The management of limited liability companies and directors’ duties in the UAE

January 2012

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Introduction

A number of different forms of company may be established onshore in the United Arab Emirates (UAE), or in one of the UAE’s free zones. In this article we focus on the liability issues for managers of limited liability companies (LLCs) incorporated onshore in the UAE, since these are currently the most common form of corporate entity used by foreign investors in the UAE.

Composition and powers of management

Unlike joint stock companies which have a more readily recognised concept of a board of “directors”, LLCs in the UAE have “managers” and, under article 235 of the UAE Commercial Companies Law (CCL), must have between one and five such managers. However, despite such difference, CCL provisions relating to liabilities of directors of a joint stock company apply equally to LLC managers (article 237 of the CCL) – so the analysis given here to manager liabilities applies equally to directors of UAE joint stock companies (although directors of public, as opposed to private, joint stock companies may be subject to additional duties).

Under article 235, the appointment of LLC managers is governed by the company’s contract of establishment (COE)1, by separate agreement, or by the shareholders at the general assembly. Although not referred to or required by the CCL, it is common to find the position of “General Manager” referred to in the COE of LLCs.

Any LLC with more than seven shareholders must also have a supervisory board, appointed under the COE for a specified period and comprising at least three shareholders (article 240 of the CCL). This supervisory board may inspect company books, documents, finances etc, and may request the directors to provide reports on company activities, budget, financial distributions and other matters.

Unless the managers’ powers are otherwise specified in the COE, the managers will, pursuant to the CCL, have full authority to manage the business of the LLC and their actions are binding on the company. However, it should be noted that “the full authority to manage the business” provided for under article 237 of the CCL is not sufficient to entitle the managers to undertake all activities - some activities such as opening bank accounts, signing cheques, obtaining loans, initiating proceedings and appointing advisers will need to be explicitly mentioned in the appointment mandate of the managers.

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Managers’ duties and potential liabilities under the CCL

The general obligations placed on managers arise from a number of sources, including the company’s COE, the CCL, the UAE Civil Code and the UAE Penal Code.

Article 111 of the CCL

Whilst the CCL does not contain explicit provisions relating to directors’ duties, these can be inferred from the provisions of the CCL which deal with the liability of directors. Of key relevance is article 111 of the CCL which applies to both directors of joint stock companies and managers of LLCs. This provides that the chairman and the directors are liable to the company, the shareholders and third parties for:

  • all acts of fraud
  • abuses of power
  • violations of the law or the company’s COE.

Directors may also be liable for the mismanagement of the company. There is little in the way of reported cases providing guidance on how the UAE courts interpret the potential application of article 111 and, in particular, the scope of “mismanagement”. However, it appears to be a fairly wide-ranging offence – not necessarily limited to acts of deliberate or serious wrongdoing.

Persons to whom managers are liable under article 111

Article 111 of the CCL clearly sets out that the managers are liable to the company, the shareholders and also to third parties. This could include creditors, employees and, in theory, any other person who has suffered loss as a result of the managers’ actions.

Any person considering accepting a manager position in an LLC should be aware that – in the event of a breach of one of the duties set out in article 111 of the CCL – all managers are jointly liable under article 112 if such breach arises from a resolution adopted unanimously. It is therefore important for any manager who does not agree with a proposed action to vote clearly against that resolution – and to have his objection noted in the minutes. Simply not being present at the meeting in question is not a defence under the CCL and a manager, if not present, must show that he was not aware of the proposed action or, if he was aware, was unable to object.

In addition, article 115 of the CCL provides that it is not possible for the managers to relieve themselves of liability simply by procuring a resolution of the shareholders endorsing a particular decision or course of action. However, such a resolution does have the benefit of limiting the prescription period for any action against the managers to a period of one year from the date of the relevant shareholder resolution, except where there has been criminal action.

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Potential criminal liability of managers

In addition to the general liability provisions of article 111, the CCL also sets out, at article 332, a number of areas that may expose a manager to criminal sanction, which include:

  • entering false information on corporate documents or knowingly distributing the same
  • inviting the public to subscribe for shares in an LLC
  • distributing dividends in a manner inconsistent with the provisions of the CCL or the COE of the company
  • wilfully entering false information in the company accounts or wilfully omitting substantial information
  • divulging company secrets for personal gain or for the benefit of third parties.

Managers of LLCs should also be mindful that potential criminal liability exists, not only under the CCL as set out above, but also under:

  • the Penal Code – for matters such as fraud, embezzlement, disclosing confidential information for personal benefit and writing a company cheque which is subsequently dishonoured
  • the Commercial Code – under which managers of an insolvent company can be criminally liable in certain circumstances (which we expand upon below).
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Conflicts of interest

Under article 109 of the CCL, a manager is under a positive duty to disclose conflicts of interests and is thereafter prohibited from voting on resolutions relating to that conflict.

The CCL also provides, at article 112, that a manager is prohibited from participating in any business that competes with the business of the company, or carrying out activities on his own account which are the same as the activities carried out by the company – unless prior approval is obtained from the shareholders (which approval must be renewed annually).

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Civil Code

LLC managers should also be aware of certain provisions in the Civil Code. In particular, under article 665(3) of the Civil Code, a manager is liable for any loss sustained by the company as a result of his acting outside the scope of his authority. A manager may also be liable if he resigns at a time likely to cause damage to the company (article 667 of the Civil Code). This could be of particular relevance to managers of an LLC in financial difficulties: while the temptation may be to resign from the company in an effort to minimise exposure to potential shareholder or third party claims, in doing so the manager may put himself in breach of the Civil Code if his resignation were to deprive the company of important skills and experience at a time when it was most in need of them.

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Managers’ duties in an insolvency scenario

In addition to the general duties which managers of LLCs owe, managers should also be aware that further liabilities, both civil and criminal, may arise when a company begins to face financial troubles. If an LLC sustains losses amounting to one half of its capital, the managers are under a positive duty to refer the question of dissolving the company to the shareholders under article 289 of the CCL. In addition, the Commercial Code provides that managers should file for the company’s bankruptcy within 30 days of the date of suspension of payments of debts - failure to do so could result in the manager being considered an offender in the subsequent bankruptcy2. Managers therefore need to closely monitor the financial status of the company and ensure that actions are taken at the appropriate times to avoid becoming personally liable.

The Commercial Code contains extensive provisions as to how courts should treat insolvent companies and their managers3. In particular, article 882 of the Commercial Code provides that managers may find themselves liable to a custodial sentence if:

  • they have failed to enter sufficient detail in the financial books to reflect the true financial position of the company
  • they refrain from supplying the information needed by the judge of the bankruptcy or the trustee in bankruptcy or if they deliberately supply untrue information
  • following suspension of payment of debts4, they deal with any property of the company with a view to keeping such property out of creditors’ reach
  • following suspension of payment of debts, they honour the debt of any creditor to the detriment of others or provide securities or special benefits to any of the creditors by way of preference over others
  • they have sold goods of the company at an undervalue in an attempt to delay the suspension of payment of debts or declaration of the company’s bankruptcy or have resorted to illegal channels to obtain money in order to achieve their purposes.

In addition to the above, certain provisions of the Penal Code provide for managers to be punished when complicit in fraudulent activities relating to a bankruptcy.

In circumstances where the assets of the company are insufficient to satisfy at least 20 per cent of its debts, article 809 of the Commercial Code provides that, the court may order the managers, either jointly or severally, to pay the debts of the company in cases where they are responsible in accordance with the rules of the CCL.

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De Facto or Shadow Directors

UAE law does not expressly recognise the concept of a de facto or shadow director. However, this does not necessarily mean that the concept could not be recognised by the courts in certain circumstances. In the case of an LLC "General Manager" for instance, where the relevant LLC does not appoint a board of managers but relies simply on a "General Manager", that person is likely to be treated as a "manager" and subject to all of the duties and obligations referred to above.

Footnotes

1. Which is equivalent to memorandum and articles of association.

2. Article 649 of the Commercial Code.

3. A draft bankruptcy and restructuring law designed to support companies in financial difficulties has been delivered to the Ministry of Justice and is anticipated to reach the final stages of approval soon. It is reported that the new legislation will overhaul how the law currently deals with businesses and individuals facing financial difficulties.

4. Pursuant to articles 655 to 659 of the Commercial Code this is determined as being the date when the company is no longer able to pay its debts and the court may look back over a 2 year period in order to determine such date (article 659(2)).

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