Directors' duties and UAE corporate bankruptcy

It is more important than ever that those in managerial roles of companies registered in the UAE clearly understand their duties and potential liabilities. As a result of the Covid-19 pandemic, many businesses are currently facing significant challenges to cash flow and revenue.

In ordinary times, directors have a duty to act in the company's best interests and manage the company for the best interests of its shareholders. However, when a company is in financial distress, the duties owed by its directors extend to all relevant stakeholders, including its creditors. Directors and managers should ensure they are clear on their responsibilities under the applicable insolvency regimes in order to avoid claims of mismanagement and liability.

Managers and directors concerned about the financial position of their company should:

• immediately assess the company's financial position by reference to its present assets and liabilities and future cash flow, in order to identify if either the 'cash' flow' or 'balance sheet' tests under the UAE Bankruptcy Law are, or are likely to be, met;
• if it is evident that the company may be in financial difficulties, immediately call a shareholder meeting to try to resolve those difficulties;
• ensure that related party transactions and potential 'preferred transactions', including those with shareholders, are executed on an arm's length basis to avoid potential claw backs by the courts;
• exercise good corporate governance, even if this has not been a habit in the past. Hold regular board meetings and ensure these are correctly documented. Increase shareholder involvement to the extent appropriate;
• make sure every decision taken is recorded and justified, with reference to professional advice from your lawyers and financial advisers if applicable; and
• keep track of all post-dated cheques and exercise caution when writing new cheques if the company is in financial difficulty.

If you believe that the financial distress is caused by the Covid-19 crisis then seek all immediately available financial help from the government, and ensure all details are sufficiently documented - for example, a customer cancelling orders or not being able to pay due invoices and giving Covid-19 as a reason. See our Out-Law guide: Coronavirus: the Middle East's emergency response.

UAE Bankruptcy Law

Companies in the UAE, except those incorporated in the Dubai International Financial Centre (DIFC) or Abu Dhabi Global Market (ADGM), are subject to the Federal Bankruptcy Law (Federal Law No. 9 of 2016) which regulates business insolvency. Under the Bankruptcy Law, there are two main options for companies in financial distress: preventative composition and the formal bankruptcy process.

Preventative composition is available to companies that do not meet the bankruptcy test under the Bankruptcy Law, but which wish to obtain the court's assistance in settling debts and trade out of their indebtedness. If the courts accept an application for preventative composition, the company's debt obligations will be suspended and the court will appoint a trustee to supervise the directors' management of the company. The trustee would then seek to get the approval of a majority of the creditors for a plan which enables the company to trade out of its existing financial position. During the term of that plan, the company is restricted from certain actions such as settling claims and taking on new debt.

The formal bankruptcy process may be used where a company meets one of two tests:

• the cash flow test – when a company has stopped paying its debts at maturity for more than 30 consecutive working days due to the instability of its financial position; or
• the balance sheet test – when a company's assets are insufficient to meet its current liabilities.

If either of these tests is satisfied, the directors of the company must file for bankruptcy with the local courts. Alternatively a creditor, or group of creditors, who is owed at least AED 100,000 (US$27,200) for more than 30 consecutive working days may petition the court for a company's bankruptcy.

On application, the court will consider whether the company may be restructured to become profitable again. If restructuring is not possible, the court will adjudicate bankruptcy and order liquidation of the company's assets.

Directors' liability under UAE Bankruptcy Law

The Bankruptcy Law prescribes a series of penalties that can be levied against a company's managers and directors in the event that a company is declared bankrupt. Offences like fraud, embezzlement, distributing false profits and doctoring company books can attract significant penalties of up to five years' imprisonment and a AED 1 million fine. Additionally, directors can be disqualified from managing any other UAE company for up to five years if they are found to have breached the Bankruptcy Law.

Directors and managers may also be found criminally liable if they:

• did not maintain satisfactory financial records that reflect the company's true financial position;
• fail to supply information on request to a court or trustee;
• sell assets at an undervalue to delay the suspension of debt payments or declare the company bankrupt;
• hide company property from creditors; or
• pay a creditor to the detriment of others.

The definition of "manager" in the Bankruptcy Law is a wide one, and includes any person who plays an active role in company decision making. Therefore, directors of parent companies or other people involved in managing the company may be caught by the definition. In addition, if a company does not have sufficient assets to cover at least 20% of its debts, the courts can order its managers or directors to jointly or severally pay all or part of the outstanding debt if they were in breach of their duties under the Companies Law, including if they had not taken steps to inform the shareholders of the company's financial difficulties and sought to address such difficulties.

As the Bankruptcy Law is relatively new, it has not yet been fully tested in the courts and it would therefore be advisable to take a conservative approach in order to avoid potential liability. Any person in a managerial position at a company, or director of a group company, should be fully aware of their responsibilities and take a prudent approach to management decisions and record keeping during times of financial distress.

If a manager or director has been fully compliant with their obligations under the UAE Companies Law and followed international best practice, the Bankruptcy Law actually provides a degree of additional protection. Signatories of cheques who would have faced criminal proceedings if there were insufficient funds at the time that the cheques were cashed will have all criminal proceedings suspended during a restructuring or bankruptcy process.

Directors' liability under DIFC and ADGM bankruptcy laws

The DIFC and ADGM are financial 'free zones' in the UAE, each with their own insolvency law. The DIFC's newly revised Insolvency Law incorporates the UNCITRAL Model Law, which is aimed at assisting with cross-border insolvency proceedings. In addition to the potential offences contained in the UAE Bankruptcy Law, directors of a DIFC company can also be liable for concealing or fraudulently removing any property worth over US$200; or pledging, pawning or disposing of any property obtained on credit which has not been paid for, unless conducted in the ordinary course of business. If found to be in breach, the DIFC courts can order the directors to return any money or property which has been misapplied; to compensate the company for any misfeasance or breach of fiduciary duty; to make such contributions to the company’s assets as the court sees proper; or to do, or not do, any act or thing.

As is common in many jurisdictions, the DIFC Insolvency Law allows the courts to set aside transactions at undervalue and preferred transactions. Additionally, the DIFC Insolvency Law also makes wrongful trading an offence. Wrongful trading would occur when a company is in insolvent liquidation and at some time before the commencement of the winding-up of the company one or more of the directors ought to have known that there was no reasonable prospect of the company avoiding insolvent liquidation. The DIFC has temporarily suspended the wrongful trading offence, currently in place until 31 July 2020, as part of measures to minimise the impacts of Covid-19 on businesses. This should give directors more breathing space to navigate the turbulent conditions.

The ADGM Insolvency Regulations, last updated in 2018, are very similar to the DIFC Insolvency Law. A breach by a director of the ADGM Insolvency Regulations can attract a fine of up to US$50,000. Similarly, the ADGM courts can set aside transactions at undervalue and preferred transactions. At this time, wrongful trading continues to be an offence under the ADGM Insolvency Regulations, although this can be avoided if the court is satisfied that the director took every step with a view to minimising the potential loss to the company's creditors.

Co-written by Natalia Elhage, corporate law expert, and Charlotte Holden, senior practice development lawyer, at Pinsent Masons, the law firm behind Out-Law.