Bankruptcy Reform in the UAE: A Big Change but More is Needed
By Bashar Malkawi (University of Arizona)
Like many other jurisdictions these days, the UAE has witnessed a shift from a bankruptcy and liquidation culture to a corporate rescue culture. This is important to provide a sound environment for business and investment. Initially, the UAE’s insolvency law was seen as draconian and punitive in nature with rules such as a jail term for defaulted debtors. Compared to the previous 1993 provisions on bankruptcy in the Federal Commercial Code -which included no less than 255 articles dedicated to insolvency and bankruptcy procedures - the UAE insolvency law of 2016 and then that of 2020 is ground-breaking in many aspects. First, the law provided for several options tailored to different scenarios with bankruptcy and liquidation being the last resort. Second, the law also introduced a new "agreement for settlement procedure", which can be helpful in rejuvenating businesses. Third, the law created major new provisions on creditors' committees and debtor-in-possession financing, something the old law did not provide. These changes are timely considering the current COVID-19 global health pandemic.
The Legislative Guide on Insolvency Law prepared by the United Nations Commission on International Trade Law (UNCITRAL) provides for the key elements that ought to be included in any insolvency regime. Thus, an effective insolvency law must have the following key provisions. It should clearly outline its applicability and commencement standards, as the UAE Federal Bankruptcy Law ("UAE FBL") actually does (see articles 2, 6, 68, 124 and 141 of the UAE FBL). In addition, the law should prescribe the treatment of assets of the debtor entity upon commencement of the proceedings (articles 22, 67, 132 and 164 UAE FBL). The law should also identify and provide for the rights and obligations of the key participants in any proceedings such as debtors, insolvency representatives, and creditors including secured creditors (articles 17, 82, 104, 174, and 185 UAE FBL). There should be procedures for the management of the proceedings – e.g., procedure for processing creditors' claims in priority over other creditors' claims, liquidation waterfall (article 189 UAE FBL). Ideally, the process ends with a reorganization plan when a company is economically viable despite being in a situation of financial distress. Otherwise, the company is liquidated (articles 64 and 67 UAE FBL). The UAE bankruptcy law checks all these boxes.
In reality, however, the annual number of the corporate bankruptcy cases handled by the UAE courts remains limited. After a few years in existence, one can envisage some scenarios for this state of affair and lack of effective use of the law. Many businesses are maybe hesitant to use the system out of a lack of understanding of its provisions which has since revolutionized the culture of bankruptcy from selling defaulted party assets, as the norm, to focusing on reorganization. Another explanation is that the courts are used to fair distribution (the pari passu principle) in judgment execution in lieu of bankruptcy proceedings. The execution order by the courts gives the right to seize and sell any assets of the debtor. Moreover, cultural factors, among other things, could help explain the limited number of court cases. Stigma, among peers, associated with default and bankruptcy can play a factor in the UAE and for that matter in other Arab countries.
Small and Medium Size Enterprises (SMEs) constitute a large segment of the UAE's economy. SMEs account for more than 94% of the total businesses and employ more than 86% of the private sector's labor force. In Dubai, for example, SMEs represent nearly 95% of all businesses in the city, provide jobs for 42% of the labor force, and contribute about 40% of the city's GDP. SMEs are key players in the UAE economy. SMEs encourage both innovation and economic sustainability. Similar to governments worldwide which have adopted the decision to support SMEs, the UAE Central Bank announced a plan to provide aid in the short and medium term for SMEs, which includes support to the tune of DH100 billion. However, from a bankruptcy perspective, the current insolvency law is not attractive to SMEs. A one-size-fits-all approach does not work for these SMEs. Procedures such as establishing creditors' committees, reorganization plan, court-appointed bankruptcy officer can prove complex and expensive for SMEs. The current UAE insolvency law does not accommodate the interests of SMEs. In comparison, other countries such as the U.S. adopted reform in its bankruptcy law by allowing for a SMEs reorganization plan without creditor approval, elimination of court-appointed trustee, and deferring payment of administrative payment.
Many other issues remain to be addressed to have a holistic bankruptcy regime. For example, there are no specialized insolvency judges who are trained and appointed to apply the law. The same applies for bankruptcy office-holders. In terms of coverage, the law does not apply to non-profit entities such as educational or religious or scientific institutions. The law also lacks early warning mechanisms which aim to provide prompt detection of financial distress of an enterprise, as well as a quick adoption of the more suitable remedies. These mechanisms can be activated by the control bodies such as statutory auditors, supervisory board, internal control committee or external auditors. Directors should have due regard to the need to take steps to avoid insolvency. Furthermore, the UAE law does not provide for a possibility of a cross-class cram-down, that is, the power to impose the plan on dissenting classes of creditors provided that the plan is fair and equitable for the creditors. Nevertheless, having legislation in place no doubt is a step forward. More is still needed in terms of cultural, legislative, and practical adaptations.