Shifting Sands – the Move towards Restructuring in the UAE


In summary

This article discusses the gradual shift in approach across the states of the Gulf Cooperation Council, but particularly in the United Arab Emirates, from insolvency regimes focused upon liquidation to regimes focused more on restructuring and ‘workout’ solutions. The new legislation upon which this approach is founded is discussed in detail, together with the impact such a shift is likely to have upon distressed businesses and insolvency practitioners working in the region.


Discussion points

  • Preventive composition in the onshore system
  • Legislative changes introduced due to the covid-19 pandemic
  • New financing
  • Suspension of legal proceedings
  • Preferential creditors
  • Restructuring in the DIFC and the ADGM

Referenced in this article

  • UNCITRAL Model Law on Cross-Border Insolvency
  • UAE Bankruptcy Law
  • Amendments made by Federal Law No. 21 of 2020
  • DIFC Insolvency Law
  • DIFC Insolvency Regulations
  • ADGM Insolvency Regulations

The reverberations of the 2008–2009 financial crisis had a profound effect upon governments’ presumptions as to the financial stability of economies generally but also the financial stability of sectors such as financial services.

Previous presumptions as to the efficacy of nations’ restructuring frameworks were also challenged. The concept of corporate failure necessarily resulting in liquidation was undermined. The concept of ‘too big to fail’ came to the fore and led to debate over whether any business should be permitted to fail when the knock-on effect of such failure could be so negatively impactful on both the stakeholders in that business and on other aspects of an economy.

Prior to the commencement of the covid-19 pandemic, Gulf nations had already recognised the need to move away from their historic reliance on oil production and had sought to upgrade the infrastructure supporting their economies to attract inward foreign investment. This manifested itself in a number of countries, including the United Arab Emirates (UAE), producing vision statements that promoted investment, diversification and a reduction in reliance upon oil revenues. A key part of the move to becoming a more attractive home for investment was the necessity for modern, recognisable and transparent insolvency regimes that contain modern restructuring tools for businesses facing distress.

The UAE has had the benefit of being able to look around the world at other countries’ insolvency and restructuring regimes and cherry-pick those that appear to have been successful, and in some instances improve upon them, while combining those processes with their own laws.

Also, by adopting measures that align with widely accepted principles of global restructuring, the UAE has created processes that ought to be capable of recognition by foreign courts throughout the world, particularly by those (including the United States and the United Kingdom) who have adopted the UNCITRAL Model Law on Cross-Border Insolvency.

The UAE operates a dual jurisdiction system colloquially known as the onshore/offshore system.

The onshore system consists of UAE federal law and the individual laws of the seven emirates that make up the UAE. The laws are civil law-based.

The offshore system applies to the free zone areas set up in the UAE, principally the Dubai International Financial Centre (DIFC) and the Abu Dhabi Global Markets (ADGM), both of which operate their own common law-based legal systems and courts.

Offshore

In 2015 the ADGM introduced its Insolvency Regulations, which have been amended regularly since, most recently in July 2020.

Since 13 June 2019, the DIFC Insolvency Law, Law No. 1 of 2019 (and its supporting regulations), has governed companies operating in the DIFC, repealing and replacing DIFC Law No. 3 of 2009. From a restructuring perspective, the new law introduced: (i) English-style voluntary arrangements (with the option to apply for a stay of proceedings akin to article 362, Chapter 11 US Code); (ii) a process for rehabilitation of debtors, akin to a US Chapter 11 procedure; and (iii) a comprehensive framework for the recognition of foreign insolvency proceedings by the DIFC courts.

Onshore

In 2016, the UAE introduced widespread reforms to its restructuring procedures, through the introduction of the UAE Bankruptcy Law, Law No. 9 of 2016, which came into force on 29 December 2016 (the 2016 Law).

The 2016 Law applies to UAE corporate entities (including financial institutions), except those incorporated in the UAE’s independent free zones. It was amended by Law No. 21 of 2020. In terms of the individual insolvency process, Law No. 19 of 2019 came into force in January 2020.

The 2016 Law introduced the concept of a ‘preventive composition’ as an alternative to liquidation and to enable debtors to restructure their affairs on a consensual basis, while many (but not all) of the criminal sanctions for individuals involved with companies that did not pay their debts were removed or relaxed.

The UAE also followed the lead of the United States by rendering void any provision in a contract that defines the debtor’s entry into a preventive composition as an event of default for which a counterparty could terminate (ipso facto clauses).

Preventive composition (and bankruptcy) proceedings include a moratorium on claims, which subsists for the duration of the restructuring, save where the court orders otherwise.

The preventive composition procedure can be pursued by a debtor who, while not technically insolvent (on a balance sheet basis), has defaulted on the payment of its debts, provided that such default has not been subsisting for more than 30 business days. It cannot be imposed on the debtor by its creditors.

When filing the application for preventive composition, the debtor must also file cash flow projections and a proposed restructuring plan. The court will then appoint a trustee to supervise the process, who will work with the debtor to devise a settlement plan to be put to creditors.

As with an English company voluntary arrangement, one of the perceived limitations of a plan for preventive composition is that it may not seek to compromise the rights of secured creditors without their express consent – secured creditors will not be able to vote on the plan unless they relinquish their security.

For the scheme to be approved, unsecured creditors (with admitted debts) must vote in favour of the scheme both by a majority in number, and by two-thirds in value of total ordinary admitted debts. The vote is binding on non-consenting unsecured creditors.

In contrast to preventive composition, restructuring-in-bankruptcy proceedings can be instigated by creditors owed debts of at least 100,000 dirhams, by the debtor or by the Office of the Public Prosecutor. It should be noted that a bankruptcy proceeding will no longer lead to an inevitable liquidation of the debtor’s assets and the law’s primary aim is to facilitate the ongoing trade of the debtor as a going concern through the restructuring of its debts.

Once the bankruptcy petition is approved, the court will appoint a trustee. Based on his or her assessment of the debtor’s financial affairs, the trustee will report on whether a restructuring might be possible or whether the debtor should be declared bankrupt instead. In the former case, the trustee will devise a plan and it will be put to creditors in a similar way to the preventive composition procedures. In the latter case, the debtor’s assets are liquidated and distributed among creditors.

Amendments made by Federal Law No. 21 of 2020

The catalyst for the amendments made by Federal Law No. 21 of 2020 (the Amendments) was the covid-19 pandemic and its very serious impact across a range of business sectors in the UAE. The amendments modify and supplement the existing 2016 Law. Specifically, they;

  • extend the moratorium or stay on judicial proceedings where a commencement order has been made against the debtor under either (i) preventive composition proceedings or (ii) restructuring-in-bankruptcy proceedings (subject, in either case, to the overriding right of creditors to make application to the court to lift the stay);
  • clarify the position of preferential creditors where distributions are made under formal bankruptcy procedures; and
  • introduce a new procedure in circumstances where the debtor’s obligation to file for bankruptcy under Part 4 of the 2016 Law (restructuring in bankruptcy or formal bankruptcy) is deferred by reason of an ‘emergency financial crisis’.

The Amendments introduce a new chapter (Chapter 15) to Part 4 of the 2016 Law entitled ‘Bankruptcy Proceedings during the Emergency Financial Crisis’.

An ‘emergency financial crisis’ is defined as: ‘A public situation that affects trade or investment in the state, such as the outbreak of an epidemic, a natural or environmental disaster, war, or other case whose duration shall be determined by a cabinet resolution, based on the Minister’s proposal’.

If (i) a debtor defaults in respect of the payment of its commercial debts for a period exceeding 30 consecutive business days or (ii) is deemed to be in a state of over-indebtedness as a result, in either case, of an emergency financial crisis, the debtor will no longer be under an obligation to file for restructuring in bankruptcy or formal bankruptcy procedures under Part 4. Such obligation will instead be deferred for the period covered by the duration of the emergency financial crisis.

There are no provisions to determine how long an emergency financial crisis may last, although there are placeholder provisions in the Amendments that are intended to provide a more detailed description of both cause and duration through the issue of secondary legislation.

If the debtor nonetheless decides to file a petition for bankruptcy during an emergency financial crisis, the court still has discretion to accept the petition. The court may decide to refuse to appoint an expert or a trustee in respect of the bankruptcy proceedings, provided that the debtor is able to show that its current financial condition results from an emergency financial crisis.

The Amendments also provide that the court must delay acceptance of any bankruptcy petition filed by any creditor or group of creditors against a debtor during an emergency financial crisis.

Deferral is mandatory where a creditor files a bankruptcy petition with the court but is discretionary where the debtor files under the emergency financial procedures.

Where a court accepts a bankruptcy petition filed by a debtor (but not a creditor) while an emergency financial crisis subsists, the debtor may request the court for a grace period of not more than 40 business days to reach a settlement with its creditors (a settlement request).

If the settlement request is approved by the court, it must be published in two local daily newspapers (in English and Arabic), which will include the following:

  • an invitation for the creditors to negotiate a settlement agreement with the debtor within 20 business days of the date of publication of the invitation; and
  • the place or the method by which the negotiations shall be conducted.

The settlement period offered by the debtor to its creditors should not exceed 12 months from the date of the court’s approval.

Once a settlement agreement is approved by the relevant creditors representing two-thirds of the total debt in value, such settlement agreement shall be binding in respect of all creditors, including those who abstained from engaging in the negotiations.

Once a settlement is reached between the parties, the debtor, or any of the creditors who were part of the negotiations, should notify, through the court, all other affected creditors (specifically trade creditors) within 10 business days of the settlement date.

The settlement agreement must then be approved by the court. However, the court may reject the proposed settlement within 15 business days if certain circumstances justify the decision, including bad faith.

Any creditor who did not approve the settlement may file a grievance before the court within 15 business days of the date of being notified of the settlement. Such grievance must be dealt with within five days of the date of filing such grievance.

Once the court approves the settlement agreement, it shall be considered final and binding on all creditors.

The Amendments also provide that the potential civil or criminal liability of directors and general managers (either during or prior to the commencement of financial emergency procedures) will not be triggered if such officers dispose of the debtor’s assets to pay the unpaid salaries of its employees (excepting allowances, raises and other incidental payments).

The directors and general managers must ensure that a debtor’s financial statements are updated to reflect the losses incurred as a result of the emergency financial crisis.

These provisions are without prejudice to any other civil or criminal sanctions that could be imposed against a director or manager arising under Part 6 of the 2016 Law or under any other relevant legal provision.

New financing

There are special new provisions to deal with new funding as part of the settlement arrangements on a ‘last in, first out’ basis.

If new money is provided by a bank against additional security taken over existing debtor assets that are fully collateralised, the new creditor can (with court approval) take a first-ranking pledge up to an additional 30 per cent of the existing value of such assets, giving them ‘super-priority status’.

In cases where a creditor (bank or otherwise) provides new money to be secured against assets that are not fully collateralised (ie, where there is available equity), such security will rank behind the existing security over the same assets unless the existing creditors who have security over that asset agree otherwise.

The emergency financial procedures allow for an accelerated form of settlement procedure that reflects the emergency nature of the debtor’s financial position. Given that these procedures are set out in a new Chapter embedded in Part 4 of the existing 2016 Law, they are to be treated as a separate stand-alone procedure to the existing restructuring in bankruptcy procedures described elsewhere in Part 4.

Proceedings outside emergency financial procedures and existing bankruptcy proceedings

The court also has discretion to extend the relevant time periods set out under the 2016 Law in circumstances where a petition has been filed by the debtor for a preventive composition under Part 3 or either the debtor or its creditors under Part 4 (restructuring in bankruptcy or formal bankruptcy) at any time before the emergency financial crisis procedure has come in effect, but where the debtor’s financial condition is nonetheless attributable to an emergency financial crisis event.

Suspension of existing legal proceedings

The Amendments further provide that, if the court orders the commencement of preventive composition proceedings under Part 3 or formal bankruptcy proceedings under Part 4 of the 2016 Law, existing legal proceedings against the debtor shall be suspended for a period lasting until the earlier of:

  • the date on which the court approves the restructuring plan scheme under either procedure; or
  • 10 months from the date of the commencement order (subject to the ability to extend for an additional four months).

There are exceptions, including circumstances where the creditor petitions the court to enforce if (i) enforcement would not prejudice any proposed restructuring plan or sale of business or (ii), in the case of formal bankruptcy only, the sale and liquidation of the debtor’s assets has not started within the prescribed one-month period from the date of the commencement order.

Preferential creditors

Article 185 of the 2016 Law has been amended to clarify the position of preferential creditors (ie, those defined in article 189 of the 2016 Law) in the event of sale and liquidation of the debtor’s assets in formal bankruptcy proceedings under Part 4. Specifically, secured creditors (whether security subsists over the debtor’s movables or immovable assets) shall have priority over all other creditors, including preferential creditors (who rank second) and then ordinary creditors.

UNCITRAL Model Law on Cross-Border Insolvency

The UAE has not adopted the UNCITRAL Model Law on Cross-Border Insolvency. There are no provisions in UAE law for recognition of insolvency proceedings commenced in other jurisdictions or for cooperation with the courts of other jurisdictions. The UAE courts would recognise a foreign judgment of insolvency on a reciprocal basis. However, such recognition is subject to conditions, including being compliant with public policy in the UAE, both parties having obtained adequate representation and the judgment being obtained from a jurisdiction that enforces UAE judicial rulings. As a matter of practice, however, it is thought that UAE courts will generally seek to assert their jurisdiction over any matter involving UAE parties and it is not likely that enforcement of a foreign judgment will be obtained in the UAE.

DIFC

DIFC Law No. 3 of 2009 was repealed and replaced on 13 June 2019 by the DIFC Insolvency Law, Law No. 1 of 2019 (and its supporting regulations), which governs companies operating in the DIFC (the 2019 Law). From a restructuring perspective, the DIFC has looked to identify restructuring best practice across the globe and then improve upon it. The new law introduces English-style administration, receiverships and voluntary arrangements (with the option to apply for a stay of proceedings akin to article 362, Chapter 11 US Code) but in each case modified alongside:

  • a process for rehabilitation of debtors, akin to a US Chapter 11 procedure (eg, administration can only be entered via a proposed rehabilitation plan); and
  • unlike the onshore position, a comprehensive framework for the recognition of foreign insolvency proceedings by the DIFC courts.

The 2019 Law also prescribes three types of liquidation and schemes of arrangement under the DIFC Companies Act. It goes further than merely the introduction of Chapter 11-inspired rehabilitation plans and does more to protect creditors from incompetent or untrustworthy company management. For example:

  • an insolvency practitioner must sign off on a rehabilitation plan before it goes to creditors;
  • creditors can replace management with an administrator;
  • an English-style wrongful trading offence has been introduced; and
  • an enhanced ability to investigate and challenge pre-insolvency transactions and conduct has been introduced.

The primary change in the 2019 Law is the introduction and adoption of a rehabilitation or reorganisation chapter (Part 3), which appears to be heavily influenced by US Chapter 11 procedures.

A company may apply for rehabilitation relief if:

  • it is or is likely to become unable to pay its debts;
  • and there is a reasonable likelihood that a successful rehabilitation plan will be reached (article 13).

One major benefit of rehabilitation is the 120-day automatic moratorium (which can be extended or shortened by the court (article 16)), which comes into effect automatically upon the filing of the rehabilitation plan with the court, which applies to all creditors, secured and unsecured, and without their consent. The intended effect is global.

It specifically prohibits most actions by creditors without the permission of the court, such as:

  • no winding-up petition may be presented;
  • no landlord to whom rent is payable may exercise any right of forfeiture in relation to premises let to the company;
  • no other steps may be taken to enforce any security interest in the company’s property, or to repossess goods in the company’s possession under any hire-purchase agreement; and
  • no other proceedings and no execution or other legal process may be commenced or continued, and no distress may be levied, against the company or its property (DIFC Insolvency Regulations, article 4.5).

The automatic moratorium is intended to provide companies with an opportunity to reorganise their affairs, to continue to trade and to emerge from rehabilitation largely intact. Under article 19, a creditor may apply to the court for relief from the moratorium. The court has wide discretion in relation to such relief applications but shall have regard to whether irreparable harm will be done to the debtor company in the absence of a moratorium balanced against whether the creditor would suffer any significant loss and whether that loss outweighs the interests of the debtor company.

At the end of the initial 120-day term of the automatic moratorium, unless the company obtains an extension, there are two primary alternatives: creditors or shareholders may propose an alternative rehabilitation plan or the case may convert to liquidation.

Another benefit of rehabilitation is the ability to assume, assign or reject executory contracts and to obtain priority funding.

During the moratorium period but before the sanctioning of the rehabilitation plan, the company may assume, assign or reject an executory contract or unexpired lease (article 18(3)).

This allows the debtor to retain valuable contracts while discarding onerous or unfavourable obligations.

In terms of priority funding, it is often the case that reorganisations require additional capital to be injected but corporate debtors in need of reorganisation usually have few unencumbered assets to offer as security.

Under the 2019 Law, the court may authorise the company to obtain credit that has priority over existing unsecured creditors, is secured by previously unsecured assets or is second-ranking security (article 31(1)).

If the company is unable to obtain credit on the terms in article 31(1), the court may authorise the company to grant ‘super priority’ security to a creditor over existing security, but only where the existing secured creditor is ‘adequately protected’ (article 31(2)).

Also, article 18(2) stops the operation during the moratorium period of any termination or modification provision in any contract linked to insolvency (ipso facto clauses) unless:

  • the company agrees to the termination;
  • the court grants permission to terminate; or
  • the company fails to pay any sums due after the commencement of the moratorium period that the company has agreed to pay and that remains unpaid for more than 20 days after the payment is due.

Rehabilitation

The company must appoint at least one person to be a rehabilitation nominee.

Notwithstanding the appointment of the rehabilitation nominee, the directors are authorised to continue managing the company’s affairs (and will continue to be responsible and liable for any actions taken in such capacities) except in cases where there is evidence of the company or its management, officers, directors being guilty of fraud, dishonesty, incompetence, mismanagement or other specified offences. In such latter cases, the court may appoint an administrator to manage the business and assets of the company.

The 2019 Law does not provide for any document other than the plan to be filed by the company (article 15(2)), but Regulations 2.1 and 3.1 of the DIFC Insolvency Regulations state that the plan must contain detailed information, including:

  • an explanation of the effect of the plan;
  • an explanation of the potential alternative outcomes for creditors of the company in the event that the plan is not approved;
  • an estimate of the value of the company’s assets;
  • the extent (if any) to which such assets are secured;
  • the nature and amount of the company’s liabilities and how the plan will deal with preferential creditors and creditors of the company who are, or claim to be, secured;
  • the proposed duration of the plan and proposed dates of distributions to creditors, with estimates of their amounts;
  • the manner in which the business of the company is proposed to be conducted during the course of the arrangement;
  • details of any further credit facilities that are intended to be arranged for the company and how the debts so arising are to be paid;
  • whether it is likely that there will be other proceedings in other jurisdictions; and
  • any other matters that have a material impact on any affected party.

Once a rehabilitation plan is ready to be considered by the creditors and shareholders, the company must obtain court approval for notice and voting procedures at a directions hearing (article 24). Written notice of the meeting to vote on the rehabilitation plan, along with a copy of the plan, is then distributed to creditors and shareholders (article 25).

The voting procedures must separately classify secured creditors, unsecured creditors and shareholders for plan-approval purposes (article 24(1)). A class of creditors is unimpaired if ‘each holder of a claim or interest of such class is unaffected under the terms of the Rehabilitation Plan’.

Classes of creditors or shareholders that are unimpaired by the terms of the plan are deemed to accept.

For an impaired class, a 75 per cent majority in value of those who take part in the voting process must approve the plan for it to be binding on the whole class. The term ‘impaired’ is not expressly defined but, adopting the US approach, an impairment is any limitation on a creditor’s legal, equitable or contractual rights.

Article 27 provides that the court shall sanction a plan where:

  • at least one impaired class of creditors has voted to accept the rehabilitation plan;
  • any class of creditors or shareholders voting against the rehabilitation plan has received at least as much value as the class would have received in a liquidation; and
  • no holder of any claim or interest that is junior to the claims of any dissenting class will receive or retain under the rehabilitation plan any property before the dissenting creditors have been paid in full (sometimes referred to as the ‘absolute priority’ rule).

Administration

Where an application for rehabilitation has been made and there is evidence of misconduct by the company’s management, one or more creditors may make an application regarding the appointment of an administrator. Notice of the application for the appointment of an administrator must be given to all creditors of the company. The court may adjourn or dismiss the application or make such other order as it thinks fit.

The administrator must be a person who is registered as an insolvency practitioner in the DIFC. A moratorium applies for the duration of the administrator’s appointment. On appointment of the administrator, any petition for winding up shall be dismissed and any administrative receiver shall vacate their position.

Creditors have recourse to the court if they believe the company has been managed by the administrator in a manner that is unfairly prejudicial to them.

Cross-border insolvency

The UNCITRAL Model Law on Cross-Border Insolvency is designed to assist in cross-border insolvency proceedings in cases involving companies that have assets or creditors in more than one country, and provides for ‘incoming’ recognition of insolvency proceedings commenced in other jurisdictions and sets out a framework for that recognition.

The DIFC is one of only 46 jurisdictions to have adopted the Model Law. Notable other adopters are the United States, Australia, Canada, Japan and the United Kingdom. Notable non-adopters are China, India, most of the European Union (including France and Germany) and most of the offshore tax havens.

The Model Law sets out to promote five purposes: cooperation; legal certainty; fair and efficient administration for creditors and debtors; protection and maximisation of assets; and rescuing financially troubled businesses, thereby protecting investment and employment.

The Model Law applies where:

  • assistance is sought in the DIFC in connection with foreign proceedings;
  • assistance is sought in a foreign country in relation to proceedings under the 2019 Law;
  • foreign proceeding and proceedings under the 2019 Law are taking place concurrently; or
  • creditors or other interested persons in foreign countries are interested in commencing or participating in proceedings under the 2019 Law.

ADGM

The insolvency regime in the ADGM is governed by the 2015 Insolvency Regulations (the Regulations), which were amended most recently in July 2020. Those amendments brought in similar provisions to those we have seen for onshore and DIFC companies in terms of priority funding.

The types of procedures set out in the regulations include administrative receivership, receivership, administration and the deed of company arrangement.

The appointment of liquidators and provisional liquidators is also contemplated by the Regulations.

Administration

The Regulations contemplate the inclusion of an administration process.

The role of an administrator allows for the rehabilitation of a distressed company following a period of administration. Mirroring the UK administration regime, the Regulations state that the purposes of administration (in priority order) are the rescue of a company as a going concern, achieving a better result than a winding up or realising property for secured or preferential creditors.

The administration procedure is an alternative to the ability of a secured creditor to appoint a receiver or an administrative receiver (in relation to capital market arrangements and project financings). Consistent with this approach is the fact that an administrator owes his or her duties to the body of creditors rather than to the appointing creditor (as is the case with the appointment of a receiver).

Holders of a ‘qualifying charge’ are able to use a filing procedure known as a notice of appointment with the ADGM court while shareholders, directors and other creditors would be required to make an application to the court.

Administration will have the effect of dismissing a petition for the winding up of the company (in the majority of cases).

Concept of ‘qualifying charges’

The ability to appoint an administrator or administrative receiver are conferred by the Regulations upon a secured party holding charges over the whole or substantially the whole of the relevant debtor’s property (a qualifying charge).

The concept of a floating charge is foreign to UAE federal law and instruments creating charges over the whole or substantially the whole of a company’s assets (such as a commercial business mortgage within the meaning of the UAE Commercial Code) are infrequently used. Clearly over time the nature of a company’s assets is subject to change, which presents a potential obstacle to secured creditors using the administration process to the extent that they have not included a floating charge in the relevant security instrument (nor a sufficient fixed-charge security).

Deed of company arrangement

In line with both English law and the relevant DIFC regulations, the Regulations envisage the possibility of a deed of company arrangement, being a process whereby a company and its unsecured creditors and members can achieve a compromise or restructure debts to preserve the economic value in the entity as a means of exiting from an administration.

Significantly, secured creditors and owners or lessors of the company’s property will not be bound by a deed of company arrangement unless they vote in favour of it. Importantly, the court may restrict the ability of secured creditors and the owner or lessor of a company’s property to take action against a company’s property where to do so would have a material adverse effect on achieving the purpose of the deed of company arrangement.

Summary

The shift in thinking described at the beginning of this article has now manifested itself in the significant changes to the UAE’s insolvency regimes, which we have outlined here. This is fundamentally a shift from liquidation being the aim of such regimes to the three-tiered approach now embedded in the UAE insolvency regimes both onshore and offshore of: (i) consensual reorganisation (with or without court assistance); (ii) restructuring in bankruptcy or rehabilitation; and (iii) liquidation as a last resort.

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