Operating a limited liability company in the UAE requires UAE nationals to hold a majority shareholding in the company. As such, foreign investors must enter into partnership with a local party. In some cases, disagreements between shareholders can occur, particularly if the so called "nominal shareholders" wish to enhance their share of the economic interests or to increase their involvement in the operation of the company. In this article, Elsie Habib provides foreign investors in limited liability companies with primary settlement options should things turn sour.
In brief
- Foreign investors traditionally enter into partnership with UAE national shareholders in order to comply with the provisions of the UAE Federal Law No. (8) of 1984 concerning the Commercial Companies (as amended) (Companies Law).
- The Companies Law provides that any company with limited liability to be incorporated in the UAE should include one or more UAE national shareholder(s) who hold a minimum of 51% of the share capital of the company.
- Foreign shareholders have sometimes entered with UAE shareholders into side agreements, as a means of additional protections with the objective of reducing the risks. Such agreements may not always have been carefully drafted. Similarly, other foreign shareholders may have been satisfied with the official notarised memorandum and articles of association and the protections therein due to a longstanding relationship with the UAE shareholder.
- Taking a broad view, it would appear that the Anti-Fronting Law seeks to prevent the use of side arrangements with UAE nationals (including nominee arrangements regarding the 51% shareholdings in companies) and may render such arrangements invalid.
Companies Law and Commercial Anti-Fronting Law
In November 2004, the UAE enacted the Commercial Anti-Fronting Law (the Law). The Law was originally intended to come into force on 15 November 2007. However, the UAE Cabinet's Resolution No. 229/12, issued in 2007, deferred the enforcement of the Law until 31 December 2009. The UAE Ministry of Economy has not yet provided further clarification on the implementation or further deferral of the Law. It can therefore be assumed that the Law is in effect as of 1 January 2010 unless declared.
The Anti-Fronting Law, in essence, states that "fronting" is prohibited and fronting is defined therein as "enabling a foreigner (whether a natural person or a corporate body) to undertake any economic or professional activity, which he is not permitted to carry out under the effective laws and decrees of the UAE, whether undertaken on his own account or in venture with others; or enabling him to evade obligations applicable to him".
The above definition is a key provision of the Anti-Fronting Law as it is the foundation of its scope and application. The Anti-Fronting Law prohibits fronting for any foreigner (whether a natural or artificial person) and whether by use of the name, commercial license or commercial register of the fronter, or by any other means in light of the definition of fronting stated above.
Taking a broad view, it would appear that the Anti-Fronting Law seeks to prevent the use of side arrangements with UAE nationals (including nominee arrangements regarding the 51% shareholdings in companies) and may render such arrangements invalid. Whereas previously, foreign shareholders tended to enter into side agreements with UAE shareholders with the aims of achieving additional economic interest and some risk reduction.
Enforcement
The Anti-Fronting Law imposes fines and imprisonment penalties for violations. Any company found to be involved in side agreements may be deregistered from the commercial registry with respect to the violated activity and its licence may be revoked.
Such side agreements cannot be notarised; nevertheless, they hold moral weight, vis-à-vis the nominee UAE shareholders and their respective heirs. It should be noted that third parties (eg banks, creditors, etc.) who are not on notice of the existence of such arrangements are not bound by their terms.
Dubai courts have in recent precedents recognised the existence of similar side agreements taking into consideration the wording and structure of such agreements, in addition to testimonials from third parties with respect to the ownership of the 51% shareholding. Nevertheless, the matter of enforceability of nominee side agreements remains uncertain and to be decided by the courts on a case by case basis.
It is still possible that the effective implementation of the Anti-Fronting Law may be deferred to come in parallel with either or both of the planned new Companies Law (which is anticipated to enable foreign ownership in excess of 49% and up to 100% in some business activities) and the Foreign Ownership Law.
Major reasons for disagreements
Disagreements between UAE shareholders (or their heirs) and foreign investors are typically based on common themes such as:
- The UAE shareholder has requested an increase in his annual "sponsorship" fee yet the existing fees are fixed or related to a percentage of revenue profits. In such circumstances, a review of financial statements maybe requested and questions maybe raised by the UAE shareholder on the financial performance of the company and whether he is entitled to any part of the same.
- The UAE shareholder becomes aware that the foreign investor is considering to replace him or her with another UAE national shareholder to act as local sponsor for the company.
- Following a longstanding relationship, the heirs of a deceased UAE shareholder, claim ownership of the 51% shares and demand payment of the profit share with respect to the 51% shareholding in the share capital of the company as well as demanding management rights.
The examples listed above illustrate possible, yet not atypical, scenarios where relationships can turn sour. In adverse cases, routine corporate requirements such as signing new visa application forms, renewal of trade licenses, renewal of residency visas and so on (let alone substantial management decisions) can become significant points of disagreement and burden, unduly affecting the business and operations of the company.
Resolving disagreements
Hadef & Partners regularly advises clients (UAE shareholders and foreign investors) involved in shareholder disagreements. We believe that there are three primary options available to the parties involved:
1. Amicable settlement
- If there is no side agreement in place to cover broader aspects of protection and the foreign investor wishes to continue operating with the UAE shareholder, the foreign investor could consider renegotiating existing contractual terms with the UAE shareholder. Hence, the parties can amend the notarised official memorandum and articles of association to reflect as many of the agreed protections as possible, with the objective of reducing risk.
o Notarised power of attorney: to be executed by the UAE shareholder in the presence of a notary public in favour of the foreign investor granting the latter broad rights with respect to the 51% shareholding to be held by the UAE shareholder on behalf of the foreign investor. There is, however, a residual risk that such power of attorney could be revoked by the UAE shareholder as the concept of an irrevocable power of attorney is not yet properly recognised under UAE law.
o Side agreement: notwithstanding the residual uncertainty about the enforceability of side agreements described above, some foreign investors still enter into forms of a side agreement with the UAE shareholder in the form of a legal acknowledgment where the UAE shareholder confirms that he/she did not participate in funding the share capital of the company and hence does not have the right to claim profits of the company, trade name, assets of the company, etc.
There are also other types of protection structures such as pledge and loan agreements and management agreements. However, due consideration must be made to the implications of the Anti-Fronting Law in regard to all the above.
- The foreign investor may negotiate with the UAE shareholder a mutually agreed lump sum compensation in order to persuade the UAE shareholder to transfer the 51% of shares registered in his name on behalf of the foreign shareholder to a new UAE shareholder, carefully selected by the foreign investor, and the original UAE shareholder exits the company.
2. Filing for liquidation of the company
- If all amicable attempts to resolve the deadlock with the UAE nominee shareholder come to a dead-end, then the foreign shareholder can consider filing a case with the court to request involuntary liquidation. Involuntary liquidation through the court is possible if the company incurred losses in excess of 75% of its capital or if the deadlock between the shareholders makes it impossible for it to carry out its business and hence makes the objects of the company unachievable as per Articles 281 and 289 of the Companies Law.
Conclusion
Shareholder disagreements that occur between UAE shareholders
and foreign investors must be carefully managed. It is vital for
foreign investors to consider entering into all possible
protections and, in respect of any side agreements, to carefully
assess the structure and wording of the arrangements in the light
of the Anti-Fronting Law.
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The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
