UAE to introduce new insolvency framework for banking sector

In October 2016 Sheikh Khalifa bin Zayed Al Nahyan, president of the UAE and ruler of Abu Dhabi, issued a new federal banking law by decree, thereby delivering one of the most keenly anticipated pieces of legislation in recent years. When fully implemented in 2017, the law will address a weak spot in the business environment which has presented a challenge for decades.

The first attempt by the UAE to establish a viable insolvency framework came in 1993 with the publication of Federal Law 18 of that year, better known as the Commercial Code. The insolvency provisions of the code, however, remain largely untested, according to auditor KPMG, as it was formulated with large foreign concerns in mind, rather than the many smaller businesses which are more likely to face troubling debt obligations during an economic slowdown. A number of bankruptcy crimes are set out in the UAE’s penal code, but their effect has been to encourage abscondment rather than the orderly resolution of insolvency cases.

Dedicated Insolvency Law

In 2009 the UAE’s government began to consider the case for a dedicated insolvency law, distinct from the Commercial Code, and in 2011 a draft law was published for consultation. In 2014 the precipitous decline in oil prices added new momentum to the progress of the law, as the authorities sought an appropriate response to the rising number of small business owners leaving the UAE with unresolved bank loans. Speaking to the local press in 2016, Abdul Aziz Al Ghurair, the chief executive of Mashreq and head of the UAE Banks Federation, said that the unsettled loans of business owners who had left the country amounted to approximately Dh5bn ($1.4bn). By the time of the new law’s signing there was a clear case to be made for the decriminalisation of default and the introduction of a new framework in the UAE that would be beneficial to both debtors and creditors.

Implications

A robust bankruptcy framework acts as an important filter in any given business universe, ensuring the survival of economically viable companies while also reallocating the resources of the economically inefficient. A bankruptcy law by which troubled firms can cheaply and quickly return to normal operation, and more efficiently honour obligations to creditors, is a central component of advanced economies.

Insolvency legislation is also increasingly being viewed by emerging economies as a useful means to encourage lending to the small and medium-sized enterprises (SMEs) on which much of their future economic expansion depends. The establishment in law of the responsibilities of both creditors and debtors allows banks to make proper risk-assessed decisions, and to extend credit to concerns which they might have previously declined.

This is an important benefit of bankruptcy laws, and in the context of Abu Dhabi’s determination to boost its SME sector, most recently laid out in the five-year plan it revealed in June 2016 (see Economy chapter), the finalisation of the legislation in the UAE represents a key advance along the emirate’s strategic path.

Business Environment

The implementation of the new legislation also promises to improve the UAE’s performance in the range of global indexes which evaluate its business environment. The country generally performs well in the most influential of these, such as the World Bank’s annual “Doing Business” report. In 2017 the UAE ranked 26th out of 190 countries surveyed, scoring particularly strongly in areas such as starting a business, dealing with construction permits and protecting minority investors.

However, in the areas surrounding credit, whether it be access to lending or borrowers’ rights, there has for some years been room for improvement. In 2017 the UAE scored 2 out of 12 for the strength of the legal rights of borrowers and lenders within its jurisdiction, which, while on par for the region, is indicative of a framework in need of reform.

Room For Improvement

More specifically, on the issue of resolving insolvency, the UAE scored 40.6 out of 100 in 2017. This is above average for the MENA region, and establishes the country on a similar level to its neighbours in the Gulf. However, in the global context it is an area in which the UAE could make a significant improvement to its business environment: its 2017 score ranks 104th out of 190 countries, which is not in keeping with its strong performance in other areas. The introduction of the UAE’s insolvency framework promises to significantly improve its ranking in this area.

Practicalities

The country’s new bankruptcy law repeals Chapter V of the Commercial Code, which contains the little-used provisions of the current insolvency framework, as well as the bankruptcy-related crimes detailed in the penal code.

The newly established framework applies to all companies established under the Commercial Companies Law, firms that are fully or partly owned by the local or federal government and companies in the UAE’s numerous free zones, with two notable exceptions: businesses established in the Dubai International Financial Centre and the new Abu Dhabi Global Market are not covered by the law, and will instead remain subject to the respective internal legislative systems of those zones.

Three Procedures

The law establishes a new regulatory body in the UAE, the Committee of Financial Restructuring (CFR), which will operate under the authority of the Ministry of Finance. The UAE Cabinet will decide on the number of members and entities that represent the CFR and administer its law and procedures. The CFR will oversee the procedures of financial restructuring that fall outside the scope of the courts, prepare an approved list of bankruptcy experts and maintain a national electronic database of individuals who have had bankruptcy rulings against them.

Businesses that are in financial difficulty have recourse to three main procedures. The first of these is a “protective composition”, which allows a debtor to agree a settlement with its creditors, and is designed to rescue a troubled business which is not yet insolvent. Such a solution must first be approved by a majority of the unsecured creditors. The second procedure is “insolvency with restructuring”, to be applied if a debtor is insolvent but the court determines that it is capable of being rescued by the restructuring of its debts, which, again, requires the consent of a majority of the creditors. The third procedure is “insolvency and liquidation”, a process by which the court orders the winding up of an insolvent business if the other two processes are considered to be inappropriate or not approved by a majority of creditors, or if a debtor is found to be acting in bad faith in order to avoid financial obligations. Financial companies regulated by the Central Bank of the UAE have recourse to a further measure in the form of a financial reorganisation, to be overseen by experts appointed by the CFR.

Importantly, the new law tackles the issue of criminalisation, which over the years has prompted many debtors to flee the jurisdiction of the courts rather than resolve their solvency problems. Under the old regime, if a trader unable to pay his debts did not apply to be declared bankrupt within 30 days and was declared bankrupt by default – a criminal offence – it could result in fines or imprisonment. The new law decriminalises this behaviour, replacing the threat of imprisonment with a disqualification order against the debtor.

Next Steps

The new law has been widely welcomed by the business community. Its effectiveness, however, will depend on the success of its implementation. Key questions arising from the development relate to the efficacy of the CFR, the workings of which, in the view of law firm Clifford Chance, will require a strong roll of accredited insolvency experts, a publicly accessible central register of insolvency proceedings and a list of disqualified directors for the UAE. There are also concerns about the time it will take for the courts to study bankruptcy cases and whether specially trained law enforcement officers will be needed. To answer these questions, it has been suggested that specialised business courts be set up to deal with bankruptcy claims.

Obaid Humaid Al Tayer, minister of state for financial affairs, revealed in late 2016 that the government has turned its attention to formulating a new personal insolvency law, which will apply to individuals facing bankruptcy. It is estimated that half of the Abu Dhabi’s prison population is made up of individuals criminalised by bad debts, in some cases for amounts as modest as a few hundred dirhams.

A personal bankruptcy law also carries some commercial implications: many businesses at the smaller end of the SME spectrum are funded by individual loans taken out by their owners, who often find it easier to take out a personal loan in cases where they do not have the collateral necessary to secure a business facility.

The criminalisation of personal defaults, therefore, somewhat disincentivises legitimate SME borrowing, while also encouraging abscondment should the debtor ever face difficulties in repaying a loan. The minister did not reveal a date for the implementation of the proposed law, saying only that the new legislation would take approximately 12 months to draft.