Six key legal points when investing and contracting in the UAE

Foreign direct investment in the United Arab Emirates (UAE) has shown a recent upturn and this looks set to continue as international investors search out new opportunities as part of their wider Middle East and North Africa (MENA) strategies.

Here, we summarise some key issues commonly raised by international clients investing or contracting in the UAE.

A common area of concern for international investors is the flexibility to contract under their preferred governing law.

Some commentators have argued that, under article 19(1) of the Federal Law No. 5 of 1985, as amended (the Civil Code), if both parties are UAE resident parties, then the relevant agreement must be governed by UAE law. This would mean that local operating entities in the UAE should, strictly speaking, contract under UAE law if they are dealing with UAE resident counterparties.

A counter argument to the above is that Article 19(1) only applies to invoke UAE law as a default position if an alternative governing law has not been stated in the relevant agreement. Both arguments are supported by previous court judgements.

There are however other situations where the selection of a foreign law is clearly restricted – regardless of the location or residency of the contracting entity – such as contracts in relation to possession, or ownership rights over real property situated in the UAE.

In a recent significant move, HH Sheikh Mohammed bin Rashid Al Maktoum, Vice President and Prime Minister of the UAE and Ruler of Dubai has issued a law¹ that will, for the first time, open the jurisdiction of the Courts of the Dubai International Financial Centre (DIFC) to businesses based outside of the DIFC. This is likely to be viewed as a welcome move for many international investors. View our briefing note, which provides an overview of the new law and its potential advantages.

Judgments

Under Article 235 of Federal Law No. 11 of 1992, foreign judgments may be enforced in the UAE if (among other things) the UAE courts do not have jurisdiction in the proceedings. However, it is important to note the following:

• The Dubai Court of Cassation has previously refused to uphold a foreign court judgment (and a foreign arbitration award – albeit before the UAE’s accession to the 1958 Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the New York Convention)) where it considered that the UAE courts would have had jurisdiction in the matter – because the case involved UAE nationals.
• In actions against UAE parties or foreign parties with a domicile or place of residence in the UAE, the laws may allow the UAE court (in its discretion) to re-hear the substance of the matter which is the subject of the foreign court judgment.

In contrast to the above, it should be noted that DIFC Court judgments are enforceable by UAE Courts without a right of review of the merits of the case. In light of the recent expansion of the jurisdiction of the DIFC Courts, parties to a contract should consider whether submission to the jurisdiction of the DIFC Courts would be of benefit in the context of future enforcement actions in the UAE.

Awards

Since 2006, the UAE has been a party to the New York Convention and – subject to certain criteria set out in the New York Convention being satisfied – UAE courts should allow the enforcement of foreign arbitral awards. However, this is relatively untested. That said, there is evidence of a trend towards an increasing willingness within the UAE to recognise foreign awards.

In January 2011 the Dubai Court of First Instance ordered the recognition and enforcement of an arbitral award made in London under the New York Convention. The details are not publicly available, but we understand that the enforcement action was fully contested. We also understand that the case may be appealed. If the first instance decision is upheld on appeal this should increase confidence in Dubai as a jurisdiction that will recognise foreign arbitral awards.

Further, in 2010, an arbitral award was enforced under the New York Convention by a court of first instance in Fujairah – but such a court decision would not be binding on courts in other Emirates and, in addition, the enforcement action was uncontested within the UAE.

The enforceability of an arbitration award can also be challenged on the grounds of bias/natural justice and/or certain procedural issues, albeit not on its merits. There is, therefore, always a risk that a court will fail to enforce a foreign arbitration award based on procedural grounds. Despite this, it is generally agreed that foreign arbitral awards will be easier to enforce in the UAE than foreign court judgments.

International investors are often concerned about the extent to which shareholders in UAE companies may be exposed and are keen to understand whether UAE law recognises the principle of the “corporate veil” by supporting a doctrine of limited liability for shareholders.

This principle is reflected in the UAE Commercial Companies Law (CCL), under Articles 64 and 218 which state that:

• Article 64 - “Any company whose capital is divided into negotiable shares of equal value shall be considered a public joint-stock company and a partner therein shall be liable only to the extent of his capital share.”
• Article 218 - “A limited liability company is an association of a maximum number of fifty and minimum of two partners. Each of them shall be liable only to the extent of his share in the capital, and the partners’ shares are not made in the form of negotiable instruments.”

As is the case in many other jurisdictions, there are certain exceptions that would render this protection inapplicable, including articles 219 and 226 of the CCL. For example, article 219 provides that if shareholders, who are also directors, neglect to state that the company is a limited liability company or to state the company’s share capital next to its name in papers issued by the company then they will be jointly liable to the extent of their personal assets towards the company’s debts.

However, a decision by the Dubai Court of Cassation on this issue has indicated that the court takes a strict approach in favour of the corporate veil. The court said that – in order for a shareholder to be personally liable for the companies’ obligations under article 219 – the claimant had to demonstrate that the failure by the shareholder to comply with the provisions of article 219 was the main, actual, direct and inevitable reason due to which the claimant suffered damages and not due to other reasons related to the company itself, such as winding up or insolvency for reasons beyond the control of the shareholder. Yet another decision required an element of bad faith on the part of the relevant shareholder.

As a general rule, companies in the UAE must have a minimum national shareholding of 51 per cent. Companies based in the free zones are not caught by such ownership restrictions - although their ability to do business in the UAE outside the free zone is restricted.

The most common forms of corporate vehicle in the UAE are limited liability company (LLC) and joint stock company (public and private), with LLCs tending to be the more commonly used vehicle for international investors establishing joint venture operations.

As well as differences relating to board representation and governance generally, the other clear distinction between the company forms is the minimum share capital required. A Private JSC requires a minimum share capital of AED2 million (AED 10 million for a Public JSC) and an LLC has historically required a minimum of just AED150,000 in Abu Dhabi and AED300,000 in Dubai. However, the minimum amount for LLCs has now been removed, although the authorities will expect the LLC to be established with a sufficient level of capital to conduct its proposed activities (there are no guidelines as to how this will be assessed). Certain sectors also impose additional or higher levels of capital.

Both LLCs and JSCs must allocate 10 per cent of their net profits each year to a statutory reserve, but this allocation can be suspended if the reserve reaches an amount equal to 50 per cent or more of the company’s total equity share capital. There has accordingly been a preference for shareholders of highly capitalised UAE companies to put shareholder funds in by way of loan (as opposed to shares), thereby avoiding the need to reserve more than necessary – an approach assisted by the absence of any thin capitalisation rules in the UAE.

Like a number of civil law-based jurisdictions, the UAE imposes a duty of good faith on the parties to any contract governed by UAE law. Article 246 of the Civil Code states:

“(1) The contract must be performed in accordance with its contents, and in a manner consistent with the requirements of good faith.

(2) The contract shall not be restricted to an obligation upon the contracting party to do that which is (expressly), contained in it, but shall also embrace that which is appurtenant to it by virtue of the law, custom, and the nature of the transaction.”

There are a number of examples of the UAE courts reaffirming this doctrine and international investors should consider the full extent of their obligations and duties under relevant contracts so as to ensure adherence to this wider duty of good faith.

In recent years, the UAE has become host to many free zones which offer foreign investors numerous benefits such as 100 per cent foreign ownership (in contrast to the 51 per cent minimum national shareholding mentioned above), guaranteed tax free status, a one-stop-shop of support services (including licensing and visa sponsorship procedures) and other advantages such as high technology facilities and services and real estate infrastructure. In most free zones it is possible to establish either a branch or representative office of a foreign company or to establish a limited liability company.

There are numerous free zones in the UAE - each has its own geographic boundaries and regulations and most have been established to accommodate certain types of activity (such as media, education, manufacturing and financial activities).

A free zone company is generally excluded from operating in the UAE outside of the free zone in which it is incorporated. Despite their physical locations, free zones are generally considered to be offshore jurisdictions and entities operating from such zones are not permitted to carry out their activities onshore in the UAE. Therefore, if a free zone company wants to conduct business in the UAE outside of the free zone in which it is registered, it will in theory need to enter into an agreement with a local agent or distributor in the UAE or establish a formal presence, such as a branch office, onshore.

However, in a recent development, HH Sheikh Mohammed bin Rashid Al Maktoum, Vice President and Prime Minister of the UAE and Ruler of Dubai has issued a new licensing law which, amongst other things, provides that, in coordination with the free zone authorities, the Dubai Department of Economic Development may authorise free zone entities to practice their activities onshore in Dubai. Although a welcome move, no additional clarification has been given as to the circumstances in which such authorisation will be granted and the conditions which must be complied with - the full effects and implementation of the new law therefore remain to be seen.