Clients often ask how to conduct legal due diligence or background checks on another party in the United Arab Emirates. Unfortunately, there is no straightforward answer. With no centralised company register, and over 40 different free zones, obtaining basic information about UAE free zone companies may pose a daunting challenge. Even so, there are still effective tools available to uncover the necessary information.
In the simplest terms, legal due diligence is a process of obtaining sufficient and reliable information about a business entity with the objective of uncovering any facts, circumstances or legal risks that are likely to influence a business decision.
The need for legal due diligence arises in the context of various business decisions. These include:
- deciding whether to buy or invest in a company and determining its purchase price;
- ascertaining whether to lend money to a borrower;
- choosing a joint venture partner or an agent;
- entering a contract with another party; and
- in general terms, approving a customer.
There is no one-size-fits-all approach, so a risk-based approach which takes into account the facts and circumstances of each case is recommended. As a rule, the level of due diligence needed is largely proportionate to the type of transaction or business contemplated with the counterparty.
Regulated professional services companies (eg, those in the legal or financial sectors) must conduct basic due diligence on customers, so as to ensure that they are not assisting a client that may be involved in unlawful activities, such as money laundering. This usually involves a standard know your customer (KYC) process, plus background checks.
For M&A, diligence is not mandated by UAE law. However, buyers should conduct extensive due diligence on the other party, looking for any actual, potential or constructive liabilities of the company, as well as any legal, regulatory or contraction limitations or lack of authority to complete a sale or change of ownership. Legal issues that can influence the business decision or the purchase price of acquisition are analysed from a number of dimensions, including corporate, real estate, intellectual property and employment.
Anti-corruption due diligence has gained momentum, thanks to increasing instances of fines and investigations on companies governed by anti-corruption legislation, including the Foreign Corrupt Practices Act 1977 and the UK Bribery Act 2010. Robust anti-corruption due diligence goes beyond basic KYC and background checks, and must include a risk-based approach. Indicators include the geographic location of the business transaction, industry risk, third-party risk and whether the transaction involves interaction with public officials. Based on the indicators, corruption risk may be assessed as low, medium or high, and an appropriate level of due diligence may be applied on the third party.
The key tools for conducting due diligence in the United Arab Emirates include conducting preliminary KYC checks, accessing publicly available information and obtaining information directly from the target.
KYC and background screening Conducting a basic KYC and background check involves:
- obtaining the name and address of the client;
- verifying their identity based on reliable supporting documents; and
- conducting specific checks on the client against the various sanctions, laws and enforcement lists.
For an individual, the documentation would typically include a passport copy and proof of address (eg, a utility bill). For corporate bodies, this includes obtaining a certificate of incorporation and a commercial licence, and:
- carrying out a search to ascertain that the company still exists;
- verifying the identity of the person who controls the business;
- identifying shareholders and key directors; and
- ascertaining that the person being dealt with has the authority to act in this capacity.
Various types of third-party risk management and compliance software are available which assist companies in screening and assessing third-party risks, such as Thomson Reuters' WorldCheck and Dow Jones' Risk Reports.
Company searches and credit ratings While there is no central database of companies in the United Arab Emirates, it is possible to uncover information about companies in the public domain. Below are various options available to ascertain and mitigate legal risks, particularly credit risks.
Department of Economic Development database If a company is based on the UAE mainland, it may be possible to obtain basic corporate information from the Department of Economic Development's website, where the company is registered. The Department of Economic Development provides information such as the trade licence number of the company, status (whether active or expired), expiry date, its licensed activities, contact information and coordinates.
Dubai Chamber of Commerce As most mainland companies are registered with the Dubai Chamber of Commerce and Industry, it can provide third parties with business information reports on registered companies for a nominal fee (and without the knowledge of the subject). This includes credit ratings and recommended credit limits in addition to companies' business, economic and financial information, such as details of shareholders, directors, auditors, bankers, payment history, purchasing terms and major customers.
Al Etihad Credit Bureau The Al Etihad Credit Bureau (AECB) is a federal government company which operates a credit reporting system across the United Arab Emirates. It collates data from all UAE banks, financial institutions and individuals and produces credit reports for a nominal fee which specify the debt levels and financial creditworthiness of both individuals and corporate entities incorporated in the United Arab Emirates. Obtaining this report requires the consent and cooperation of the individual or corporate entity.
For individuals, an AECB report includes details about debt levels, financial obligations, credit payment history and the company's track record of payments over the past two years. To obtain this report, it is necessary to submit the individual's original emirates identification card and a copy of his or her passport.
For corporate entities, the AECB report includes the company's address, the details of its ownership, credit facilities availed by the entity and total amount of credit taken and the company's track record for payments over the last two years. To obtain this report from the AECB, it is necessary to submit the original emirates identification card of the company's owner or authorised signatory, the original trade licence and the articles of association of the company.
Litigation search In the United Arab Emirates, information about litigation or fines against a third party is not available to the public. However, it may be possible to obtain such information if the third party gives an express power of attorney to do so.
Real estate Unlike other jurisdictions, the land register maintained by each emirate in the United Arab Emirates is not publicly accessible and can be inspected only by interested parties, judicial authorities, experts appointed by judicial authorities and other competent authorities.
Intellectual property A basic search of registered trademarks in the United Arab Emirates may be carried out via the Department of Economic Development's website, which aims to increase awareness about registered trademarks and avoid IP infringements.
Obtaining information directly from target Due diligence based on publicly available information is generally deemed insufficient, especially for a critical business decision such as an M&A or loan transaction. Robust due diligence will involve direct interaction and interviews with the target to obtain further information and documentation for review.
For example, an M&A due diligence would need the other party's cooperation and availability to provide the acquirer's lawyers with information and documentation, as per a checklist or questionnaire. The objective is to:
- investigate the target's business through review of internal documents, contracts and licences;
- identify any regulatory approvals or third-party consents;
- confirm title to assets; and
- evaluate factors that may have an impact on the business.
Similarly, meaningful anti-corruption due diligence would involve checking whether the counterparty has adequate systems in place to detect or prevent corrupt payments and evaluating the counterparty's anti-corruption compliance programme and policies.
Information from the other party is usually obtained via a data room. This is a secure location (either physical or virtual) which houses confidential data or information that may be accessed by investment banks or potential acquirer's lawyers to conduct due diligence.
Traditionally, physical data rooms located in targets' offices were used for the due diligence process. While this practise is still prevalent, the more modern approach is to provide online access to due diligence documents through a virtual data room (VDR). The advantages of a VDR are that it enables uniform access to the due diligence documents if there are multiple potential acquirers, ensuring that the process is fair. Additionally, the target retains control over the documents and can restrict the users from saving, printing or even viewing the documents, ensuring that access is secure.
Requests for clarifications from the target are generally obtained by a written questionnaire or interviews with management representatives.
The party conducting the due diligence and the party under review generally enter into a confidentiality and non-disclosure agreement before the due diligence process, particularly where sensitive commercial or personal information are involved.
The legal due diligence report will generally contain the following information:
- the company, its shareholders and directors;
- any restrictions in the constitutional documents of the company which prevents it from performing the transaction;
- key contracts that the company has entered into and any contractual provisions that may impose limitations on transaction;
- financial facilities used by the company and any restrictions that they impose;
- details of the company's licences and compliance with applicable laws;
- real estate owned or leased by the company;
- the quality of the company's insurance cover;
- the company's IP rights; and
- any litigation in which the company is involved.
As well as determining if there are any fatal flaws in a proposed transaction, the legal due diligence process helps decision makers to evaluate commercially negotiable issues and key contractual provisions that need to go into the transactional documents.
For example, in an M&A transaction, the acquisition price is often adjusted based on the outcome of the due diligence if there are red flags which affect the deal value. Conditional precedents are commonly added to the share purchase agreement, requiring the buyer to remedy legal non-compliances, such as renewing an expired licence.
Tailored representation and warranties backed by suitable indemnity provisions may also be incorporated in the transaction documents. In this respect, the other party generally provides a letter disclosing any exceptions to the representations and warranties in the transaction documents to protect itself from the scope of such warranties.
Legal due diligence is generally limited to review of the documents and information relating to a fixed period, such as the previous two to five financial years. Further, the legal due diligence report expresses no opinion on commercial, financial or fiscal issues.
Slowly but surely, the United Arab Emirates' regulatory framework is developing, making it more conducive to conducting due diligence on business entities. Looking forward, a computerised public database of companies and a system to check title assets of an owner will go a long way in making it easier to do business and raising investor confidence. With the Dubai government's ongoing efforts to make Dubai a smart city, it may not be long before these measures are in place, with the first steps having already been made on the Department of Economic Development website's trademark database.
For further information on this topic please contact Franco Grilli or Priyasha Corrie at Fichte Legal Consultants by telephone (+971 4 43 57 577) or email (email@example.com or firstname.lastname@example.org). The Fichte Legal Consultants website can be accessed at www.fichtelegal.com.
This article was first published by the International Law Office, a premium online legal update service for major companies and law firms worldwide. Register for a free subscription.