – If the act complained of was capable of being ratified by

simple majority of the members in a general meeting, individual shareholders

cannot sue. This is because the company may decide to ratify the action or to

annual it.

4. Majority principle – As in any association, matters or disputes in a company

should be decided by majority vote. Those who take interest or buy shares in a

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company should be prepared to accept majority decisions even if they disagree

with them.

Exception to the rule (the majority protection)

The role in Foss v. Harbottle is a general rule. In some circumstances, the rule

will be displaced to allow individual shareholders to take action. Where the

majority abuse their position, or where there are allegations of mal-

administration against directors who are majority shareholders, difficulty arises

as to how to protect the interest of the company or those of the minority. This is

because those in control may not be willing to sue on behalf of the company

because they are the wrongdoers.

For example:

Fraud on the company/minority – Where there has been a fraud on the company

or on the minority, the rule does not apply. Fraud includes any act, which was

not done bona fide in the interest of the company as a whole. Therefore where

the majority shareholders do any act calculated to oppress the minority or to

defraud the company, this will be regarded as fraud entitling affected

shareholders to bring an action. Misappropriation of corporate assets or

opportunity by majority shareholders or directors may also be regarded as fraud

on the company and the minority shareholders. Accordingly a breach of

directors' duty could amount on the company/minority.

Below are some examples of fraud on the company or minority:

Cook v. Deeks (1916) – Directors used their position to obtain a contract, which

the company would have obtained. They then used their majority votes in the

company to pass a resolution that the company was not interested in the

contract. It was held that a fraud was done on the minority. The directors were

held liable to account.

Daniels v. Daniels (1978) – Directors of a company sold properties belonging to

the company to one of the directors at a gross undervalue. The same property

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was later resold at a huge profit. It was held that a shareholder could sue to

bring the directors to account since they have used their position to benefit

themselves to the detriment of the company.

Where majority shareholders forcibly buy the shares of the minority

shareholders in order to force them out of the company, this will be regarded as

a fraud on the minority. – See Browne v. British Abrasive Wheel Co. Ltd. (1919)

Conditions for bringing the action

Before an action could be brought under the exception to Foss v. Harbottle, it

needs to be shown that:

- The wrongdoers are in control of the company and would not take action

on behalf of the company.

- The complainant did not take part in the wrongful act.

- The company would be the beneficiary of any judgment. Any benefit

from the case to the company and not to the complainant personally.

Therefore the company is normally joined as a defendant in the case in

order to benefit from any judgment. However, the court may order the

company to pay complainant's cost.

This kind of action is called a "derivative action" because the shareholder derives

his authority to sue from the right of the company. The action is brought on

behalf of other aggrieved shareholders.

The exceptions to the rule in Foss v. Harbottle are as follows:

1) Derivative Claims for directors' breach of duty

Members of the company may bring action on behalf of the company where

directors have been involved in an actual or proposed act or omission involving:

negligence, default, breach of duty, or breach of trust. This is statutory version

of the derivative claim under the exceptions to the rule in Foss v. Harbottle

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This provision covers failure to perform duties expected of the directors, breach

of any duty owed by directors, including fiduciary duties and duty of care and

skill.

The action may be brought against a director or may any other person

responsible for the wrongdoing. Remember 'director' includes shadow and

former directors

Members may sue in respect of actual or proposed action by directors. They may

also sue in respect of omissions (i.e. failure or refusal by directors to take action)

Members may sue for wrongdoing committed while they are members or before

they became members

In order to bring a derivative claim, a member would need to apply to the court

and show a prima facie case for the action. This means he must prove on the face

of it that a wrongdoing as described above has taken place. The court may

decide either to permit the action, to dismiss the action, and/or give such

directions as necessary

In deciding whether or not to give permission, the court would consider:

- Whether the act is such as would likely be authorized or ratified by the

company

- Whether the member bringing the action was acting in good faith

- Whether the company has decided not to bring any action in respect of

the wrongdoing

- Whether the action should rather be pursued as a personal claim by the

member concerned

- Evidence of members who have no personal interest in the matter

The court would refuse permission where a perceived wrongdoing was

authorized, approved, or ratified by the company

Continuing an action as a derivative claim

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Where the company or any member has brought an action against a director for

wrongdoing, another member of the company may apply to the court to take

over and continue the case as a derivative claim.

The court would give permission for the take over and continuation if it is

appropriate for the claimant to take over the case and the court is satisfied that

the action was brought in abuse of court process and the company or those who

brought it have failed to pursue the case diligently.

The provision is made to prevent directors or interested shareholder from

blocking court action against their wrongdoing.

NB: these provisions are designed to give further ammunition to shareholders or

members to hold their directors to account and help ensure directors fulfil their

obligations to their companies

2) The Unfair Prejudice Remedy

Company law makes provisions to protect minority shareholders from the

wrongful act or conduct of the majority shareholders.

Under company law, a member or shareholder of a company may petition the

court for remedy on the ground:

- That the affairs of the company have been or are being conducted in

manner unfairly prejudicial to the interest of its members generally or part

thereof (including himself), or;

- That an actual or proposed act or omission of the company is or would be

prejudicial

Meaning of 'unfairly prejudicial' conduct

The act complained of must amount to a prejudice and must also be unfair. An

unfairly prejudice act means an inequitable act or act done in bad faith, which is

injurious or detrimental to the minority shareholders. This would include a

serious breach or abuse of the company's rules.

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The unfair prejudice must however be a commercial detriment or disadvantage.

Emotional or social disadvantage is not enough. For example any act or omission

that devalues shareholders' shares or interest in the company would be a

commercial detriment.

Examples of unfair prejudicial conduct:

- It is unfairly prejudicial for majority shareholders who are directors to

dismiss minority shareholders who are also directors from the board

without just cause.

- It is unfairly prejudicial for majority shareholders to divert business from

the company to another company or to appropriate company property.

In Re London School of Electronics Ltd. (1985) – Shareholders who control 75% of a

company's shares diverted the business of the company to another company in

which they were also the major shareholders. This deprived holders of the

remaining 25% shares of their share of the company's profits. It was held that

this was unfairly prejudicial conduct.

In Re Cumana Ltd. (1986) – Two owners of a company agreed to share the profits

at the ratio of 2:1. The majority shareholder devised many ways to deprive the

minority of his own share. First he diverted the company business to another

company controlled by him; secondly he made large issue that he knows the

minority shareholder could not afford; thirdly he got the company to pay

excessive contribution to his pension fund. It was held that these conducts were

unfairly prejudicial to the interest of the minority shareholders.

Re Little Olympian Each Ways Ltd(No.3) (1995)

Directors of a company transferred their shares to a new company in which they

had controlling interest. They then sold the assets of the company to the new

company for a nominal price of £1.00. these directors subsequently sold their

shares in the new company for £10 million thereby making very huge profits. It

was held that this was unfairly prejudicial conduct.

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In Re Elgindata Ltd (1991) – the MD of a company used assets of the company for

his personal benefit and the benefit of his family and friends to the detriment of

the company. This was held to be unfairly prejudicial conduct.

- It is an unfairly prejudicial conduct to prevent a shareholder from selling

his shares at the best price. In Re a Company (1985), there were two rival

bids for the takeover of a company. The chairman of the company

deliberately misled the company into accepting the lower bid by falsely

claiming the higher bid would not succeed. This meant the shareholders

sold their shares at a much lower price. It was held that this was unfairly

prejudicial conduct.

- It is unfairly prejudicial for majority shareholders to force the minority

shareholders to sell their shares to them (especially at less than their

market value)

Orders that can be made by the court:

The company law empowers the court, if it thinks an action was well-founded, to

make such orders as it thinks fit to give relief from the matters complained,

including (but not limited to):

- An order to regulate the affairs of the company in the future

- An order requiring the company to stop doing the act complained of, or

an oreder for it to do an act which it has omitted.

- An order authorizing civil proceedings to be brought in the name or on

behalf of the company by certain persons under terms specified by the

court.

- An order for purchase by the company or other members of the shares of

any members of the company at the market price.

- An order preventing alteration of company articles without court

approval

In order to give effect to its order the court may insert new provisions in the

company's memorandum and articles. It was also alter the provisions of the

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documents. Any alteration or insertion made by the court cannot be changed by

the company without the permission of the court.

3) The Just and Equitable Winding up

A member of a company may petition the court to wind up a company on the

ground that it is just equitable to do so.

In order to be able to petition for winding up under this provision, the petitioner

has to show that the wrongdoing affects him in his capacity as a member and

not in any other capacity.

The remedy of winding up is a drastic one as it brings a company's life to an end.

Accordingly the court will usually only grant it where no other remedy would

suffice to redress the situation. In Re Westbourne Galleries Ltd. (1973) the House

of Lords laid out the circumstances under which an order for just and equitable

winding up may be made:

- The company must be regarded as a quasi partnership. In other words it

was formed or continued on the basis of personal relationship and

confidence and these personal relationship and confidence have been

destroyed. Therefore the company will usually be a small private

company.

- There has to be an understanding that the shareholders would be

involved in management and this agreement has been breached.

- Winding up is the only way the dispute could be resolved

In Re Westbourne Galleries Ltd, the company was formed by E and N on the basis

of equality in both management and profit sharing. Subsequently N brought his

son into the company as an equal shareholder and director with E and N. later N

and his son colluded to remove E as a director. They also stopped paying

dividends but paid themselves directors' remuneration. They further used

company's import network to trade on their own account. In despair, E

petitioned the court to wind up the company on just and equitable ground

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because N and his son had destroyed the basis on which the company was

formed.

It was held that company should be wound up on the just and equitable ground.

In Re Appey Leisure (1990), the company was formed on the understanding that

its sole purpose was the acquisition, refurbishing, and management of nightclub.

The nightclub was acquired but subsequently sold. The plaintiff petitioned for

the 'just and equitable' winding up of the company on the ground that the

purpose for forming the company had been defeated by the selling of the

nightclub. It was held that the company should be wound up on the just and

equitable ground.

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Protection of Minority Shareholders in UAE

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 section 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.

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The First Tool – The Board Seat

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 2015 ("CCL") makes no 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 143 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 11. 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 83 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.

Article 161 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:

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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 162/1 of the CCL. In this context, Article 162/2

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 of Directors' Remuneration

Article 169 of the CCL requires the company's articles of association to specify

the directors' remuneration. The CCL provides that the remuneration drawn by

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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 169 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 Third Tool – Access to Confidential Corporate Information

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.

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The CCL contains a provision (refer Article 247), 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 221, 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 fourth Tool - Agreement for Cash Exit

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

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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 theirs.

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:

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What should be the "trigger" for the exercise of the put option?; and

How is the option price to be set?

The fifth Tool - Shareholder Litigation

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 162/1, which makes

directors liable to be sued by the company, the shareholders and third parties. It

is the most likely avenue for shareholder litigation. Article 166 permits every

shareholder to file a legal action individually against the board of directors if not

filed by the company. 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 165 further amplifies the remedies available under Article 162/1 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. 3

3 Derivative action does not yet exist under the new company law. A shareholder derivative suit is a

lawsuit brought by a shareholder on behalf of a corporation against a third party. Often, the third

party is an insider of the corporation, such as an executive officer or director. Shareholder derivative

suits are unique because under traditional corporate law, management is responsible for bringing and

defending the corporation against suit. Shareholder derivative suits permit a shareholder to initiate a

suit when management has failed to do so.

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Furthermore, according to article 167, any decision passed by the general

assembly to relive the board of directors shall not prevent the filing of the

liability lawsuit against the board of directors due to the errors committed by

them during the performance of their duties.

Article 186/2 bars directors (who are also shareholders) 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 191 of the CCL provides grounds to suspend (and as such annual) general

assembly resolutions where the shareholders have chosen to pass resolutions:

on demand by the shareholders who hold a percentage of at least 5% of the

shares of the company, the authority (securities and commodities authority)

may issue a decision to suspend the execution of the decisions passed by the

general assembly of the company to the detriment of the shareholders or in

favour of a certain class of the shareholders or to bring a special benefit to the

directors or others whenever the grounds of the request are serious.

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

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being the sole European exception) and UAE law imposes stringent

requirements on the judgments 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 judgments of foreign courts. The UAE ratified the UN

Convention on the Recognition and Enforcement of Foreign Arbitral Awards in

August of 2006.

The fifth Tool – Unfair prejudice remedy

Article 164: The new CCL introduces a new ‘unfair prejudice’ procedure whereby

shareholders holding individually or together at least 5% can apply for remedies

to the SCA (or the competent court, in case of rejection of the request or failure

to act by the SCA) if the affairs of the company are deemed to be conducted to

the detriment of any or all of the shareholders. The SCA may issue a relevant

resolution at its discretion, or alternately, seek a court order and the court is

required to hear the suit as a matter of urgency and granted the authority to

issue a judgment to annul an act or to require an omitted act (Art. 164). This

provision increases the rights of minority shareholders. It will be very

interesting to see how the SCA and the courts interpret and apply this provision.

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The sixth Tool – Shareholders' agreement

Explained earlier page 15 of this handout

INSOLVENCY AND WINDING UP OF COMPANIES

A limited company may run into difficulties, become solvent, or need to close

down its business for different reasons. However, the company cannot simply

stop doing business and close shop. Certain stator rules must be followed either

to rescue the company from difficulties, to settle the company's liabilities, or

otherwise end the company's business and existence. The various steps to be

taken in these circumstances are covered by the rules relating to insolvency,

administration, and winding up or liquidation of companies. Most of these steps

are insolvency procedures. In other words they take place only when a company

has become insolvent. These include administration, administrative receivership,

voluntary arrangements, compulsory winding up, and creditors' voluntary

winding up. Some other procedures take place when a company is still solvent.

An example is members' voluntary winding up.

The following are steps, which may be taken when a company becomes

insolvent or wishes to end its existence.

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1. Company Voluntary Arrangement

Voluntary arrangement is a mechanism where a company in financial difficulty

reaches an arrangement or compromise with its creditors on the management

or payment of its debts. A voluntary arrangement will involve things like

rearranging or rescheduling the payment of a company's debts or modifying its

terms to make repayment easier for the company. CVA should be the first line of

action of an insolvent company because, if successfully negotiated, it can allow a

company to continue its business without disruption while it tries to come out of

insolvency.

- CVA are usually negotiated by a company's board of directors which

remains in place during the period.

- CVA must be approved by the members and three 3/4 of the company's

unsecured creditors.

- But once the voluntary arrangement has been approved the decision is

binding on all unsecured creditors of the company.

- If the company is in administration, the scheme or arrangement may be

proposed by the administrator, and must also be approved by the

members and three quarters of the unsecured creditors. But if the

company is in liquidation, the liquidator may make the proposal.

- A proposal for a voluntary arrangement should be filed with the court

although court permission is not required for the arrangement to take

effect.

- A qualified insolvency practitioner must be appointed as nominee to

supervise the implementation of the voluntary arrangement.

Effect of Voluntary Arrangement

a. Moratorium – Moratorium means the general postponement of enforcement

of all debts owed by the company. During this period no legal action for the

recovery of debt, property or goods can be brought against the company; no

execution can be levied against its property; and a landlord cannot retake

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possession of any property rented by the company. Moreover no winding up

proceedings may be commenced against the company (unless by a court order)

In short, rights over the company by third parties are frozen during the period of

the arrangement. The company may unable to pay debts due to cash-flow

problems but may expect to be able to pay them in the near future.

The moratorium will prevent creditors who do not want an arrangement from

taking steps to scupper the proposal by, for example, applying for winding up or

administration or appointing an administrative receiver before the proposal is

approved by the creditors.

b. Composition of debt: Creditors are offered a percentage of their debt in

settlement. For example, they might be offered ‘65 pence in the pound’: that is ,

65 pence for every pound which the company owes them.

c. Debt for equity swap: Major creditors may be offered the chance to swap their

debt for shares in the company. From the company’s point of view, the removal

of the debt should ease cash-flow problems.

- CVA gives an insolvent company an opportunity to try and trade its way

out of insolvency.

2. Receivership

Receivership means the realization of the assets of a company secured by a fixed

charge for the purpose of satisfying the debt secured by the charge. The officer

responsible for this is called a receiver. Usually no court order is required for the

appointment of the receiver since the debenture includes this right. Without

such stipulation, a receiver can only be court order.

- The main concern of a receiver is the enforcement of the charge of the

creditor who appointed him. He does not have to be concerned about the

interest of the company as a whole.

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- The receiver does not owe fiduciary duties to the company as a director

does, his interest being the welfare of the appointing creditor; he should

however act with diligence and could be sued by the company if he

abuses his position.

- A receiver appointed by a creditor is normally an agent of the company

and therefore, has the right to enter into contracts and employ staff in

the name of the company for the purpose of the receivership. This right

ends if the company goes into the process of liquidation.

- A receiver must submit an account to the company on the conduct of his

work.

3. Administrative Receivership

An administrative receiver is a receiver appointed to realise/gather the whole or

substantially the whole of an insolvent company's properties for the purpose of

paying off debts secured by a floating charge. Such a receiver doubles as a

manager of the company.

- Administrative receivers are appointed by holder(s) of a floating charge

over a company's whole undertaking. The power to appoint is normally

include in the debenture creating the charge; the court's permission is

not needed for appointment.

- Only qualified insolvency practitioners may be appointed as

administrative receivers.

Effect of appointment of a receiver

- The administrative receiver has sole authority to deal with the properties

subject to the charge. Because this usually covers the whole or almost the

whole undertaking of the company, the admin. Receiver is practically in

charge of the whole business.

- The company directors remain in office and in control of other aspects (if

any) of the company's affairs. Practically, however, the directors may

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have little to do as the receiver's power extends to wide areas of the

director's business.

- An administrative receiver inherits the contracts of the company,

including those of employees. However, he is at liberty to make workers

redundant if need be.

- A receiver may however, be required to settle some preferential debts

before paying off the charge. Preferential debts include government

taxes, levies, and customs duties.

Powers of administrative receiver – The powers are vast and include:

- To gather and take possession of a company's properties

- To sell or otherwise dispose of those properties

- To carry on the business of the company

- To borrow money on behalf of the company and to use company's

property as security

- To enter into contracts on behalf of the company

- To dispose (with court authorization) of any properties subject of a

charge (however the proceeds must applied to settle the creditors)

- To sue or defend a suit on behalf of the company

- To apply for the winding up of the company, etc.

4. Administration

When a company is insolvent, it may be necessary to attempt to save it from

being liquidated by appointing other people manage its affairs. This mechanism

is known as administration and those who carry it out are referred to as

administrators. An administration therefore, is a person appointed to manage

the affairs, business and property of an insolvent company.

- An administrator has a duty to work and deal with the properties of a

company for the benefit of all interested parties. These include the

company itself, the shareholders, and the company's creditors.

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- Only qualified insolvency practitioners may be appointed as

administrators. An insolvency practitioner is a person licensed by law to

engage in insolvency practice.

- An administrator may be appointed by the courts on the application of

the company, its directors, or its creditors. He may be appointed by a

holder of a floating charge on the whole undertaking of a company.

- An administrator is an officer of the court and must perform his duties in

the interest of the company and those of its creditors.

Purpose of administration

- To try to rescue the company as a going concern. This objective must first

be pursued unless this is not reasonably practicable; or

- To ensure a better result for creditors than would be achieved by winding-

up. This is the second in priority of the administrator's duties and should

be undertaken when the first option is not reasonably practicable or a

better result is envisaged; or

- To realise the properties of the company for the purpose of paying off

secured and preferential creditors. This is a last resort and the interests of

creditors would not be harmed unnecessarily.

- Before a court could make an administration order, therefore, it must be

satisfied that the company is or is likely to be insolvent, and that

administration is reasonably likely to achieve its purpose. According to

Gibson J. in Re Consumer and Industrial Press Ltd., this means:

“The court must be satisfied on the evidence put before it that at least

one of the purposes in s. 8(3) is likely to be achieved if it is to make an

administration order. That does not mean it is merely possible that such

purpose will be achieved; the evidence must go further than that to

enable the court to hold that the purpose in question will more probably

than not be achieved.”

Effect of appointment of an administrator

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- Upon appointment, an administrator takes over the running of the

company and its entire business.

- The directors of the company cannot exercise any functions that can

interfere with the work of the administrator unless they are permitted to

do so by the administrator himself.

- Moratorium – Upon the appointment of an administrator, or upon filing

an application or notice for his appointment, a period of moratorium

applies as in the case of CVA

Powers of an administrator

- An administrator must prepare and submit to the companies' registrar

and the particular company's unsecured creditors, within eight weeks of

appointment, his proposal for the company. The company's unsecured

creditors must approve this proposal for the administration proper could

commence.

- An administrator has all the powers, which the creditors of the company

and the administrative receiver could exercise. In particular, he could sell

any of the company's properties, could enter into contracts, and could

terminate contracts of employment. He could also "do anything

necessary or expedient for the management of the affairs, business, and

property of the company" without have to seek the approval of the court

or the creditors – Re Transbuss International Ltd. [2004] 2 All ER 911

- An administrator is an agent of the company and does not (unlike the

administrative receiver) incur any personal liability for adopted contracts

of employment.

Duties of an administrator:

- An administrator has a duty, in the exercise of his powers to take

reasonable steps to obtain the best price for the company's assets.

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- He also has a duty to perform his assignment in such a manner, as would

an ordinarily qualified and diligent insolvency practitioner. He could be

liable if was negligent.

- An administrator does not owe a duty of care to creditors of a company

unless there is a special relationship between them. (This was the Court

of Appeal decision in Peskin v, Anderson [2001] BCC 876, and in Kyrrisv.

Oldham [2004] BCC 111)

Duration of administration

An administration comes to an end automatically after one year unless it is

extended:

- It may be extended once for six months by all the secured creditors and

majority of unsecured creditors of the company.

- It may be extended by the court for as long as it thinks necessary

- Administration may be terminated before one year by the administrator

on his own motion, on creditors' instructions, or by court order

5. Compulsory winding up

Where any or all of the above insolvency measure fail, a company's life may be

formally brought to an end either by compulsory winding-up or voluntary

winding-up.

A compulsory winding up occurs when a court makes an order that a company

be wound up compulsory. It is also called winding up be the court. This is an

insolvency and liquidation procedure. The order for compulsory winding up may

be made when:

(a) A company is unable to pay its debts. A company is to be regarded as being

unable to pay its debts:

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- If it is proved that the company could not pay its debts as they

become due. Inability to pay the debts of the creditor/petitioner is

enough

- If it is proved that the company's liabilities exceed its assets

(b) It is just and equitable to wind up the company. This may happen for e.g.

where minorities are oppressed, or in quasi-partnership where the basis

for forming the company has been destroyed; or where a company was

formed for a fraudulent purpose; or where there is a complete deadlock

in management.

Who may apply for compulsory winding up?

Application for voluntary winding up may be made by:

- The company's creditors

- The contributories to the company's funds (where the number of

members is reduced below two)

- The company or its directors

- Supervisor of a voluntary arrangement

- An administrative receiver

- An administrator

- The secretary of State for Trade and Industry

Powers of the liquidator include:

- To do everything necessary for winding up the company and distributing

its assets

- To pay the debts of the company and to sign any documents and issue

cheques, bills of exchange, promissory notes on behalf of the company.

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- To distribute any surplus assets of the company after paying the debts to

the shareholders and others entitled to it

- To enter into arrangements and compromise with creditors with regard

to the company's debts

- To take legal action on behalf of the company and to defend any such

action

- To carry on the business of the company as is necessary to wind it up

beneficially

- To sell any of the company's properties

- To recover money from any contributories of the company

NB: A liquidator owes a fiduciary duty to the company and must act within his

powers and without negligence. He could be held personally liable for

negligence.

Effect on directors of liquidator's appointment:

Because of the extensive powers of the liquidator, the directors of the company

have nothing to do upon the appointment of a liquidator. Their functions are

assumed by the liquidator even though, technically, they remain in office.

6. Voluntary Winding up

Voluntary winding up is one not ordered by a court but initiated by the company

itself. There are two types – members' voluntary winding up and creditors'

voluntary winding up.

(a) Members' voluntary winding up

A members' voluntary winding up can only happen if a company is still solvent.

In members' voluntary winding up, the members themselves appoint the

liquidator. There is no need to involve the court.

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A member's voluntary winding up occurs:

(i) Where the period for which the company was set up has expired or an

event has happened which the articles provide would lead to the

winding up of the company. In these cases only an ordinary resolution

is required.

(ii) Where the members pass a special resolution that the company be

wound up voluntary. The members may pass this resolution simply

because they want the company to cease business for any reason.

Declaration of Solvency

As earlier stated, members' voluntary winding up could only happen when a

company is still solvent. Therefore before a company could be wound up

voluntarily it has to be proved that it is still solvent. Accordingly the directors of

the company have to make a declaration of solvency – this is a statement by the

directors that the company is able to pay all its debts and interests on them in

full within 12 months of the winding up.

The declaration must be made before the passing of the resolution on winding

up and must be accompanied by a statement detailing the company's assets and

liabilities.

The declaration of solvency and the accompanying documents must be

submitted to the registrar of companies with 15 days of the passing of the

winding up resolution.

It is an offence for directors to give a false or misleading declaration of solvency.

If the debts of the company and any interests on them were not paid in full

within the time stated in the resolution, this is evidence that the directors have

presented a false declaration of solvency.

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(b) Creditors' voluntary winding up

Where a members' voluntary winding is proposed but the directors of the

company fail to submit a declaration of solvency and the accompanying

statements before the passing of the resolution for member voluntary winding

up, the winding up automatically becomes a creditors voluntary winding up.

- The company in this circumstance is deemed to be insolvent. Thus

creditors' voluntary winding up is an insolvency procedure.

- A meeting of the company's creditors must be convened within 14 days of

the meeting of the members. The creditors would then appoint a

liquidator to carry out the winding up unless they decided to approve the

one appointed by the members. The powers of the liquidators in

voluntary winding up are similar to those under compulsory winding up.

On the appointment of a liquidator, the directors' functions cease as their duties

are transferred to the liquidator.

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Corporate governance

The new law will enforce stricter corporate governance standards and

procedures on PrJSCs in accordance with international standards and practices.

The Ministry of Economy will be issuing a decree setting out corporate

governance requirements and a framework for PrJSCs consisting of more than

75 shareholders. Banks, finance companies, financial investment companies,

exchanges and money brokerage companies are excluded. In addition to this

provision, it is intended that the Chairman of the Emirates Securities and

Commodities Authority (ESCA) will issue corporate governance requirements for

PrJSCs and the board of the company.

The new law also requires companies to keep accounting records evidencing

their true financial position as well as keeping their accounting books at their

head office for a period of at least 5 years.

Companies Exempt from the new law

Unlike the CCL, the new law will not apply to the following:

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Companies excluded by Cabinet resolution

Companies wholly owned by Federal or local authorities or any entities

wholly owned by such companies

Companies in which the Federal or local authority, or any establishment,

authority, department or company controlled or held by any of the

foregoing (directly or indirectly) holds at least a 25% shareholding and

which operates in oil exploration, drilling, refining, manufacturing,

marketing or operating in the energy sector in power generation, gas

production, or water desalination and distribution.

Corporate Governance defined

“Corporate governance involves a set of relationships between a company’s

management, its board, its shareholders and other stakeholders. Corporate

governance also provides the structure through which the objectives of the

company are set, and the means of attaining those objectives and monitoring

performance are determined."

Corporate governance, while underpinned by the principles of openness,

integrity, and accountability, is about the management and control of

companies, providing a framework that defines the rights, roles, and

responsibilities of various groups – management, board, controlling

shareowners, minority shareholders, and other stakeholders. In essence, it is

based on the efficient functioning of the interplay between these groups and its

objective is to promote strong, viable and competitive companies.

Governance differs from management and is about ensuring that those

responsible for directing an organization ensure that resources are exclusively

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devoted to pursuing its defined goals, and account appropriately to

shareholders and other stakeholders, who in turn can hold them accountable.

Good corporate governance goes beyond compliance with legislative and

regulatory requirements. It is about embedding the principles of accountability

throughout the organization and creating a mechanism of checks and balances.

The understanding and implementation of a good corporate governance

framework presents SMEs a structured path to infusing better management

practices, effective oversight and control mechanisms which lead to

opportunities for growth, financing, exit strategies and improved performance.

The Capital Markets Authority (the “CMA”) has recently issued resolution no. 25

of year 2013, dated 27 June 2013, covering the Corporate Governance Rules (the

“Resolution”) for companies subject to the CMA. The Resolution is effective

from the date it was issued.

The rules comprehensively cover all of the aspects of the functioning of a

corporate entity, including but not limited to, composition of the board,

selection criteria of constituent members, risk management and corporate social

responsibility. In summary, the rules promote to improve talent, transparency,

reporting accuracy, performance, risk governance, and instill accountability and

fair dealing with all stakeholders of an organization

The following is a review of the corporate governance rules (the “Rules”) and

the principles of which they comprise.

First rule: Strengthen board competition

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The majority of the board of directors shall consist of non executive members, as

well as independent members, who enjoy complete independence. This permits

them to make decisions without being exposed to undue pressures. The board of

directors shall regulate its businesses and allocate sufficient time to undertake

the tasks and responsibilities entrusted to it.

What are “independent” and “non-executive” directors?

To answer this question, we have to first; categorize board membership into two

main categories according to the nature of the appointee. Generally speaking, a

board member could be either; (i) a natural person, or (ii) a corporate entity. By

law, a corporate entity could be appointed as a board member provided that it is

represented on the board by a natural person who is the representative of the

entity.

The board membership criteria stipulated under the Decree will therefore be

addressed according to these categories.

Board members, whether natural persons or corporate entities, are classified

into three sub-categories:

A. Executive members:

Executive members are members responsible for the daily management of the

company and, are the delegates of the board to take certain decisions

determined in their assignment. They must be full time members and fully

dedicated for the assigned managerial duty and may be granted a fixed salary

for managerial tasks apart from the annual remuneration of the board.

Any board member who is granted a fixed salary aside from the annual board

remuneration determined by the general assembly will be considered an

executive member. Other expenses, allowances and salaries granted to the

board member as a result of a board member being appointed as a member of

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the board’s committees will not be considered as a fixed remuneration that

would fall into executive members’ remuneration.

B. Non-Executive Board Members:

As stipulated under the Decree, the majority of the board members must be non-

executive members, who have adequate experience to protect the interests of

the company and, to bring a diversified vision to the board and the process of

decision making. The non-executive board member should be able to devote the

time necessary for undertaking duties and responsibilities of their membership,

and membership of the board does not constitute a conflict of interest with any

other positions they hold.

Under the Decree, the roles of the chairman and the managing director should

not be exercised by the same individual to avoid the potential conflict of interest

between the duties of the chairman, being a non-executive member and the

managing director or the manager of the company as a part of the executive

team of the company.

It is worth a noting that the Decree did not address the position of the vice

chairman, who replaces the chairman upon his absence, and whether the vice

chairman should be elected from the executive or the non-executive members.

However, applying the merits of the Decree, we would argue and recommend

that the role of vice chairman must be elected from the non-executive members

to maintain the same criteria applicable on the chairman being his replacement.

C. Independent Board Members

As mentioned earlier, the board is constituted of at least one third of

independent members. The independency criterion is related to the nature of

the relationship between the board member, the company and its related

parties.

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A board member will not be considered independent if, the member himself, his

spouse or any first degree relatives have served as a member of the executive

management of the company during the last two years, or has had any a

relationship that resulted in financial dealings with the company, its parent

company, sister company, or allied company, within the previous two years, in

an amount exceeding 5% of the paid up capital of the company, or the amount

AED 5 million whichever is lesser.

Second rule: Establish clear roles and responsibilities

The company shall outline in detail the tasks, responsibilities and duties of each

member of the board of directors and executive management, as well as the

powers and authorities delegated to the executive management. The board of

directors shall form specialized independent committees, in order to assist it to

perform the tasks entrusted to it.

Third rule: Recruiting highly qualified candidates for the board of directors and

senior management

The board of directors shall form a committee whose main role is to prepare

recommendations for the board of directors in connection with all the required

nominations. Furthermore, the board of directors shall form a remuneration

committee, whose main role shall be to define the policies and regulations

regarding compensation and remuneration.

Fourth rule: Safeguarding integrity in financial reporting

Written undertakings shall be submitted by the board of directors and executive

management for the soundness and impartiality of the financial reports

prepared about the company. The board of directors shall form an internal audit

committee, whose main role shall be to ensure the soundness and impartiality of

financial reports and internal audit systems. The external auditor shall be

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independent and impartial be professionally competent, experienced and have a

good reputation.

Fifth rule: Robust systems of risk management and internal control

The company shall have an independent department for risk management, to

determine, measure and follow up the risks to which the company is exposed.

The board of directors shall form a risk management committee, whose main

role is to develop risk management policies and regulations, in line with the

company’s risk tolerance. The company shall ensure the sufficiency of its

internal control and audit systems.

The board of directors shall form a committee on governance applications,

whose main role is to develop the governance framework. The same committee

shall guide and supervise its implementation, along with any changes when

required.

Sixth rule: Promote ethical standards and responsible conduct

The company shall develop a code which comprises the standards and criteria of

professional behavior and ethical values. The board of directors shall outline the

policies and mechanisms to limit events of conflict of interests, and the handling

of them when they arise.

Seventh rule: Ensure timely and high quality disclosure

The board of directors shall develop quality disclosure and transparency policies

and regulations.

The board of directors shall regulate the disclosures of the board of directors

and executive management members. The company shall disclose in a precise

and detailed manner the remuneration offered to members of the board of

directors and executive management, whether in cash benefits or advantages.

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The company shall develop the infrastructure for information technology and

rely on it widely for disclosure processes.

Eighth rule: Respect the rights of shareholders

The company shall determine the general rights of shareholders and ensure

justice and equality between them. The company shall encourage shareholders

to participate and vote in the company’s general assembly meetings.

Ninth rule: Recognising the legitimate interests of stakeholders

The company shall develop systems and policies which ensure protection of

stakeholders rights, and encourage stakeholders to participate in following up

the company’s various activities.

Tenth rule: Encourage enhanced performance

The company shall develop mechanisms to allow each member of the board of

directors and executive management to participate in training programs and

courses on regular basis.

The company shall develop the systems and mechanisms to evaluate the overall

performance of the board of directors, as well as the performance of executive

management.

The board of directors shall constantly ensure the significance of institutional

value creation among the company personnel, by constantly working to achieve

the company’s strategic objectives, enhance performance rates and comply with

the laws and instructions, particularly governance rules.

Eleventh Rule: Importance of social responsibility

The company shall develop the mechanisms that ensure balance between the

company objectives and the community objectives, and shall outline the

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programs and mechanisms which assist to manifest the company’s efforts in the

community.

The above eleven Rules are subjects to supervisory requirements by the

Corporate Governance Department Control Sector of the CMA, which shall be

furnished on a quarterly basis with proof indicating execution of the

requirements set out under the Rules, as well as the organizational structure

approved by the company board of directors.

The Rules shall be complied with no later than 31 December 2014, taking into

consideration that the company should immediately apply any principle or

requirements set out under these Rules of a binding statutory character,

whether according to the CMA Law, executive regulation or the Companies Law

and its executive regulation.

Moreover, the CMA is entitled to request any additional information or data it

deems necessary in order to ensure the extent of compliance with all the

requirements and conditions set out under these rules.

Non-compliance of these Rules shall expose the violator to disciplinary

accountability, in accordance with the CMA Law and its executive regulation.