The nation's laws surrounding insolvencies remain virtually untested as matters are almost always settled outside the courts.
Courting insolvency reform
Gary Bell has not been paid in full for six months. He says his company, a project management and consulting firm, owes him almost Dh500,000 (US$136,165) in wages, and he is suing in the UAE's labour courts to recover that sum. Mr Bell is also working through legal channels to force the company into insolvency. The company he works for is not alone. Many firms in the Emirates that have been hit by declining orders are taking drastic steps to survive, revising contracts, seeking delays in payment and cutting back on benefits, bonuses and raises.
But for those companies that are unable to continue trading, more hazards lie ahead as insolvency procedures have yet to be fully tested in local courts. "There's a reluctance to use the court system because of the uncertainty of the outcome, but also because of the cost and the amount of time it might take," says Martyn Rogers, a partner at Ashurst, an international law firm with offices in the UAE.
Company failures are increasing around the world in the global recession, as bank lending remains constricted. The credit insurer Euler Hermes said last Thursday that it expected corporate insolvencies worldwide to rise 35 per cent this year. Insolvencies in the UK may reach their highest in 50 years this year, according to KPMG. If a company in the UAE does not make payments to creditors for 30 days, it must by law declare it is insolvent, or face charges of bankruptcy by negligence, a criminal offence.
Legal structures also exist for companies after they declare insolvency. The courts can appoint trustees to manage a bankrupt firm, for example, and they can adjudicate on agreements between creditors and troubled companies to work their way out of financial distress. The courts can also preside over liquidations of firms when they are deemed unsalvageable. But the sections of the UAE commercial code and companies law that relate to insolvencies remain virtually untested by the judicial system.
According to one lawyer at a local firm, there have only ever been a handful of insolvency cases in the UAE. Since the financial crisis began, only two companies have declared themselves insolvent: Al Barakah, a developer in Ajman, declared insolvency in January, while Khoie Properties, a developer in Ras al Khaimah, said it was insolvent in March. Neither appears to have gone to the courts for a resolution.
Many companies do not go to court because the laws are untested, lawyers say, although they also often cite a cultural preference for keeping the companies' troubles out of the public eye. The amount of time it takes for legal proceedings is also often cited as a reason not to go to court. According to a World Bank report, it takes 3.5 years for companies in the MENA region to go through an insolvency, a little more than double the 1.7 years it takes in the developed world.
This drawn-out process and lack of legal certainty has had other consequences for struggling companies in the UAE. For one, it has left local company managers and directors open to unpredictable liabilities, so lawyers often advise managers to tread carefully when their companies may be lurching towards insolvency. "The position is clearer where someone has been fraudulent," says Kuljit Ghata-Aura, a partner at Eversheds, a large international law firm with offices in Abu Dhabi.
"What is not as clear is how the courts would interpret behaviour which falls short of fraud, such as mismanagement, which is a potential claim under the UAE law that a liquidator or bankruptcy trustee could theoretically bring against a manager." Another consequence, supporters of legal reform say, is that creditors are less willing to lend when there is little certainty about how much of their money they would recover after an insolvency.
Creditors typically recover about 30 per cent of their loans to insolvent companies in the Middle East, well below the average in the developed world. If banks and other lenders knew what they could expect to get back, the hope is that they would lend more money, stimulating economic activity. A strong insolvency system might also lead to greater economic flexibility, allowing for the rapid opening and closing of companies as the global economy undergoes fundamental shifts.
"Insolvency and creditor rights are part of market infrastructure, and they are part of the core standards for sound financial systems," Nasser Saidi, the chief economist at the Dubai International Financial Centre and the executive director of Hawkamah, a corporate governance group based in Dubai, said at a conference on insolvencies last month. "These international standards were developed to help countries achieve transparency of economic risks and a financial system governed and regulated in a safe and sound manner, which serves the nation efficiently and sustains ongoing growth and economic development."
Whatever the logic, most insolvencies in the UAE are resolved outside of court, according to lawyers. Creditors usually come to private agreements with companies that run into trouble, or help organise a winding up of bankrupt businesses. While that is likely to continue for some time, there has been a groundswell of discussion around modernising insolvency laws in the UAE and around the region. Hawkamah, a non-profit organisation, released a report last month that advocated "sound insolvency and creditor rights systems" to support the development of regional capital markets and private-sector companies.
In a declaration that accompanied the report, Hawkamah urged the modernisation and harmonisation of insolvency and creditor rights systems throughout the region, and called for a forum to address the issue. The organisation also suggested further study of insolvency, education for regulators and judges, and the possible establishment of separate courts to adjudicate complex company failures, while recognising that different countries may have different priorities and preferences when it comes to bankruptcy.
"I think you may well see people bringing formal proceedings in two scenarios: companies bringing proceedings themselves because they become aware of the criminal liabilities they face if they don't; and also companies taking advantage of the moratorium to reach agreements with creditors," Mr Rogers says. Efforts to modernise insolvency are still in their nascent stages, but the financial crisis may help speed up the pace of reform.
With more companies like Mr Bell's facing financial difficulties, the need for a clearly understood system for dealing with insolvent companies and protecting creditors has become a priority. @Email:firstname.lastname@example.org