Significant reforms to the UAE Commercial Agency Law
Bankruptcy Proceedings in the UAE: the approach of the Courts towards debtors and their managers
Legal Development 04 April 2023 04 April 2023
Over the past year or so, we have seen a number of examples of Dubai Courts taking an extremely cautious approach to handling debtor-led bankruptcy cases, particularly in relation to determining whether there is a legitimate distressed financial position and enquiring as to the conduct of managers leading to the bankruptcy of companies.
The UAE Bankruptcy Law (Federal Law No. 9 of 2016, as amended) (the Bankruptcy Law) provides a possible avenue for an insolvent debtor (i.e. in a state of bankruptcy) to restructure the company (if a restructuring plan is approved by the Court and creditors) or otherwise to proceed into liquidation if the Court considers that restructuring is not possible. These statutory mechanisms are intended to benefit the interests of creditors of a distressed company by providing a level of confidence in the legal process and by maximising the likelihood that creditors will be paid in a debtor’s bankruptcy situation.
In very brief terms:
- a debtor is required under the Bankruptcy Law to file for bankruptcy if it is in default of payment of a due debt for more than 30 UAE business days due to its unstable financial condition or where the assets of such debtor are, at any time, insufficient to cover its debts which are due and payable to its creditor(s);
- a creditor may also initiate bankruptcy proceedings in respect of a debtor where it holds a debt of at least AED 100,000 and has issued a written demand to the debtor for repayment which has not been satisfied within 30 UAE business days.
Whilst the UAE Courts have been dealing with bankruptcy cases under the Bankruptcy Law since it came into force in late 2016, these were principally creditor-led filings with very few debtor-led examples. It is fair to say that the number of bankruptcy cases filed in aggregate across the Emirates was not significant in circumstances where more filings would have been expected.
While an analysis of the possible reasons for this is beyond the scope of this article, they are likely to include the unfamiliarity or uncertainty of segments of the UAE business community in engaging informal bankruptcy proceedings, as well as the emergency legislative measures introduced during the height of the 2020 COVID-19 pandemic, which placed limitations on bankruptcy filings for a certain period of time. Where such restrictions no longer exist, the number of bankruptcy cases has increased, as has debtor-led filings.
In this article, we comment on some aspects of recent Dubai Court cases on debtor-led bankruptcy cases and the potential liability of managers of bankrupt companies.
Debtor-led bankruptcy filings
A recent case in Dubai involved the owner and operator of a restaurant group filing for bankruptcy after failing to pay its debts when they were due. Although the bankruptcy appeared a straightforward matter and the evidence submitted to the Court showed that the company was unable to pay its debts, the Dubai Court of First Instance questioned the reasons for the company’s distressed financial situation. In particular, the court-appointed expert, who assessed the company’s financial position at the preliminary stage of the case (i.e. before any declaration of bankruptcy), appeared to have doubts about debts incurred by the company to purchase goods necessary for its operations and on that basis, the Court referred the matter to the Public Prosecutor in order to determine whether or not fraud had been committed.
Although the Public Prosecutor found that there was no fraud, the ensuing process took approximately 24 months from the filing of bankruptcy proceedings to the Court issuing a judgment ordering the liquidation of the company.
In another case, the Dubai Court of First Instance dismissed the application of a debtor who had filed for bankruptcy proceedings because the debtor did not provide the necessary evidence to prove its distressed financial status in accordance with the law, despite having provided evidence that it was not able to pay its debts. Although the judgment was appealed and the Court of Appeal is currently considering the appeal, the judgment of the Court of First Instance is an example of the courts taking an extremely strict procedural and evidentiary approach to the information provided by debtors regarding their (in)solvency, which is surprising.
In another similar example, the Dubai Court of First Instance also dismissed the application of a debtor who had filed for bankruptcy because it had failed to file an audit report establishing its financial position in the year leading up to the bankruptcy application, although not a prescribed requirement of the Bankruptcy Law.
Liability of directors and managers
In a landmark judgment in the ‘Marka Case’ in October 2021, the Dubai Court of First Instance held the directors and managers of the bankrupt debtor company (a Public Joint Stock Company) personally liable to pay the company’s outstanding debt (approximately AED 450 million), since the assets of the company were not sufficient to pay at least 20% of its debts.
Shortly after the Marka Case, the Bankruptcy Law was amended to limit the liability of directors and managers to their respective liability for the relevant debts of the company if the Court finds that any of them committed any of the acts set out in Article 147(a)-(c) of the Bankruptcy Law, which requires the directors and/or managers to have contributed to the losses that rendered the company insolvent. The Marka judgment at First Instance was therefore a high watermark decision from which the law rapidly developed through some refinements into the personal liability regime and legal process.
The Marka judgment was appealed by the directors and managers of the debtor company and the Court of Appeal decided to refer the case back to the Court of First Instance for reconsideration.
In October 2022, the Court of First Instance (in reconsidering the matter) clarified in a judgment that the liability of the decision-makers of the company is not automatically engaged when the company that they manage has insufficient assets to settle at least 20% of its debts. To engage their liability, the decision-makers (managers, directors, or de facto decision-makers) must have contributed to the losses that rendered the company insolvent, for example through:
- disposing of assets at lower than market value; or
- disposing of property without consideration, or against insufficient consideration, or in circumstances where the benefit received is not proportionate to the property disposed of; or
- discharging the debts of a creditor to the detriment of other creditors while the company is insolvent.
The Court distinguished between decision-makers who contributed to the company’s losses and its insolvency, on the one hand, and subsequently appointed managers who attempted in good faith, tried to improve the company’s already insolvent financial position before the bankruptcy proceedings commenced (who would not have the liability).
In order to limit the risk of liability of managers and directors of companies who are considering filing for bankruptcy, managers/directors are advised to seek advice on what actions they can and cannot take on behalf of the companies they manage before the company files for bankruptcy. It also highlights the importance of record keeping and good corporate governance.
In addition, to ensure that the bankruptcy proceedings run smoothly, it is advisable that the debtors, before filing for bankruptcy proceedings, prepare all the documents required under the Bankruptcy Law, along with a detailed explanation of the financial position of the company, to limit the risk of the courts having doubts about the financial position of the company.