Commercial companies law 2.0: New legislation makes the federation kinder to foreign investors

The UAE is a federation of seven emirates: Abu Dhabi, Ajman, Dubai, Fujairah, Ras Al Kamiah, Sharjah and Umm Al Quwain (the Federation). In establishing the UAE, the rulers of these emirates agreed to a provisional constitution (the Constitution), which provides the legal framework for the Federation and declares Islamic sharia jurisprudence the main source of legislation.

The Constitution balances power between the federal government, based in Abu Dhabi, and the local governments of its constituent emirates. The federal government has the mandate to promulgate substantive legislation concerning and regulating the principal and central aspects of the Federation.

The municipal governments of each emirate are authorised to regulate local matters not confined to the federal government. On this basis various federal and local laws have been enacted governing, inter alia, civil and commercial transactions, companies, contracts and legal procedures for each emirate. In the event of a conflict between federal and local laws, the federal law will supersede the local law.

The Constitution gives the individual emirates the right of sovereignty over their own territories and territorial waters in all matters not within the Federation’s jurisdiction, such as foreign affairs, defence, justice and public health. It states that the Federation shall form a single economic and Customs entity with free movement of capital and goods between the emirates. As such, the UAE enacted the Federal Law No 8 of 1984 (as amended) concerning commercial companies in the UAE (the CCL).

Since its enactment there have been a few amendments to the CCL; however, it still does not meet the need for attracting more foreign investments and does not support the developments and the phenomenal growth that have taken place in the UAE market over the last two decades. Out of this has arisen the necessity of issuing a new commercial companies law to replace the CCL. A draft of this new commercial companies law (the NCCL), which has been passed by the UAE Federal National Council, has been circulated over the last few months. Though the NCCL is still going through the legislative processes to become an effective law, the following are the significant points on which it differs from the CCL.

Foreign Ownership

 Under the CCL, a UAE national or a company wholly owned by UAE nationals must hold at least 51% of the issued share capital of a limited liability company, private joint stock company or public joint stock company. These are the three most commonly used corporate structures. In certain cases nationals of GCC countries may hold 100% of the issued share capital in these companies.

Foreign enterprises often use joint ventures to invest in the UAE market in order to avoid breaching these restrictions. The NCCL provides for greater flexibility in the provisions on foreign ownership by giving authority to the Cabinet of Ministers to issue a resolution setting out, from time to time, exemptions that allow certain economic activities to exceed 49% in the ownership of UAE companies.

There is no indication at this stage as to the sectors in which foreign investors will be permitted to own more than 49%, but the cabinet resolution setting out such exemptions would be issued upon the recommendation of the minster of economy after consultation with the competent authority in the relevant emirate. Although this step does not open the UAE market for 100% ownership in all sectors, it is a significant step towards attracting foreign investments into the UAE and a major shift from foreign ownership rules under the CCL. We understand that the final form of the NCCL may not contain such flexibility on foreign ownership, and that this issue may be dealt with in the proposed foreign investments law, which is expected to be issued in the near future.

Single Shareholders Company

 The CCL requires at least two shareholders for formation of a company in the UAE. This has been an obstacle to individual investors. Historically, many individual investors in the UAE have chosen to set up their businesses through sole proprietorship structures. Under the CCL, a sole proprietorship is not a recognised form of company and does not constitute a separate legal person from its owner, nor does the CCL provide limits on the liability of the owner. It is merely a trading name for the owner. The NCCL, by contrast, provides for a single shareholder limited liability company which resembles the form of a free zone establishment under the regulations of some of the free zones in the UAE.

Holding Companies and Investment Funds

: undefined The NCCL defines a holding company as “a joint stock company or limited liability company that establishes subsidiaries inside the state or abroad or has control of existing companies, by holding shares or stock enabling such company to control the management of the subsidiary and to have influence on the resolutions of the subsidiary”. This is an important development in the legislation on corporations in the UAE, as there has always been a strong need to have a holding structure for groups of companies.

The CCL, however, does not recognise the holding company structure. Instead, a series of corporate structures has to be created to put a group of companies together. Under the NCCL, a holding company, which may also be owned by a single shareholder, may be established for the following purposes: holding shares in group companies, providing loans and guarantees, acquiring moveables and immoveables, managing its subsidiaries and holding intellectual property rights. Unlike the CCL, which requires companies to be operational, the NCCL prohibits holding companies from conducting business activities except through their subsidiaries.

The recognition of the holding company structure will strengthen legal ties between group companies, and will lead local and regional groups based in the UAE to reorganise themselves in more efficient corporate structures. This will also have a positive effect on their asset valuation and the bankability of their financial transactions. The NCCL also gives public and private joint stock companies the right to be licensed as “common investment companies” and permits them to establish and manage investment funds.

This is another development that will strengthen the position of the UAE in becoming an important regional financial centre.

Issued and Authorised Capital

 Under the CCL, companies are not permitted to state the amount of their authorised capital and are generally required to make payment of capital in full at the time of incorporation. This makes any subsequent capital increase burdensome. The NCCL now draws a distinction between paid-up capital and authorised capital regarding joint stock companies. Although the paid-up capital for a public joint stock company should be not less than Dh30m ($8.17m), the NCCL permits such companies to state the authorised capital in their articles of association provided that the authorised capital is not more than double the issued capital.

Pledge Of Shares

 Pledge of shares in the UAE is not covered by the CCL, though, in practice, parties to agreements for share pledges have had success in registering such pledges in some of the emirates, relying on the provisions of the civil and commercial transactions laws. It is not possible under the current regime to register a partial pledge of shares unless such pledge covers all the shares in the company. Also, under current practice, pledges can only be registered in favour of financial institutions licensed in the UAE. The NCCL recognises the right of the shareholders in a limited liability company to pledge or effect a lien over their shareholding to another shareholder in the company or to a third party.

This provision will have an important impact on the security packages provided by limited liability companies to secure their debts and borrowings from financial institutions. It will also provide a level of comfort to shareholders in lending money to each other and secure such lending by way of pledge over their respective shareholding. The NCCL requires such pledges to be registered in the commercial register, until which time a pledge will not be valid against the company and third parties. It also requires such pledge or lien to be written through a notarised instrument, and that the pledge or lien be permitted by the company’s constitutional documents and carried out in accordance with its memorandum of association.

Registrar Of Companies

 The CCL requires companies to register in the commercial register during their incorporation and following their incorporation, and to record any changes to the company’s information or constitutional documents in the commercial register from time to time. There is no central commercial register in the UAE; the competent authority in each emirate keeps its own commercial register in accordance with the provisions of the UAE Federal Law No 5 of 1975 concerning the commercial register (the Commercial Register Law). The Commercial Register Law defines competent authority as “the concerned government departments in the member emirates of the federation”.

The decentralisation of the commercial register resulted in the duplication of companies’ trading names across the emirates and in unnecessary disputes over trading names between companies registered in different emirates. The NCCL introduces a central registrar of trading names for firms through the Ministry of Economy, though the individual emirates will continue to keep their own commercial registers. The primary role of the registrar of companies is to ensure that trading names of companies are not double registered. The minister of economy shall issue a resolution setting out the implementation regulations for the duties of the registrar.

Although the role of registrar does not appear to be identical to the role of the registrar of companies in a common law jurisdiction, it is by all means a progressive step towards the improved management of companies’ information and towards organising the register of companies across the country.

Corporate Governance

Unlike the CCL, the NCCL introduces corporate governance concepts in recognition of the need for more governance in UAE companies. It provides for the application of a general framework to regulate the governance of public and private joint stock companies. It makes it compulsory for private joint stock companies to follow such framework and regulation of governance if the number of shareholders is more than 75. The minister of economy will set out the rules of governance for private joint stock companies, while the chairman of the Securities and Commodities Authority (SCA) will do so for public joint stock companies.

It is worth mentioning that the NCCL defines “related parties”, which is not done in the CCL. Related party is defined under the NCCL as “the chairman and other directors and the senior executive management of the company, such companies in which any of such persons holds at least 35% of their share capital and subsidiary, associated or sister companies”. The clarification and specificity of this definition will doubtless improve the compliance of a firm’s management when the company is likely to enter into a transaction with a related party.

Accounting and Book Keeping

The CCL does not place strict requirements on companies as to how to maintain their books and accounts and for how long. Generally, small to mid-size companies in the UAE do not have reliable audit and accounting systems. This can make it challenging to value a target, produce accurate completion accounts and secure appropriate warranties in respect of financial information.

Article 25 of the NCCL, in line with the practice in other civil law jurisdictions, introduces the obligation imposed on companies to maintain their accounting books for a period of at least five years from the end of each financial year. This also conforms to the provisions of Articles 30 and 31 of the Commercial Transactions Code in terms of duration for bookkeeping, and of Article 38 in terms of maintaining an electronic version of such books and accounts.

This adherence to unified accounting standards in the UAE will not only allow companies to disclose their financial position precisely at all times, but will also increase their financial transparency. The disclosure and transparency of financial information will also aid healthy investments into equity capital markets, which is very much dependent on the information companies provide regarding their current financial positions and on forecasts of their future performance.

Management of Limited Liability Companies

 Undefined The NCCL provides for the change in the number of managers permitted in the corporate structure of limited liability companies from a maximum of five under the CCL to an unlimited number under the NCCL. Under the NCCL, the managers are required to be appointed from among the shareholders and third parties as specified in the company’s memorandum of association or a separate contract. In the absence of either, the company’s managers are to be appointed by the general assembly of the firm’s shareholders.

This change will provide a great deal of flexibility for multi-party joint ventures to have a wider board of management in which all the shareholders can be adequately represented. This is especially the case given that the NCCL lifts the ceiling on the number of shareholders from 50 to 75, as this will require a larger number of members of the board of management to represent such shareholders. The NCCL also provides that the rules governing private and public joint stock companies will also apply to limited liability companies, save where the NCCL explicitly mentions the distinction between such applicable rules. This uniformity in the legal framework of the two forms of company does not exist under the CCL.

Competition

 The NCCL imposes an obligation on the managers of a company which prevents them from managing another company that may be operating in competition with the company in question or may have similar objects to it. If in breach of this obligation, the manager may be dismissed and required to compensate the company.

This will ensure that there is no conflict of interest for the manager, hence protecting the interests of the shareholders. Under the CCL the concept of conflict of interest is not explicitly adopted, whereas the NCCL makes it clear that the management should not be allowed to conduct other business that conflicts or competes with the business of the company. FOUNDING MEMBERS OF A PUBLIC JOINT STOCK COMPANY: The NCCL provides that the founding members of a public joint stock company shall subscribe an amount equivalent to 30-70% of the issued share capital of the company at an initial public offering (IPO). This is a significant increase from the 20-45% range stipulated in Article 78 of the CCL.

The higher range permitted by the NCCL is designed to encourage local companies and family businesses to go public. It allows founding members, especially in family businesses, to list their companies without the fear of losing control over their business. This is also helpful for companies that do not need to raise substantial funds in comparison with their existing issued capital. This change will doubtless encourage IPOs in the UAE and will generally create movement and trust in the equity capital markets. The minimum number of founding members has also been changed from 10 under the CCL to five under the NCCL. The founding members may form a committee of founders of not less than three members, whose primary role is to complete the incorporation and registration of the company with the competent authority.

The founding committee, the consultants and any third party involved in the incorporation of the company, including their nominees, will be liable for the validity, accuracy and completeness of all documents related to the incorporation of the company.

The NCCL gives the Emirates Investment Authority the rights to subscribe for a maximum of 5% of the offered shares in any IPO in the UAE. This is another indication of the support and encouragement of IPOs by the federal government, which will also increase trust in and stability of the UAE equity capital markets. Another change that will help the development of the equity capital markets is the recognition of the role of a certified underwriter, for the first time under UAE law, to underwrite “what has been left from shares of subscription”. The recognition of underwriters and their role will contribute to the success of IPOs in the UAE market. The NCCL also provides for a decree to be issued by the chairman of the SCA to regulate the activities of the underwriters.

Book Building

 The NCCL recognises the book building process with respect to pricing of shares of a public joint stock company. There is no explicit reference to book building in the CCL. Furthermore, the NCCL states that the SCA will issue a resolution setting out the book building procedure.

Pre-emption Rights

 The NCCL gives shareholders of public joint stock companies a priority to subscribe to any capital increases. Shareholders are also permitted to sell their pre-emption rights (their right to subscribe) to the new shares to existing shareholders or third parties. While the pre-emption right is recognised under Article 204 of the CCL, there is nothing expressly allowing shareholders to sell on their pre-emption rights.

The NCCL also states that the chairman of the SCA shall issue a resolution relating to the conditions and procedure of selling pre-emption rights. While the said regulations are expected to be issued and published following the enactment of the NCCL, this provision is expected to provide companies with better access to funds as shareholders who do not wish to or are not in a position to subscribe to additional shares may, in return for a fee, make way for others to step in and provide the funds needed.

Under the NCCL, pre-emption rights in respect of shares in limited liability companies remain largely the same as stated in the CCL. The CCL gives preemption rights to the shareholders of a limited liability company on the shares of each other once offered for sale. If a shareholder wishes to transfer his or her shares to a person who is not already a shareholder in such company, the selling shareholder must first notify the other shareholders of that company of the terms of such proposed transfer and offer the nonselling shareholders the right to buy such shares (on the same terms as the offer), instead of completing the sale with any third party who is not a member in the company. Such notice must be in writing and should be sent via the board of directors or the managers of the relevant company. The non-selling shareholders have 30 days from receipt of such notice to notify the relevant board of directors or managers of their decision to exercise their pre-emption rights. If more than one non-selling shareholder exercises his or her pre-emption rights, the shares will be sold to each of the applicable non-selling shareholders in proportion to their shares already held in the company. It is important for the buyer and seller to ensure that this procedure is followed or a waiver of such preemption rights is properly obtained.

The NCCL follows the same procedure as set out in the CCL. This pre-emption requirement may, in some cases, cause issues or conflict with contractual rights of the shareholders where such shareholders have agreed, for example, in a shareholders agreement, to follow a different method of offering such shares through tag-along or drag-along rights, especially when the tag-along or drag-along rights were meant to override statutory pre-emption rights.

Classes Of Shares

 The CCL does not allow a limited liability company or other forms of company to issue different classes of shares, convertible notes or other “synthetic” equity. Public joint stock companies may, subject to certain conditions, issue debentures. All shares are subject to equal rights and transfer of such shares is subject to the approval of the relevant governmental authorities. Although the NCCL also requires that the shareholders in a company are equal in the rights attached to their shares and that a company may not issue a different class of shares, it also provides for an exception allowing a resolution by the Cabinet of Ministers to be issued to allow other classes of shares, the conditions of issuing them and the rights and obligations arising from such shares in addition to the rules and procedures regulating them. It seems that this will apply to public joint stock companies but not to other types of company.

Conversion Of Debt to Equity

 The NCCL introduces the option for a public joint stock company to convert its debt into equity via a special resolution by the company. This may be done only if the board of directors of the company successfully convinces the general assembly of the need to capitalise the debt. The chairman of the SCA is expected to pass a resolution outlining and streamlining the criteria and the procedural requirements to capitalise the debt.

Strategic Partner

 The NCCL also allows companies to offer shares to a “strategic partner” without offering them to the existing shareholders first. A strategic partner is defined as “such partner whose contribution to the company provides technical, operational or marketing support to the company, for the good of the company”. The conditions for offering shares to a strategic partner are:

• That the strategic partner conducts activities similar or supplementary to those of the company; and

• That the strategic partner has issued balance sheets for at least two financial years (this condition shall not apply to government entities, whether federal or local). It also states that the chairman of the SCA will issue a resolution setting out further conditions and the procedure for the entry of a strategic partner as a shareholder in the company. This is an important step towards enabling public joint stock companies to attract technical and other expertise that may not be available to ordinary investors.

Employees' Incentive Scheme

 It is uncommon for UAE public joint stock companies to adopt share plans or shares-based incentive schemes for their employees. This is because the CCL is silent on the award of such plans or schemes to employees.

That said, there are a few UAE public joint stock companies that have also adopted such schemes or plans on the basis of best practices in other jurisdictions and subject to approval by the SCA and the relevant stock market. The approval of the SCA is usually given on a case-by-case basis and subject to review of the structure and the terms and conditions of the plan or the scheme to ensure that it is not in violation of the SCA regulations in relation to governance and other good practices.

The NCCL permits a joint stock company by way of special resolution to increase its share capital and to allocate such shares to employees of the company within an incentive scheme or plan provided that such scheme or plan is approved by the general assembly of the company. The directors of a UAE public joint stock company may not participate in such scheme or plan. The NCCL states that the chairman of the SCA may issue a resolution stating the mechanism and the conditions of implementation of any such incentive scheme or plan. This will give an opportunity for public joint stock companies to reward their high-performing employees, whether such award is given in addition to other statutory entitlements under the UAE labour law or in lieu of them.

National Service Agent

 Under the CCL, foreign companies are required to appoint a national service agent. The draft of the NCCL circulated in 2011 does not make it a mandatory requirement for foreign companies to appoint a national service agent.

It suggests that a foreign company seeking to start its business in the UAE will no longer be required to appoint a local or national service agent. This, however, seems to leave the appointment of a national service agent to the choice of the foreign firm. We understand that this change may not be approved in the final draft of the NCCL and that the requirement to appoint a national service agent may therefore remain a part of the new legislation when it shall have gone through its final stages of approval.

Free Zone Companies

 The NCCL exempts the free zone companies, in situations where the laws or regulations of the specific free zone explicitly allow, from falling under the umbrella of the commercial companies law. However, if a free zone company wishes to operate outside its geographical limits but within the UAE, its operations outside the free zone will be governed by the NCCL. The NCCL further provides for a resolution to be passed by the Cabinet of Ministers outlining the prerequisites and procedural registration requirements of free zone companies that wish to carry out business onshore or outside of the free zone limits. At the moment, free zone companies may open a representative or branch office in the UAE, but the activity of such branch office remains subject to the approval of the licensing authority in the emirate. With the exception of the Dubai International Financial Centre, other commercial and civil laws of the UAE will apply to free zone companies in addition to the free zone regulations. It should be noted that, in the UAE legal system, the criminal law applies in free zones as well as onshore.

Exemption From The Application Of The Law

undefined In addition to free zone companies, the exemption from the provisions of the NCCL extends to other types of company. The exemptions provided under the NCCL are broader than the ones in the CCL and include the following:

• Companies exempted by a resolution of the UAE cabinet of Ministers to the extent such exemption is incorporated in such company’s memorandum and articles of association;

• Companies wholly owned by federal or local government, and companies owned by other companies wholly owned by federal or local government;

• Companies in which the federal or local government or any of their departments owns, directly or indirectly, not less than 25% of their capital and which operate in oil exploration, drilling, refining, manufacturing, marketing and transportation, and companies which operate in the power industry or in its generation, gas production, or water desalination, transportation and distribution; and

• Companies exempted under provisions of the CCL. To be exempted, all of the above categories of company are required to have relevant provisions in their memorandum and articles of association to that effect. Exempted companies are also required to amend their position in accordance with the NCCL if they sell or publicly offer any percentage of their share capital or list their shares in any of the financial markets in the UAE.

This article is not an exhaustive summary of the NCCL but instead merely highlights the key areas of change from the existing legislation. Further, this article is based on the most recent draft of the NCCL available at the time of printing, which may have changed since its release as such drafts are still subject to review by the relevant legislative authorities in the UAE.