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Directors' duties and the increasing requirement for D&O insurance in the UAE

Written by Mark Beswetherick

In the aftermath of the global economic recession awareness of, and the requirement for, good corporate governance is high on the legislative agenda of many countries; the UAE is no exception. In light of this, the UAE is in the process of enacting a new company law, which will represent an overhaul of the existing legislation, first enacted 28 years ago pursuant to Federal Law No. (8) of 1984 ("Commercial Companies Law').

As directors of local companies begin to realise the potential liabilities for breaching their duties are now just as real as in many more established jurisdictions, Insurers will wish to know what effects the proposed legislation will have on the developing D&O market in the UAE.

The duties

Crucially, the draft commercial companies law (the "Draft Law") contains an express statement of directors' duties. This is in stark contrast to the current regime where directors' duties are scattered around various sources and, in some cases, exist by little more than implication.

Article 21 of the Draft Law attempts to codify the basic duties that are owed by the directors of all types of company incorporated in the UAE:

"A person authorised to manage the company shall preserve its rights and work for the benefit of the company honestly and faithfully. Such person shall do all such acts in agreement with the objective of the company and the powers granted to such a person under authorisation issued by the company in this respect."

Three separate duties can thus be derived from Article 21:

1. Duty to preserve the company's rights

This places a positive duty on directors to protect the legal rights of the company. Ordinarily preservation of such rights will align with acting in the company's best interests, though not always. A divergence could occur, for example, in the litigation context where a commercial settlement is being negotiated.

2. Duty to work honestly and faithfully

In addition to the prima facie duty for directors to conduct themselves in an honest and faithful manner, this requirement also implies a duty not to compete with the company and to avoid conflicts of interest. Arguably this is simply a restatement of duties that already exist, as under the current Commercial Companies Law, a director is under an obligation to disclose any personal conflicts of interest to the board for deliberation and approval. Similarly, under the existing Commercial Companies Law, a director may not conduct their own business in a way that competes with the companies' business without prior approval of the shareholders.

3. Duty not to act ultra vires

Analogous to the duty found under English common law, a director must act within the powers given to his position by the Articles and in accordance with the objectives of the company as set out in the Memorandum of Association. Article 111 of the current Commercial Companies Law makes a director liable for violation of the company's memorandum of association, however the duty found in Article 21 of the Draft Law is seemingly drafted to cover both breaches of power under the Articles and Memorandum, as well as breaches of any Powers of Attorney, which directors frequently enjoy in the UAE.

Under the current regime, directors owe their duties to the company, to shareholders and, in some cases, to third parties. On the basis that Article 166 of the Draft Law states the directors are jointly liable to indemnify the company, shareholders and third parties for damage, we can probably assume that directors will owe their new duties to the same parties. It should also be noted that there is still no provision for shadow directors to be held to account for breach of duty.

Mismanagement

One particular duty from the current Commercial Companies Law that Insurers may be aware of is a director's liability for 'mismanagement'. This wide-ranging and unwieldy provision has the potential to extend well beyond what would be expected of directors in other jurisdictions, and has the ability to expose directors to liability for failings in the performance of a company attributable to management. This obligation has, however, resulted in very few known cases against directors and officers in the UAE.

Liability for 'mismanagement' has not been included in Article 21 of the Draft Law, though Article 166 does impose a duty on directors to jointly indemnify the company for errors in management. Insurers will need to take this seemingly wide ranging provision into account when offering and pricing coverage.

While the Draft Law looks will replace the current Commercial Companies Law (though the exact date of its coming into force is not yet known), directors' duties found in other sources will remain unchanged. By way of example, the UAE Civil Code imposes a tortious duty on directors to make good any harm caused to the company by their decisions or the actions of those they direct. Furthermore, the UAE Commercial Code imposes a host of duties that apply on the insolvency of a company, and the UAE Penal Code provides criminal sanctions for fraud, breach of trust, embezzlement and disclosing confidential information for personal advantage. A director may also face criminal sanctions for writing a cheque on behalf of a company without the funds to honour it.

Indemnification

In many jurisdictions, including the UK, a company is permitted to indemnify a director for his personal loss caused by breaches of certain duties (usually related to claims by third parties). It is also commonplace for companies to advance defence costs to a director in all circumstances, although these costs must be repaid on final judgment and are often seen as a loan rather than indemnification.

While under the current Commercial Companies Law, a company is able to indemnify a director against all liabilities arising in the performance of his professional duties, the Draft Law is unclear as to whether such an indemnification will continue to be permitted.  Article 23 of the Draft Law states that any provision in the Memorandum or Articles which exempts a director from personal liability for a breach of duty is void.

It remains to be seen whether or not local courts will construe an indemnification as the same as an exemption of liability. In theory, a director could be found liable to the company, while the question of where he will obtain the funds to pay damages is a separate issue.

In addition to Article 23, the joint liability provisions contained in Article 166 of the Draft Law (as discussed above) suggest a change from the current regime, to the effect that companies are no longer able to offer indemnities to directors for breaches of duty.

Effect on D&O insurance

There are no specific laws or regulations covering D&O insurance in the UAE. General UAE insurance legislation requires insurance to be placed locally with a licensed insurance company. Any insurance placed in respect of risks located within the UAE with an unlicensed and/or offshore insurer is null and void under UAE law. For directors covered under global programmes, this obligation should be borne in mind.

When enacted, the wider scope of the duties in the Draft Law may mean that comprehensive D&O insurance will be crucial to many companies' ability to attract and retain talented directors. This is especially true of directors based overseas who sit on a board alongside one or more UAE-based directors, and who have very little to do with the day-to-day running of the company. Further, the prima facie prohibition on indemnification will mean that the company may not be able to protect directors from personal liability for claims which arise. On this basis, it is likely that more and more will turn to D&O insurance for protection.

From the directors' and officers' perspective, the potential blanket ban on indemnification means that 'Side A' cover, which is usually designed to fit around a company's indemnification rights and plug gaps where necessary, will be of greater importance. With companies unable to provide indemnification for breaches as wide as 'mismanagement', directors and officers will have to ensure that the D&O policy steps in as the first level of protection.

Directors and officers in the UAE face an inevitable increase in claims that tougher corporate governance regime coupled with creditors and counterparties who are much more aware of, and willing to enforce, their rights inevitably brings. The upside for Insurers is that, should the Draft Law come into force, D&O insurance is something that no directors and officers can afford to be without in the UAE.

 Should you have any questions in connection with this article or the legal issues it covers, please contact Mark Beswetherick.