Enabling the economic phoenix

Why the UAE needs a better insolvency system

Dubai International Financial Center. Credit: AFP PHOTO/KARIM SAHIB

In his 2003 book “The law of insolvency,” Ian Fletcher writes “commercial morality, and respect for the rule of law, may be said to constitute the very bedrock upon which the law of bankruptcy is founded.”

The development of an efficient, transparent and foreseeable insolvency system is arguably at the center of a country’s economic advancement. The globalization of businesses is an unstoppable phenomenon, and its key feature is that it requires a highly effective risk management process that can only crystallize if a country has implemented a modern and clear insolvency law framework. Such a regime enables businesses to grow systematically and facilitates the rescue of valid enterprises, promoting innovation, entrepreneurship, safety for investors and market stability. 

Since the 2008 global financial crisis, insolvency regimes around the world have been tested and scrutinized. The MENA region, and in particular the United Arab Emirates, have been examined, and many commentators have argued that reforms are needed in order to modernize existing insolvency regimes, which are viewed as archaic and misaligned with the current economic realities.

The main problems with the [UAE’s] current regime are that there is no specific definition of bankruptcy and the legal structure is fragmented

UAE insolvency legal framework

Winning the bid for Expo 2020 has put the UAE in the global limelight. As more and more investors look at the country as one of the main international hubs for finance and entrepreneurship, the vestiges of the financial crisis add uncertainty. During the crisis, the number of insolvencies increased dramatically and the UAE’s existing legislation faced numerous challenges.

In the World Bank’s “Doing Business Report 2014,” the UAE is ranked 101st for resolving insolvency matters — behind Azerbaijan, Togo and Senegal — and 98th for protecting investors, although it is ranked 23rd in relation to doing business. According to Arabian Business, the statistics are as follows: “It takes an average 3.2 years to resolve an insolvency issue, compared to the Organization for Economic Cooperation and Development’s average of 1.7 years, and the recovery rate is 29.4 cents on the dollar, as opposed to 70.6 cents in the OECD countries.” 

Two of the main points of controversy have been the treatment of debtors, who have been jailed for bounced checks or forced to flee the country, and the failure to salvage companies that may have been restructured effectively. In addition, the dispute resolution process is very lengthy and the distribution of assets to creditors lacks the required certainty dictated by international standards, as expressed by top entrepreneurs. There is a strong view that institutional infrastructure needs to be developed further. As a result, in 2013 it was declared that a new insolvency framework was in the making and would be implemented, which hopefully will address the criticisms and allow for the establishment of a world class institutional infrastructure. 

Current regime

The founder of Virgin Group Richard Branson said in an interview with Arabian Business on February 15, 2014: “I’m flabbergasted to hear there’s no bankruptcy law in the UAE.”

Currently, there is no specific UAE insolvency legislation. The relevant provisions covering bankruptcy are included in the Civil Procedure Code Federal Law No. 11 of 1992; the Commercial Companies Law, Federal Law No. 8 of 1984; the Evidence Law, Federal Law No. 10 of 1992; and Book 5 of the Commercial Transaction Law, Federal Law No. 18 of 1993.

The main problems with the current regime are that there is no specific definition of bankruptcy and the legal structure is fragmented. From a practical perspective, the courts have been more inclined to opt for liquidation and are reluctant to use the many fractional provisions. In addition, the concept of business reorganization is unknown, and there is no appeal mechanism for dissenting creditors. The lack of experienced bankruptcy courts and regulation of insolvency practitioners, as well as the unpredictability of decisions, all highlight the systemic weaknesses. Specifically, although the freedom of contract principle is embedded in UAE law, it is a common fact that the UAE courts may, on the grounds of public policy and morality, disapply the foreign laws. In fact, most restructurings since the 2009 global financial crisis have been resolved outside the courts. The Dubai International Financial Center and London Court of International Arbitration are becoming options that may offer greater reliability.

The new regime

The new draft insolvency law is modeled on French bankruptcy laws and is at present under review, while the public is hoping for a swift implementation. The objective of the law is to modernize the existing regime and shift the focus from a creditor-friendly establishment to a more debtor-friendly regime. It is also designed to be more flexible and transparent, and aims to safeguard the interests of businesses, the economy and creditors. The new law seeks to implement a swifter process of insolvency resolution than that carried out through the courts, with the establishment of an independent commission.

One of the main criticisms of the existing system is that it did not protect either debtors or traders sufficiently, nor did it allow for the restructuring of businesses or address the issue of ‘small bankruptcies.’ The sphere of the new legislation is designed to be wider — although it carves out the international financial zones and focuses on companies and juridical persons.

Notable provisions are (i) a streamlined bankruptcy process for small bankruptcies; (ii) rescue provisions for non-trading individuals; (iii) simplification of set-offs; (iv) regulation for bankruptcy experts; (v) facilitation of debtors’ and creditors’ arrangements; and (vi) moratoriums for creditors. Overall, this provides for a significant improvement, but there are also criticisms, particularly in relation to its applicability to larger forms of restructurings with sovereign and quasi-sovereign companies. The insolvency law appears to be more suited for family-owned businesses, and the concept of ‘trader’ as defined in the law does not appear very fluid. A reconciliation between sovereign entities and commercial entities under the insolvency law umbrella is required in order to provide the required stability and modernism.

Essam Al Tamimi, senior partner at Al Tamimi & Co — speaking at the Hawkamah Judicial and Financial Colloquium on March 18 and 19, 2014, held at the DIFC Conference Center in Dubai and focusing on insolvency — correctly pointed out that “a good bankruptcy law is good for the economy, but whether it is the best solution for cases such as these involving government-linked companies, possibly not. A process outside the bankruptcy law is better but I’m in favor of having a good structured law and not leaving things totally loose.”

The expected introduction of the new insolvency law in UAE is regarded as a very positive development for the country’s future prospects. As already argued above, a lack of clarity in this sector can be very unsettling for businesses and investors alike. Yet it is critical that the implementation of the law operates hand-in-hand with society’s acceptance of the proposed legislation. In this regard, a proactive approach is required to ensure that the population is educated and that the framework is applied consistently and predictably.

Culturally, a wider understanding and acceptance of entrepreneurial collapses must be promoted. After all, several successful entrepreneurs have experienced bankruptcy — often personally — and were able to learn significantly from such experiences. Consideration must be given to legislating for larger conglomerates.  

The new laws must be passed soon if the country wants to develop even further. The essence of the question was clearly elucidated by Fabio Scacciavillani, chief economist at the Oman Investment Fund in June. “The essence of a market economy is risk across several dimensions: financial, operational, competition and many more,” he said. “Inevitably, when one of these risks materializes, a company goes bankrupt and the consequences need to be dealt with in the most effective and rapid fashion. A law that follows the best international practices would be a key ingredient for making the business environment in Dubai and the wider region extremely attractive for international investments.”

Nicole Purin

Nicole Purin is senior legal counsel at Standard Chartered Bank

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