Joint ventures in the UAE
This “Guide to Joint Ventures” initiative is aimed at helping parties to structure their joint venture arrangements in the UAE in a manner which best protects their interests.
There are many different reasons why a business may seek to enter into a joint venture. It may wish to access new markets, develop new products or benefit from the particular expertise of its JV partner or share risks and resources.
The phrase “joint venture” can have a number of different meanings. The UAE attracts significant foreign investment so it may involve the partnering of UAE and non-UAE investors. The JV will typically involve the incorporation of a company to act as the JV vehicle. This Guide will focus on corporate JVs since that is the most common approach, although the phrase “joint venture” may also be used to describe a contractual arrangement, for example, in the areas of commercial agency, franchise and (less commonly) a simple unincorporated contractual co-operation agreement.
The first step is to choose whether to establish the JV vehicle in onshore UAE or in one of the free zones. The key advantage of free zones is that they allow for 100% foreign ownership, whereas onshore UAE companies must be at least 51% owned by UAE nationals or UAE companies that are wholly owned by UAE nationals (subject to certain recent developments which are discussed below). However, free zone companies are generally speaking not permitted to carry on business outside of the relevant free zone without establishing a separate subsidiary or branch office for such purposes, so a proper analysis of where business will be conducted and associated risks needs to be undertaken. As a result, many JVs in the UAE will involve the incorporation of an onshore limited liability company (“LLC”) to act as the JV vehicle. This Guide assumes that an LLC will be used as the JV vehicle.
Structuring the joint venture
Pursuant to Federal Law No. 2 of 2015 concerning Commercial Companies (the “UAE Companies Law”), a foreign investor can only hold a maximum of 49% of the shares in an LLC (the “Foreign Ownership Restriction”). However, the Foreign Direct Investment Law (Federal Law No. 19 of 2018) has relaxed the Foreign Ownership Restriction by allowing for up to 100% foreign ownership in certain sectors. On 2 July 2019, the UAE Cabinet issued a resolution whereby it specified a total of 122 economic activities across 13 sectors which will be eligible for up to 100% foreign ownership – see here and here for further details.
In those cases where the Foreign Ownership Restriction applies and the commercial agreement is that the foreign JV partner will beneficially own a higher percentage of shares than is permitted by this, the challenge for its lawyers is how to structure the JV arrangements in an efficient manner which best protects the interests of the foreign JV partner, while at the same time being enforceable under applicable law.
We have been at the forefront of the market in our understanding of corporate law, including the Foreign Ownership Restriction and its practical interpretation by the relevant government officials and legal departments, enabling us to devise and implement optimal corporate structures for our clients.
We work closely with the relevant licensing authorities to ensure that various corporate structures proposed by us for JVs are acceptable. In our experience, such authorities are keen to engage with us to enable innovate corporate structures, given their objective of attracting and facilitating foreign investment into the country.
Our objective is to allow our clients to focus on their business and have a legal corporate structure that they know is robust and flexible enough for their short, medium and long term objectives.
Key provisions in joint venture or shareholders agreements
In addition to our structuring expertise, we also have a wealth of experience in advising on the relevant JV documentation. Various documents will be required depending on the circumstances of the JV, but typically the principal document will be the joint venture or shareholders agreement.
The following are key provisions in any joint venture agreement (although there are others which are not noted below):
- The purpose and scope of the JV.
- Board composition and management arrangements.
- Financing of the JV company.
- Reserved matters requiring consent of shareholders/directors and voting requirements.
- Dividend policy.
- Restrictive covenants.
- Deadlock resolution.
- Transferability of shares under different circumstances.
- Termination or exit from the JV.
Certain of these matters are discussed in more detail below.
1. Board composition and management arrangements
Board composition will usually be proportionate to each Party’s shareholding. In a 50:50 joint venture, it would be normal for the parties to be entitled to appoint an equal number of directors, although this is not always the case. Any party that has minority representation on the board should require a number of issues to be reserved for shareholder approval, depending on the nature of control and veto rights which are appropriate to the JV. The list of shareholder reserved matters will often be one of the more heavily negotiated aspects of a JV agreement.
Under JV agreements, it is common for the shareholdings of parties to be subject to mechanisms that change these, e.g. on a capital call, one shareholder may subscribe for shares whilst the other may not so diluting the latter shareholder. It is therefore important that board composition provisions cater for the possibility of change and enable board appointment rights to vary where a shareholder’s proportionate ownership has increased or decreased.
Day-to-day management of the business of the JV will often be delegated by the board to the general manager or CEO. On a 50:50 joint venture, the board will normally be entitled to appoint the general manager or CEO, but this is not always the case and in certain instances this right could be given to one of the shareholders. Whilst the general manager or CEO will have broad powers to operate the business on a day-to-day basis it is important to ensure that certain key matters are reserved to the board or the shareholders. This is of particular significance for a shareholder where the other shareholder has the right to appoint the general manager or CEO.
2. Financing of the JV company
In any joint venture, the funding provisions need to be carefully tailored to reflect the parties’ chosen method or methods of funding the JV company. There are various options available but a typical process would involve the board of the JV company (or senior management such as the CEO) deciding that funding is required. Following this “funding call” an agreed mechanism will determine from whom funding should be procured (for example, loans from banks or other third parties or equity/shareholder loans from the shareholders). This would often be subject to shareholder approval, with the deadlock resolution mechanism being invoked if the shareholders cannot agree any relevant issues within a stipulated timeframe (see Deadlock resolution section below for further details).
Where the shareholders are obliged to make contributions (typically pro rata to their shareholdings), the agreement should clearly state what happens if one of them defaults. For example, should the other shareholder be able to fund the shortfall amount and receive additional shares, thereby further diluting the defaulting shareholder? Or should the other shareholder be entitled to provide a shareholder loan equal to the shortfall amount and, if so, should this shareholder loan rank ahead of all other shareholder loans and attract a preferential rate of interest? A failure to comply with a funding obligation would also typically constitute an event of default triggering the compulsory share transfer provisions, whereby the non-defaulting shareholder can elect to purchase the shares of the defaulting shareholder at a discount to market value (occasionally an option is also included for the non-defaulting shareholder to sell its shares to the defaulting shareholder at a premium to market value). These types of clauses are designed to incentivise the shareholders to comply with their funding obligations, providing the JV company with the financing it needs to successfully operate its business.
3. Dividend policy
It is important for the parties to consider the dividend policy of the JV company at the outset. This will often depend on the nature of the business, in particular on whether the JV’s purpose is intended primarily to be cash-generating or as a growth company.
The dividend policy will need to be clearly stated in the JV agreement in order to reduce the likelihood of a dispute arising in the future. One option is to provide for the distribution of an annual dividend of a certain percentage of the JV company’s annual profits. A more flexible option is to allow the board of the JV company to determine a reasonable level of dividend on an annual basis. In either case, it is important to include certain caveats – for example, dividends should only be payable to the extent that they comply with applicable laws (for example, regarding distributable reserves or requirements to maintain a reserve) and do not result in the JV company being in breach of any of its banking covenants. Where it is envisaged that the parties will make shareholder loans to the JV company, the JV agreement should make it clear that no dividends will be paid until all such shareholder loans have been repaid in full. The payment of dividends would often be subject to shareholder approval, with the deadlock resolution mechanism being invoked if the shareholders cannot agree within the stipulated timeframe (see Deadlock resolution section below for further details).
4. Deadlock resolution
Deadlock can arise in various circumstances, but the most common circumstance is when a board or shareholders resolution is not passed by the requisite majority of directors or shareholders respectively.
It is usual to ensure that, as a first step, appropriate efforts are made by the parties and their representatives to resolve a deadlock. There could be a “cooling off period” during which the parties are required to use reasonable endeavours to resolve the dispute within a certain period of time. If they are unable to do so, referring the dispute to the chairman/CEO of each party can be a useful tool. It is not uncommon to refer disputes to an independent expert, although it may not be sensible to have a third party adjudicate on a matter of commercial or financial significance.
Other more extreme options can be included but these should be used with caution as they have the potential to bring the JV to an end and can be manipulated by an unscrupulous party. However, such options include the following in a deadlock situation:
- “Russian Roulette”: Under this mechanism, any party may serve a notice on the other, either requiring the receiving party to purchase its entire holding from it, or for the receiving party to sell its entire holding to the initiating party, at the price set out in the notice. The receiving party then has a period in which to accept the offer made in the notice or reject it, in which case the roles of "vendor" and "purchaser" are reversed. This method ensures that a realistic price is set by the initiating party, as that party may either have to sell its holding, or buy the other's holding, at the price it states in the notice.
- “Texas or Mexican Shoot Out”: Under this mechanism, the initiating party may serve a purchase notice on the receiving party stating that it is willing to buy the other out and setting the price at which it is prepared to buy. The receiving party then has a period in which to serve a counter notice, stating that it either (i) is prepared to sell at the price contained in the purchase notice; or (ii) wishes to buy the interest of the initiating party at a higher price. If the latter situation occurs and both wish to buy, then a sealed bid system will be put into operation, with the person who bids highest being entitled to buy the other out. Alternatively, this bidding process can be run as an auction with the parties raising their bids in competition with one another. This is a starker mechanism than the “Russian Roulette” procedure. It is more openly susceptible to misuse where one party does not have the resource or desire to buy, requiring a strong nerve in that case to increase a low opening price.
Naturally, these mechanisms or the points raised above will not be appropriate for all JVs so it is important that the parties carefully consider the relevance and applicability of these provisions at the outset.
How we add value
We are recognised in the market as experts in structuring and advising on JV agreements and believe that the following key factors clearly distinguish us from our competitors:
- We have a dedicated corporate structuring team who regularly advise clients on how to structure their JV agreements in an efficient manner which best protects their interests.
- Our transaction lawyers all come from leading international law firms and have the required strategic, structuring and drafting skill set to prepare and negotiate all types of JV documents to international standards.
- One key difference is that our transaction lawyers are integrated with experienced lawyers from the region who possess specific local law and bilingual skills and expertise to ensure our advice is efficient, accurate and pragmatic.
- We use our knowledge and experience to properly assess those risks which require special focus in any particular JV transaction, and our extensive network of contacts to resolve these (where necessary).
- Our significant experience of negotiating JV documentation allows us to protect our client from the key risks by always having a partner leading on negotiations (supported by a team of more junior lawyers appropriate to the deal requirements).
We have set out below a case study of how we structured a recent JV for a foreign client, which illustrates our structuring expertise.
- Our client was a European manufacturer and distributor.
- Our client was selling its products to a local third party distributor in the UAE as it did not have any distribution company established in the region to sell its products directly to UAE customers.
- Our client entered into a distribution agreement (“Distribution Agreement”) with a UAE company (“UAE Co”) under which UAE Co was responsible for, among other things, marketing and selling our client’s products in the UAE (“Products”).
- The Distribution Agreement was to be terminated and our client wished to establish a new company which would be licensed to carry out the sale and distribution of the Products in the UAE (the “Licensed Activities”). The Licensed Activities were to be carried out in onshore UAE and, accordingly, it was necessary to establish an onshore LLC in order to carry out these activities (“UAE Distribution LLC”).
- The shareholding of UAE Distribution LLC would need to comply with Foreign Ownership Restriction. However, the commercial agreement was for UAE Distribution LLC to be a 50:50 JV between our client and UAE Co.
- Our client wished to implement a robust corporate structure for the purpose of owning, managing, marketing, distributing and selling the Products in the UAE via a 50:50 JV with UAE Co.
Solutions provided by Hadef & Partners
We created a robust and flexible structure for our client, the key features of which are set out below.
- Our client owned forty nine per cent (49%) of the legal interest and fifty percent (50%) of the beneficial interest of the entire issued share capital of a joint venture company limited by shares incorporated in the DIFC (“DIFC JVCo”), whilst UAE Co held fifty one percent (51%) of the legal interest and fifty percent (50%) of the beneficial interest of the entire issued share capital of DIFC JVCo. UAE Co held, on behalf and to the account of our client, one percent (1%) of the legal interest of the entire issued share capital of DIFC JVCo (the “Nominee Shares”) for the purpose of complying with the Foreign Ownership Restriction.
- Our client and UAE Co incorporated a nominee holding company in the Jebel Ali Free Zone (JAFZA Offshore Co”) for the purpose of complying with the licensing regulations requiring a second shareholder for UAE Distribution LLC. Our client and UAE Co held, in the same proportion as DIFC JVCo, the legal and beneficial interest in the share capital of JAFZA Offshore Co.
- DIFC JVCo and JAFZA Offshore Co together held the shares in UAE Distribution LLC.
- Accordingly, our client was the indirect legal owner of 49% of the share capital in UAE Distribution LLC and UAE Co was the indirect legal owner of 51% of the share capital in UAE Distribution LLC, therefore complying with the Foreign Ownership Restriction.
- The relationship between our client and UAE Co in respect of DIFC JVCo was governed by the memorandum and articles of association (“DIFC JVCo MOA”) and a shareholders agreement subject to DIFC law (the “SHA”). Unlike the position under UAE law, where the only remedies for breach of contract are generally damages and/or rescission, DIFC law allows scope for the remedy of specific performance. A court order for specific performance will require a party under a contract to fulfil a contractual obligation which it has otherwise failed to satisfy. Accordingly, contractual provisions in the DIFC JVCo MOA and the SHA which required the transfer of shares should be enforced by the DIFC courts – such provisions included, amongst others, put/call options, drag along/tag along rights and compulsory share transfers on default events.
- Given that this was a 50:50 JV, the composition of the board of each of JAFZA Offshore Co, DIFC JVCo and UAE Distribution LLC was comprised of an equal number of directors appointed by our client and UAE Co. Therefore, the SHA included share transfer mechanisms to deal with potential deadlocks. As noted above, and unlike other free zones or in onshore Dubai, such share transfer mechanisms are more likely to be upheld in the DIFC.
- Another key advantage of using a DIFC company was the greater degree of protection it offered in respect of our client’s beneficial interests in the Nominee Shares, which was achieved by way of the following:
- a pledge was registered in respect of the Nominee Shares at the DIFC Security Register (it is not always possible to perfect a pledge over shares in this way in onshore UAE or in one of the other free zones);
- an irrevocable power of attorney was issued by UAE Co in favour of our client to deal with the Nominee Shares; and
- the concept of a trust is not recognised in the UAE but is recognised as a matter of DIFC law. Accordingly, a declaration of trust was executed pursuant to which UAE Co acknowledged and undertook that it held the Nominee Shares on trust for the benefit and to the account of our client.