In last month's edition of Middle East Exchange, we looked at the risks for directors of UAE companies in financial difficulties. In this month's edition, we consider the position from the other side of the negotiating table, namely the risks for creditors when a UAE company faces financial difficulties.

Financial difficulties in the UAE - the risks for creditors

The UAE's Commercial Transaction Law contains a number of provisions relevant to creditors when owed money by a UAE company in financial difficulties. We have summarised the key ones below. However, these laws are largely untested by the judicial system and open to interpretation on a case by case basis. Therefore, specific advice should always be sought based upon the factual circumstances of each case.

For ease of reference, we shall refer to "company" as meaning any commercial enterprise which is subject to the federal laws of the UAE.

Risk of preferences being set aside

Once a company has defaulted on, or suspends payment of, its debts, then a creditor should be aware that the following transactions could be set aside if the company later goes bankrupt:

  • any prepayment of debt before its due date;
  • any settlement of debt other than as per the existing agreement;
  • the granting of any mortgage or security to secure existing debt;
  • all other disposals by the company which are prejudicial to the general body of creditors if, at the time of such disposal, the creditor was aware of the suspension of payments/payment default,

(we shall refer to each of the above as "Preferences"). The Preferences will only be set aside if they take place between the date of default/suspension of payments (as determined later by the court) and the date of the bankruptcy judgment.

Risk of criminal liability

Perhaps of utmost concern, in addition to Preferences having to be repaid or reversed as above, is that a creditor also commits a criminal offence (and shall be sentenced to imprisonment) if, following a payment default or suspension of payments by a company, the creditor concludes an agreement with the company to procure a Preference in his favour, knowing that it will be detrimental to other creditors, where that agreement is not disclosed to and agreed by the other creditors.

Therefore, bankers who exert genuine commercial pressure on companies to get some repayment, will need to be careful not to enter into new agreements or arrangements, following a payment default, that might be considered to be a Preference, unless they are certain that it is being agreed to with the knowledge and consent of the other creditors of the bankrupt company.

Also, it is a criminal offence in the UAE under the Penal Code if any individual, who by reason of his profession or craft is entrusted with a secret, discloses that secret or uses it for his own advantage, in cases other than permitted by law or with the consent of the party concerned. Therefore, bankers who obtain confidential information from companies regarding the status of the company's business or financial affairs must be very careful about confidentiality (and obtain waivers/consents when appropriate).  

Repayments received post-bankruptcy

In the UAE, once a company has been declared bankrupt by the court, it may no longer discharge its debts owing to creditors until the bankruptcy is terminated by court order. Recoveries by creditors post-bankruptcy may therefore be required to be repaid to the bankruptcy estate.

Set-off

Under UAE law, the general rule is that set-off is not allowable in bankruptcy unless there is sufficient linkage (or commonality) as between the respective cross-claims. Therefore, unless the cross-claims arise under the same contract, or under a right to combine accounts, set-off may not be permissible and contractual or other rights of set-off may not be enforceable.

This position is unlike that seen in many countries where set-off is allowable (or even mandatory) in the event of bankruptcy. Therefore, creditors in the UAE may need to be alert and seek to achieve set-offs prior to bankruptcy where possible.

Termination of rights under contracts

In relation to finance and other contracts on-going as at the date of bankruptcy (e.g. loan facilities, hedging arrangements, sale and leaseback arrangements etc), the declaration of a bankruptcy may not lead to the termination of such contracts. It is possible, though unclear, therefore that bankruptcy cannot, of itself, be relied upon as a ground for terminating such contracts in circumstances where there is a contractual right to do so. However, if the bankruptcy trustee fails to continue to perform the contract, the creditor may apply to court for termination.

Therefore, creditors should be aware that they may not be able to rely upon the bankruptcy trigger contained in a legal agreement, and may instead need to rely on other termination events (e.g. non-payment, or breach of covenant or financial ratio etc), insofar as they have also been triggered, in order to terminate any continuing contracts or obligations.

Legal actions by creditors

Once a company has been declared bankrupt in the UAE, its property, books and records are generally sealed by the court and taken into custody by the trustee. In addition, all legal proceedings and actions by creditors are suspended and no new proceedings may be commenced against the company, except with permission from the judge.

It is not clear as to whether this prohibition precludes a creditor from taking legal actions against the company outside the UAE. The extent to which the UAE's bankruptcy laws have extra-territorial effect is unknown and will depend partly on the laws and practice of the foreign country where legal action is being contemplated. However, given that UAE law does not appear to expressly prohibit legal actions overseas, it may be possible for a creditor to continue legal actions overseas in respect of the company's assets outside of the UAE post-bankruptcy. However, if such actions are successful, and recoveries achieved, creditors should be aware that there is a risk that their conduct might be considered improper by a judge in the UAE (namely, contrary to the moratorium under UAE law outlined above) and that any proceeds recovered might be judged invalid and be required to be repaid to the bankruptcy in the UAE. In addition, any judgment obtained overseas in such circumstances would be unlikely to be recognised in the UAE.

Conclusion

The above laws may not be significantly different to the position in many other countries. However, by criminalising creditors who divulge confidential information, and also those who, knowing of a suspension of payment or default by a company, nevertheless seek to procure a Preference for themselves confidentially at the expense of the general body of creditors, UAE law sends a powerful message. Namely, that the UAE expects a high degree of integrity from creditors, and relative pari passu positions to be maintained, following any payment default or suspension of payments by a company.

As a matter of international best practice, the requirements for there to be confidentiality and no Preferences are usually crucial pre-requisites for creditors to be willing to enter into restructuring negotiations with a company, and also with each other. Therefore, one might consider that UAE law facilitates and encourages restructuring negotiations to take place during the pre-bankruptcy period, following a company defaulting or suspending payments and prior to its bankruptcy being declared.