Amongst the most talked about new concepts of the UAE Commercial Companies Law is the prohibition on financial assistance. In this article, we look at the likely policy reasons for the introduction of a financial assistance prohibition, and at which entities and transactions are most likely to be affected.
The new Commercial Companies Law (Federal Law No. 2 of 2015) (the Companies Law) brought into force, for the first time in the UAE, the concept of financial assistance. Article 222 relating to shares, bonds and sukuk of Public Joint Stock Companies (PJSCs), states the following:
The company or any of its subsidiaries may not provide financial assistance to any shareholder to enable the shareholder to hold any shares, bonds or sukuk issued by the company. In particular, financial assistance shall include:
- Providing loans;
- Providing gifts or donations;
- Providing the assets of the company as security; and
- Providing a security or guarantee of the obligations of another person.
Using the most straightforward example, a PJSC may not lend the acquisition price to a third party to allow that third party to acquire shares in the PJSC. However, the transactions and scenarios which are captured by financial assistance are often more complex or less obvious than this example, such as upstreaming cash from the target group to help meet debt repayments by the purchaser.
Public policy reasons behind financial assistance
To date, the Ministry of Economy has not issued guidance on the UAE public policy reasons behind prohibiting financial assistance. One of the general aims of the Companies Law, however, is to improve corporate governance in the UAE. Other countries have successfully used restrictions on financial assistance to support this aim.
A prohibition on financial assistance is designed to protect creditors and shareholders from a depletion in, or misuse of, the company’s assets.
Protection of shareholders
In the case of shareholder protection, there may be many small, minority shareholders holding listed shares in a PJSC. The interests of these shareholders may be prejudiced if the PJSC used its cash reserves or other assets, not to build the company’s business, but to (for example):
- facilitate a new shareholder acquiring shares in a placing; or
- permit an existing shareholder to consolidate control by acquiring additional shares in the market.
Set against other new provisions of the Companies Law, such as the possibility of non pre-emptive offers of new shares by a PJSC to a strategic partner (Articles 223 and 224), and the decrease in the minimum percentage of the share capital of a PJSC which must be offered publicly (the free float) from 55% to 30% (allowing a stronger capital holding by one shareholder), it is clearer how controls on financial assistance may be necessary within the new company law regime.
Protection of creditors
Generally, all creditors of a company have an interest to ensure that the assets of the company with which it deals are used in the ordinary course of business and are not subject to abuse by the company in favour of specific third parties. If the company’s assets are depleted to the extent that the company may not continue as a going concern, this would prejudice creditors, particularly if they are unsecured in an insolvency situation.
In a number of countries globally, a ban on financial assistance has applied to private companies as well as publicly listed companies. In this scenario, the protection of creditors is the paramount concern. This is because it is often the shareholders in a closely held company which would benefit, directly or indirectly, from the financial assistance.
Financial assistance in relation to private companies may be permitted, in other countries, under certain conditions designed to ensure the protection of creditor interests. For example, under the UK Companies Act 1985, financial assistance was permitted if the directors of the private company made a legally binding statutory declaration that the company would be solvent for a prescribed period after the assistance was given. The company’s auditors also provided a report on the company’s ability to pay its debts for the next 12 months. In the DIFC, where the Companies Law is based on the UK 1985 Companies Act, financial assistance is prohibited by private companies. However, there are express exemptions from the ban, including that the financial assistance does not materially prejudice the interests of the company (or its shareholders, who must vote in favour of the assistance by at least a 90% majority) or, crucially, the company’s ability to discharge its liabilities as they fall due.
Which companies are caught by the UAE financial assistance ban?
PJSCs and PrJSCs
It is clear that the UAE ban on financial assistance applies to PJSCs. Because the provisions which apply to PJSCs also apply to private joint stock companies (PrJSCs), assistance by a PrJSC will also be prohibited. This is not surprising from a public policy perspective because PrJSCs are subject to stricter regulation than LLCs, and are frequently used as a "stepping stone" en route to a public listing as a PJSC.
It is more difficult to say whether the ban on financial assistance also applies to limited liability companies (an LLC). LLCs are closely held companies (and may now be wholly owned by one national shareholder). They may be best categorised as a quasi-partnership in the sense that the holdings in an LLC are more similar to ownership "interests", than freely transferable instruments ("shares").
Article 104 of the Companies Law provides that the provisions relating to PJSCs apply to LLCs unless otherwise provided by the Companies Law. There is no express provision disapplying Article 222 on financial assistance to LLCs and therefore some market uncertainty has arisen. It is beyond doubt that the Arabic language of Article 222 makes reference to the term which translates as "share", not "interest".
When looking at whether an LLC is caught by the Article 222 provisions there are two questions to consider:
- Is an LLC prohibited, as a subsidiary of a PJSC or PrJSC, from providing assistance for the acquisition of shares or other securities of the PJSC or PrJSC – so called "upstream financial assistance"?
- Is an LLC (or one of its subsidiaries) prohibited from providing assistance for the acquisition of an interest in the LLC?
In our view (and notwithstanding the limitations of the language used in Article 222), it is likely that upstream financial assistance is prohibited under UAE law. This view is partly based on the fact that Article 222 in itself allows for this prohibition, without needing to also apply Article 104. In addition, on public policy grounds, this ban makes sense. To allow otherwise would be an obvious loophole for PJSCs to exploit by using its LLC subsidiary to make the assistance available. Overall, the interests of shareholders and creditors in the PJSC’s group may be damaged by such financial assistance.
The application of Article 222 to direct financial assistance by an LLC in respect of its own interests is more doubtful. Firstly, as we mention above, this type of direct financial assistance is only prohibited if you apply Article 104 to Article 222, and change the term for "shares" into "interests" to make the provisions operable for an LLC. The general public policy reasons behind Article 104 are not certain, but this seems to be a "stretch" in the application.
It has been argued that the fact that an interest in an LLC may be pledged (or mortgaged) means that such an interest is a "negotiable instrument" and therefore similar to a share in a PJSC. However, in our view, the ability to create financial security over a PJSC share or LLC interest does not, in itself, make them the same type of right or asset. In the UAE, it is possible to mortgage many different types of tangible and intangible assets which may include goodwill, perishable items in a warehouse and (in recent practice) an interest in an LLC, under a notarised commercial mortgage permitted by the Commercial Code, in favour of a UAE financial institution and registered in the Commercial Register. There are separate provisions of the Companies Law for the creation of a pledge over PJSC shares. There is little market experience at present in relation to a mortgage of an LLC interest, but it appears that the process differs to a PJSC pledge, not least because it continues to include registration in the Commercial Register as part of the perfection of the mortgage.
It is also worth noting that the term "negotiable instrument" is, under English law (from where the term derives), used to describe a document which may be transferred from one party to another by endorsement and delivery, and by which the right to be paid is transferred unconditionally (such as a cheque or a promissory note, or bearer securities). The term will not apply to any instrument where title is passed by registration or similar external process, such as an interest in an LLC. This is the case regardless of whether an LLC issues a share certificate because that document does not represent title to the LLC interest and transfer of that certificate does not bring with it title. It is only at the end of a process, involving a notarised share transfer, and culminating in an amendment to the company’s commercial licence by the local DED, that title to an LLC’s shares is transferred.
Equally compelling for the view that direct financial assistance is not outlawed for LLCs is the public policy argument. As we explain below, financial assistance is commonly found in M&A transactions. A ban on financial assistance for all companies in the UAE, with no ability for an LLC to provide it if creditors’ interests have been protected, would make the UAE company law regime very restrictive. Furthermore, we believe that there are a number of new concepts in the Companies Law which make the ban on LLC financial assistance unnecessary in terms of creditor protection. For example, the Companies Law introduced a new statutory standard of directors’ duties (Article 22). This includes a duty to preserve the rights of the company – similar to acting in its best interests. In addition, Article 84 contains, for the first time, a specific right for concerned third parties in relation to an LLC to take action against its managers for breach of the Companies Law (which would include breach of directors’ duties). In other words, it is difficult to see how a manager may permit financial assistance which would imperil the solvency of the company he manages, against the interests of creditors, without those creditors having other actionable remedies under the Companies Law. The UAE market is also expecting a new Insolvency Law shortly and we expect that this will deal with penalties for certain actions by LLCs and their managers involving a company’s solvency.
Cross border financial assistance
The UAE is a place in which many multinationals choose to do business in the Middle East. Therefore, it is important to understand the extent to which financial assistance applies across an international group which includes UAE companies.
Article 222 applies to "companies" which is not defined. However, we think that this will be linked to the description of a company in Article 9 of the Companies Law which sets out the types of entity which may be incorporated in the UAE, and that there is no intention that the financial assistance ban will have extra-territorial effect in relation to assistance provided by a foreign company in respect of that foreign company’s shares.
The position in relation to a "subsidiary" is less clear because there is no definition of subsidiary which applies generally to all provisions of the Companies Law. This gives rise to two questions:
- Can a UAE subsidiary provide financial assistance in respect of its foreign parent’s shares?
- Can a foreign subsidiary provide financial assistance in respect of its UAE parent’s shares?
In relation to the first question, we think that the better view is that this not prohibited financial assistance, because the company in respect of which the assistance is being provided is not a UAE company caught by Article 222.
The answer to the second question is more uncertain – the assistance is being provided in respect of an acquisition of a UAE company’s shares and therefore it would seem to be prohibited. However, it would be difficult to take enforcement action against a foreign incorporated subsidiary and, therefore, from a jurisdictional and practical perspective, this may not fall within the scope of Article 222 either. Drawing parallels to the UK position on financial assistance, the provision of assistance by a foreign subsidiary in respect of a UK company’s shares is not prohibited. However, under UAE law, it is possible that the UAE company, although itself not providing financial assistance, may be penalised for allowing its foreign subsidiary (over which it exercises control) to provide the assistance.
The forms of financial assistance
As we mention in the introduction, the simplest form of financial assistance is a loan from the company whose shares are being acquired to the prospective purchaser of the shares. However, under UK law, there was a long history, before the financial assistance ban in relation to private companies was abolished in 2006, of considering and "whitewashing" financial assistance in a wider range of scenarios. The following may be captured under the UAE financial assistance prohibition:
- acquisition finance (and the post-acquisition refinancing of such debt) under which the assets of the target (and its subsidiaries) are part of the financial security "net", following the acquisition by the purchaser;
- an "upstreaming" of revenue from the target group to the purchaser by way of loan to repay the purchaser’s acquisition finance debt;
- other actions taken by the target group in support of the purchaser (to "stand behind" its acquisition finance debt) such as indemnities and guarantees;
- an accelerated repayment of an existing loan by the target to its parent at the time of an acquisition of the target’s shares (depending on the terms of the loan);
- a sale of assets by the target or its subsidiaries to the purchaser at the time of the acquisition of the target’s shares by the same purchaser (depending on the terms of the sale, for example at less than market value);
- the payment by the target company of the transaction fees and expenses of a prospective purchaser in an acquisition process, such as the payment of a break fee;
- the funding of the preparation of an information memorandum or a vendor due diligence process by the target in relation to the marketing of its shares.
If financial assistance is unconditionally prohibited in relation to private companies, the impact on the market in private M&A will be significant, with the effect being felt most keenly by local companies because of the likely territorial effect of Article 222.
Penalties for UAE financial assistance
As a final comment, it is interesting to note that the Companies Law does not set out a specific offence for breaching the financial assistance ban. The Ministry of Economy has not yet provided guidance as to which offence will be committed by providing unlawful financial assistance. The "sweep up" offence in Article 360 of the Companies Law may apply which specifies a fine of between AED10,000 and AED100,000 for any violation of the Companies Law for which there is no specific penalty provided. However, managers should carefully consider their own duties and potential civil liabilities under the Companies Law and other laws as well. Furthermore, there is a risk that any resolution approving the relevant transaction may be unlawful and therefore potentially invalid under Article 170 of the Companies Law – potential purchasers, lenders and other interested third parties may be unwilling to proceed with a transaction in these circumstances.