New Federal Bankruptcy Law: Balance Check
There has been a lot of excitement generated around the fact that the UAE has finally adopted a Federal bankruptcy law. But this is not strictly accurate. Although the new Federal Bankruptcy Law No. 8 of 2016 (BL) is the first standalone bankruptcy legislation coming into force end of December 2016, the UAE has had a bankruptcy regime since 1993, laid down in the Commercial Transactions Code (CTC). However, it was rarely used.
During the drafting process, the BL was publicised as a law drawn on the best bankruptcy protection laws around the globe, with the aim of facilitating doing business in the UAE and boosting credit markets.
We will run a balance check of the BL in an attempt to assess the level of reform and modernisation brought about by it. However, judging the impact of the BL before testing it could be considered premature: a thorough assessment will largely depend on the courts’ application and the infrastructure necessary for an efficient and effective implementation.
- Introduction of financial re-organisation committee: The BL introduces a framework for an out-of-court financial re-organisation process. A “financial re-organisation committee” will be established by the Council of Ministers entrusted with supervising the re-organisation of regulated financial institutions in distress.
The brevity of this section of the BL does not allow an analysis of the effectiveness of the role of this committee; a forthcoming secondary legislation will be passed determining the powers and roles of the committee. This committee is anticipated to play a very useful role in the context of an out-of-court process.
- Simplification of preventive composition: Preventive composition (which pre-dated the BL) remains a possible pathway for businesses in distress. However, the conditions to opt for preventive composition have been relaxed. The ability to settle 50% of the debt is no longer a condition for the composition plan to be approved. Any debtor that is not in default for more than 30 business days or is not in a “debited financial position” may initiate a composition. The provisions of preventive composition appear to be more advantageous than those of the CTC.
However, more clarity on the definition “debited financial position” and “the debtors’ assets” is necessary. As currently defined, it seems that the legislator has opted to apply a balance sheet test and not a cash flow test. The balance sheet test is widely used in several jurisdictions.
- Setting a monetary threshold for initiating bankruptcy: Creditors whose receivables amount to AED 100,000 or more may commence bankruptcy proceedings against the debtor. The CTC, on the other hand, did not include a threshold for commencing bankruptcy proceedings.
- Debt restructuring is now an option: If bankruptcy proceedings are initiated, debt restructuring is considered and may be opted for. Whilst this is also a court-supervised process, debt restructuring may be initiated with the debtor's consent if the bankruptcy trustee deems that the debt restructuring will enable a higher recovery compared to the recovery under a normal bankruptcy process entailing the sale of business. The debtor must agree to adopt the debt restructuring process.
It is important to note that debts do not become automatically due as a result of ordering the commencement of debt restructuring proceedings and any contractual provision to the contrary shall be null and void. Lending institutions may need to consider the impact of this legal provision on a number of common events of default.
- Crimes of dishonoured cheques are suspended: Criminal actions filed for dishonoured cheques are suspended if a preventive composition plan or a debt restructuring plan is initiated. In this case, the cheque holder becomes one of the unsecured creditors. This may encourage distressed businesses to initiate composition plans and potentially consider filing for bankruptcy and debt restructuring rather than prompting members of the management to abscond and exit the UAE.
However, one should note that the wording of the BL on this point appears to imply that this suspension does not apply if the normal bankruptcy proceedings are opted for, as opposed to a preventive composition plan or a restructuring plan.
- Relaxing limitation to seeking new financings: The ability to seek new financings is reinforced. The provisions adopted in the BL are more flexible compared to those of the CTC. The trustee may request the court to approve seeking new financings, secured or unsecured, necessary for the continuance of the debtor’s business. Additionally, any approved new financings will rank above the debts of unsecured creditors.
- More powers attributed to bankruptcy trustees: Trustees are nominated by debtors and have been significantly empowered under the BL. This may potentially reduce the courts’ involvement and lead to a smoother and more efficient process. A trustee may also be a corporate entity.
- Broader scope of application: The scope of application of the BL is broader than the CTC. All commercial companies (except for financial free zones that are subject to special bankruptcy regulations, such as the Dubai International Finance Centre and Abu Dhabi Global Market), traders/merchants and civil partnerships (set up pursuant to the Civil Transactions Code) are subject to the BL. Individuals remain out of the scope of the BL, and the Civil Transactions Code continues to govern individuals unable to repay their debts.
- Procedurally heavy: The BL continues to be procedurally heavy. All proceedings continue to be administrated and supervised by courts (potentially except for financial re-organisations). The process of filing for bankruptcy has not materially changed. Courts, experts, trustees and controllers continue to be heavily involved, inevitably leading to a protracted process.
- Enforcement actions by secured creditors revisited: The BL confirms that the ranking of secured creditors remains unaffected by the initiation of any of the proceedings set out in the BL.
Enforcement actions over secured assets prior to the ratification of the composition plan or the debt restructuring plan (or the issuance of a bankruptcy judgement) are permissible if: (i) the underlying debts are due; and (ii) the court approves such enforcement action. The grounds for rejection of an enforcement request are very restrictive.
However, following the ratification of the preventive composition plan or the debt restructuring plan, the trustee becomes entrusted with the sale of assets in line with the restructuring plan and the sale proceedings must be used first to repay the debts due to the secured creditors. If a secured asset is essential to the continuance of the business, the court may decide to substitute the secured assets with another asset without prejudicing the interest of the secured creditors.
If the debtor is declared bankrupt (i.e. the debt restructuring plan and/or the preventive composition were unsuccessful), all debts become due, the appropriate assets must be sold and the sale proceedings must also be used to repay the secured creditors. If the sale does not take place within one month from the date of the bankruptcy judgement, the secured creditor may request the court to approve the enforcement over the secured assets.
The position under the CTC was relatively different. Technically speaking, the CTC stated that all enforcement actions shall be suspended in the context of preventive composition but not in the context of a judicial composition or bankruptcy proceedings.
- Directors’ liability remains as is: Directors whose actions have caused losses continue to be jointly liable for the debts of the company if the assets of the debtor are not sufficient to cover 20% of its debts.
- Suspect period remains as is: The provision that any transaction entered into within two years before the issuance of bankruptcy proceedings (the suspect period) is void or voidable remains unchanged.
- Monitor the issuance of secondary legislation on financial re-organisation.
- Businesses anticipating any potential inability to meet their financial obligations may wish to review their financial position and assess whether any of the advantageous provisions of the BL may be put in action.
- Broadly, the BL has introduced a number of modern concepts that may support businesses facing financial difficulties. Nevertheless, the new bankruptcy regime has not brought about a substantial transformation.
Background factual information (1985 to 2016)
- Bankruptcy under the Commercial Transactions Code (CTC): The bankruptcy regime applicable to merchants and traders was set out under the CTC. Preventive composition, judicial composition and bankruptcy were the available pathways for businesses in debt. All these actions are court-supervised actions initiated either by the debtor or by the creditors or public prosecutor depending on the extent of financial distress and the surrounding circumstances. Bankruptcy-related crimes were set out under the CTC and the UAE Penal Code.
- Bankruptcy under the Civil Transactions Code: As to non-merchants, i.e. civil persons, the Civil Transactions Code (issued in 1985) governed in some pertinent parts, notably Articles 401 through 413, the possible measures that may be taken against a civil person in financial distress. A moratorium is imposed on a civil person if his due debts exceed his assets. These legal provisions dealt with bankruptcy-related crimes and a number of procedural aspects of bankrupt civil persons.
- Bankruptcy vs. Insolvency: Unlike other jurisdictions, the UAE legislation does not distinguish between the terms insolvency and bankruptcy.
- Bankruptcy vs. Liquidation: The Commercial Companies Law No. 2 of 2015 regulates the liquidation and dissolution of commercial companies as was the case under the previous Commercial Companies Law.
- The BL was signed on 20 September 2016, published in the UAE Official Gazette dated 29 September 2016 and will come into force after three months from its date of publication, i.e. 30 December 2016.
- The BL has entirely repealed Part 5 of the CTC.
- The BL only applies to merchants and traders. Individual non-traders remain out of the scope of application of the BL, and the Civil Transactions Code continues to govern individuals unable to repay their debts.
- All bankruptcy-related crimes have been consolidated, as the BL has repealed the former provisions of the UAE Penal Code. However, regrettably, the very recent amendments introduced to the UAE Penal Code promulgated two days before signing the BL did not capture this repealment. Nevertheless, the BL is a posterior law and should prevail over the amendments of the UAE Penal Code.