Talking legal: Bankruptcy laws explained

We live in uncertain times. Businesses need to prepare themselves for all contingencies. Misconceptions persist among business owners and directors as to the purpose of the UAE Bankruptcy Law that was introduced in 2016 and its comparative likeness to international counterparts. All too often they mistakenly regard the regulations as a magic bullet which can make their financial problems disappear.

According to Kortbawi, a struggling business should first assess its finances and options to see if there might be a way to avoid bankruptcy. Vital to that assessment is simply that the business model and practices should enable the business to generate cash, with which it can pay its debts. These can include:

• Collecting receivables in a timely manner

• Reducing expenses down to only the essentials for the business

• Ensuring that the business is ‘economy-proof’, as far as possible, make the most of any relief from governments, landlords, vendors etc.

However, an important step for any struggling business is to identify, ideally foresee the difficulty, and be proactive. Communicating with creditors early and demonstrating to them that you have a plan may encourage them to give the business some leeway.

If all of these fail, the UAE bankruptcy regime encourages a rescue culture, but only if the business is viable in the eyes of the court.

What are the bankruptcy laws in the UAE?

Michael Kortbawi (MK): The relatively new Federal Law No. 9/2016 on bankruptcy (the Bankruptcy Law) governs bankruptcies in the UAE, replacing the regime under Federal Law No. 18/1993 on Commercial Transactions. It applies to:

• UAE companies established under the Commercial Companies Law,

• Partly/fully government-owned companies, where the company has chosen to opt into the Bankruptcy Law in its articles,

• Free zone companies that are not governed by existing free zone bankruptcy laws (e.g. DIFC and ADGM companies are excluded as those free zones have their own bankruptcy laws),

• Individuals classified as “traders” under Federal Law No. 18/1993 relating to commercial transactions, and

• Licensed civil companies of a professional nature.

This new law is designed to promote a rescue culture and consists of different processes under financial reorganization for financial institutions, protective composition for struggling solvent debtors, and ‘bankruptcy’, consisting of financial restructuring or insolvent liquidation, for insolvent debtors.

How does it affect a business owner - professionally and personally?

Bankruptcy can have a significant impact on the business owner. The benefits of bankruptcy are fleeting, e.g., temporary relief from creditors, holds on criminal actions, and a chance of business rehabilitation.

The Bankruptcy Law incentivises small and medium enterprises to be proactive with their debt restructuring. A company is required to initiate the bankruptcy process after 30 consecutive working days from it either being unable to pay its debts when they mature, or its assets being insufficient to cover current liabilities.

On the other hand, the severe personal and professional drawbacks include:

• Criminal prosecution if fraud or bad faith was involved,

• Directors and managers may be personally liable if the company is unable to pay 20% of its debt.

• The negative impact to reputation,

• Inability to conduct future business,

• Harsh penalties for directors and general managers such as imprisonment for up to five years and a fine up to AED 1,000,000 for certain actions, as listed in Article 198 including hiding, damaging, or altering company records with the intention of harming creditors; embezzling or hiding company assets; obtaining a preventive composition or restructure for the company through deception, or announcing false information regarding the finances of the company.

How can a business owner "prepare" themselves for bankruptcy? What processes and paperwork should they have in place?

To commence the bankruptcy procedure, an application must be submitted to the court with justifications and reasons for the same. In terms of paperwork, the debtor’s application under Article 73 needs to contain:

• A brief memorandum of the debtor’s economic and financial situation, information on his assets, and detailed data on his employees.

• A certified copy of the commercial, industrial or professional licence, and his commercial register issued by the competent authority at the Emirate.

• A copy of the commercial books or financial statements related to the debtor's business for the fiscal year preceding the application.

• A report containing the debtor's cash flow forecasts and the profits and losses expectations for the twelve months following the application; names of known creditors and debtors, their addresses, the amount of their debts and guarantees offered in return, if any and a detailed statement on the debtor company's movable and immovable properties, the approximate value of each of these properties on the date of the application, and a statement of any related guarantees or rights in favour of others.

• Designation of a trustee nominated by the debtor.

• A copy of the decision of the shareholders authorising the application, and a copy of the company's incorporation documents (with any amendments).

• Any other supporting documents, e.g., notarized power of attorney if managers or shareholders are outside the country.

• A report issued by the competent authority (e.g. Al Etihad Credit Bureau) on the credit information at the State.

If any of the above data or documents are not submitted, reasons should be provided in the application. Getting the required paperwork in order may take 2-4 weeks, which means debtors must be proactive when financial difficulties arise. Additionally, the following costs should be accounted for:

• an AED 20,000 deposit to cover court costs

• around AED 5,000 in translation fees if company documents are in English, and

• legal fees (that can differ among law firms).

There is no blueprint to prepare for bankruptcy as each case is nuanced and specific. The Bankruptcy Law is relatively new and untested for the most part. The best way for a business owner to generally “prepare” for a bankruptcy is to be proactive when financial difficulties are expected and arise, and not perform any illegal or bad faith acts during and before bankruptcy, as they open the door to personal liability.