A new companies’ law in the UAE came into force on 1 July 2015.
One of the objectives of the new Companies Law (UAE Law No. 2 of 2015) is to enhance the UAE’s corporate governance regime. The UAE government highlighted this in Article 2 of the new Law, where the organisation of governance rules is emphasised as an important part of the development of the UAE’s business environment. Directors’ duties and liabilities are integral to any corporate governance regime by upholding minimum standards and providing rights of redress for management failures.
In this article, we take an look at some key changes introduced by the new Law, focusing particularly on amendments which may affect directors of Limited Liability Companies (LLCs), the most commonly chosen investment vehicle.
We also look at the practical impact these changes will have on D&O Insurers.
New positive statement of duties
The previous Commercial Companies Law (UAE Law No. 8 of 1984) (the 1984 Law) did not set out a clear set of standards for directors to meet. There was simply a list of actions for which directors may have been held accountable, including acts of fraud, abuse of power, non-compliance with the law and the company’s constitution, and mismanagement (Article 111 of the 1984 Law).
The new Law now contains a statement of directors’ duties, expressed as obligatory standards for directors to maintain. This is contained in Article 22:
A person authorised to manage the Company must protect its rights and exercise the diligence of a prudent person. He has to do all acts that are compatible with the objects of the Company and the powers granted to him pursuant to an authorisation issued by the Company to this effect. (This is a translation prepared internally by Clyde & Co. There are other translations in the market of this provision.)
From the wording of Article 22, a number of related duties are expressed, similar to directors’ duties in other jurisdictions:
- An obligation to act in a way that is compatible with the objectives of the company
- An obligation to exercise a degree of care in discharging management responsibilities
- An obligation to act within the powers granted to the management and for the purposes for which those powers were given
The introduction of the concept of exercising managerial powers with the diligence of a “prudent person” is an interesting legal development. The term “prudent person” is defined in Article 1 of the new Law as being a person who has sufficient experience and demonstrates the necessary commitment to his duties. In other words, the standard of care expected of a director in the discharge of his duties is objectively framed by reference to the standard of conduct of a person with the right amount of knowledge and skills needed for the job, and who is putting in the effort needed to perform those duties properly.
Note that it does not appear that the new Law requires an assessment of what that particular director himself is capable of, such that an inexperienced director may need to meet the objective standard of care required of the role, rather than a subjective assessment with his specific skills and experience in mind. This should operate to discourage individuals accepting management positions which they know they are not sufficiently experienced to take, and puts more emphasis on the recruitment process to protect individual directors.
It is also important to note that Article 22 does not use the Arabic word usually translated as either “director” or “manager”. The wording used has a wider meaning: any person who is authorised to manage. Many LLCs have both a board of directors (often non-resident senior managers of the overseas parent group) and a general manager with day to day operational responsibilities (but who may not sit on the board). Under the new Law, both the board members and the general manager appear to be caught by this provision, as would any person to whom management powers may be delegated.
Claims against non-executive directors, who may have little involvement in the running of the company in question, are sometimes framed in the same way as allegations against executive directors. Whilst non-executive directors do not usually take responsibility for the day-to-day management, they may have oversight responsibilities connected with the governance, performance and strategy of the company as a whole. The new Article 22 may catch non-executive directors acting in this broader management role.
Specific LLC director provisions
There is a new provision setting out the liability of LLC directors in Article 84(1) of the new Law. This is very similar to Article 111 of the 1984 Law which was set out in the section dealing with joint stock companies (and is carried over into the new Law as well). Article 84(1) states that a director of a LLC may be liable to the LLC itself, the partners and third parties for:
- Fraudulent acts
- Improper use of powers
- Breach of law or the LLC’s constitutional documents
- Breach of his or her director service contract
- Material error
Under the 1984 Law, a LLC director may have been held liable for “mismanagement” under Article 111 (and this remains the case for directors of joint stock companies).
This gave rise to potentially wide-ranging liability and could have exposed directors for failings in the company’s performance without any personal fault being committed by that director. In practice however, few claims were brought under this provision. The new reference to “material error” instead, in the case of LLC directors, indicates that there must be some material culpability on the part of the director. However, these provisions of the new Law may lead to an increase in the number of claims as a result of the new codification of duties.
For example, claims for loss due to “material error” may be based on a failure by an individual director to protect the LLC’s rights, or to exercise a sufficiently diligent standard of care in management as would be expected of a prudent person.
One important change in the liability of LLC directors is that the new Law more clearly states the circumstances in which a company is bound by the acts of its management in relation to third parties. Article 23 provides:
The company shall be bound by any act or thing by the persons authorised to manage the company upon conducting the affairs of management in a usual manner.
In addition, Article 25 states that a company is not entitled to disclaim liability to third parties on the grounds that an authorised manager was not properly appointed, provided that:
- The third party is acting in good faith and did not know (or could not have known), based on his relationship with the company, of any defect in appointment, or in the act or thing proposed to be done on behalf of the company
- The acts of the manager are within the usual limits of a person holding the same position in a similar type of company
Taken together, these Articles create ostensible (or apparent) authority in the UAE. The effect of these provisions is that they offer protection to third parties dealing with a company’s manager: if they have checked that the person is the company’s manager and the actions to be performed by the manager are squarely within the ordinary course for most managers, the LLC should be bound by his actions even if, in reality, the manager was not actually authorised for that particular act, or was not correctly appointed as a manager at the time. A third party can rely on the manager’s ostensible authority.
Ostensible authority did not exist in the UAE prior to the new Law. If a manager of a LLC acted outside of the scope of his authority, the company was entitled to disclaim the contract, leaving a third party with a remedy against the individual manager only.
Indemnities or exemptions?
Article 24 of the new Law contains a new restriction on companies exempting officers (current and former) from liability: any provision of the company’s memorandum of association authorising such an exemption of liability is void.
In many jurisdictions, it is lawful for a company to indemnify its directors against personal loss suffered as a result of a claim for breach of duties, particularly for civil liability to third parties. Under the 1984 Law, a LLC was able to provide such an indemnity to its directors and it was commonplace for the memorandum of association to do so. It is not clear whether a directors’ indemnity will be considered to be an exemption of liability under Article 24 of the new Law.
With an enhanced regulatory environment, including more stringent corporate governance requirements, directors and officers in the UAE face an inevitable increase in claims. Creditors and counterparties will be more aware of, and willing to enforce, their legal rights. Against this backdrop, in order to attract and retain talented management, local companies will need to reassure directors about their personal liability.
On this basis, it is likely that more companies will turn to D&O insurance policies to provide protection, where there is doubt over the legal validity of the company’s own indemnification of its directors. In particular, we envisage that “Side A” cover which is designed to fit around a company’s indemnities and plug the gaps will be of greater importance in the UAE market.
The implications for D&O insurers – a summary
There is now more certainty about Directors’ duties and the standards that they must meet
- There is likely to be a continuation of claims against non-executive directors being framed in the same way as allegations against executive directors, and Article 22 catches non-executive directors in a broader management role
- There is a provision in the new law which provides that directors of Limited Liability companies may be liable for “material error”. The previous law referred to liability for “mismanagement” which was not defined and potentially gave rise to wide ranging liability, even where a Director was not personally at fault. This change and reference to “material error” may alter the position, although the new codification of duties may increase claims overall
- As ostensible or apparent authority now exists, companies may be saddled by liability to third parties even if the relevant manager or Director was not in fact authorised
- Companies are now restricted from exempting Directors from liability. D&O cover is likely to become more sought after and important