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This article is originally published in Thomson Reuters

A Practical note addressing the legal and practical considerations in the mainland of the United Arab Emirates for a company director where that company is in financial distress and may subsequently enter insolvency proceedings. This note also outlines the types of claims that an official appointed to oversee the insolvency proceedings or represent the creditors’ interests, or both, may bring against the company’s former directors, or to unwind transactions that took place before any insolvency proceedings.

When a company is in financial distress and enters into insolvency proceedings, there are a variety of legal and practical issues to consider. Before the distressed company goes into insolvency proceedings the directors may need advice on what they must do to fulfil their duties to the company, its creditors, and shareholders, and must consider the status of any ongoing transactions the company may be engaged in. Once the company has gone into insolvency proceedings, the pre-insolvency actions of the directors will be scrutinised by insolvency officials attempting to achieve the greatest return for the company’s creditors.

This note considers the legal and practical issues involved in the law of the United Arab Emirates and addresses:

• The duties that are binding on the company’s directors, its shareholders, and its creditors and how these may change according to the company’s financial situation.
• The investigation of the pre-insolvency actions of the directors by insolvency officials.
• The powers of the insolvency officials to unwind any ongoing transactions and general powers of recovery in their aim to achieve the greatest possible return for the company’s creditors and other applicable aims.
• The potential for any claims against the company’s directors, and whether the directors can be personally pursued because of certain conduct even if ordinarily they would not be liable for the insolvent company’s debts.

Directors’ Duties

In the United Arab Emirates (“UAE”), the Federal Law No. 32/2021 on Commercial Companies (CCL) governs the duties of directors of a company. In general, directors owe several duties to the company, its shareholders, and creditors.

While there is no specific definition of a director under the CCL, the duties also apply to:

• The general manager, executive director, Chief Executive Officer of the company.
• Any deputies of the above parties.
• Anyone occupying an executive-level position.
• The executive management officers.
• Those who have been appointed personally by the board of directors.

Article 162, CCL.

Article 22 of the CCL outlines the specific duties of directors of UAE companies, which stipulates that a person authorised to manage the company must act with due care and avoid ultra vires acts regarding the company’s activities and constitutional documents.

While Article 22 does not set out an exhaustive list of duties, the general duties of directors are:

• To abide by the company’s memorandum of association and articles of association.
• Not to disclose confidential information about the company.
• To act with loyalty towards the company.
• To avoid any conflict of interest between a director’s personal interests and those of the company, and to notify the board of directors if this conflict exists.

Article 150, CCL

Public Joint Stock Companies

Public joint stock companies (“PJSCs”) are regulated by the Securities & Commodities Authority (“SCA”). The Governance Guide for Public Joint-Stock Companies Attached to the SCA Board Chairman’s Decision No. (3/Chairman) of 2020 (Governance Guide for PJSCs), also known as the New Rules, elaborates on the duties these companies’ directors under:

• Articles 14 in relation to operating the company (see Article 14 of the Governance Guide for PJSCs).
• Article 16 in relation to broader general duties (see Article 16 of the Governance Guide for PJSCs).

While the governance code sets out minimum corporate guidance standards required of a PJSC, the constitutional documents of the relevant PJSC can impose higher standards.

Article 14 of the Governance Guide for PJSCs

The duties of directors of public joint stock companies under Article 14 of the Governance Guide for PJSCs include:

• Undertaking the necessary procedures to ensure compliance with applicable laws, regulations, and resolutions, as well as the requirements of the supervisory authorities.
• Adopting strategies to achieve the main objectives of the company.
• Establishing an internal auditing department to ensure compliance with the applicable laws, regulations, decisions, and requirements of the supervisory bodies, the internal policy, regulations, and procedures.
• Ensuring the soundness of administrative, financial, and accounting systems, including the systems related to preparation of financial reports.
• Ensuring the use of appropriate regulatory systems for risk management by outlining potential risk and discussing it transparently.
• Setting out a clear delegation policy in the company to determine delegated persons and the powers assigned to them. Setting out internal policies and guidelines to cover all aspects of the company’s business.

Article 16 of the Governance Guide for PJSCs

The duties of directors of public joint stock companies under Article 16 of the Governance Guide for PJSCs include, but are  not limited to:

• Maintaining the interests of the company and its shareholders.
• Acting with such due care, diligence, and skill as would be expected of a careful professional person in similar circumstances.
• At all times acting in good faith, honestly, and sincerely, and avoid all potential or actual conflicts of interest.
• Complying with the applicable laws, regulations, and decisions, as well as the company’s articles of association and bylaws.

Implied Duties

Certain articles of the CCL impliedly provide for director duties by outlining actions that, if committed by directors, are punishable by law. For example:

• Deliberately including false information in company documents, including the constitutional documents (Article 346, CCL).
• Distributing dividends in violation of the CCL and the company’s constitutional documents (Article 348, CCL).
• Deliberately providing false information in the company’s balance sheet or profit and loss account, or concealing the true and accurate picture of the company’s financial position (Article 349, CCL).
• Using or disclosing the company’s confidential information obtained by virtue of being a director (Article 354, CCL).
• Deliberately declining to provide documents or information to authorised inspectors (Article 350, CCL).
• Directly or indirectly engaging in activities aimed at influencing the price of the securities issued by the company (Article 355, CCL).

How Directors’ Duties Change in the Pre-Insolvency Period

Articles 84 and 162 of the CCL provides that UAE companies’ director duties extend to all stakeholders in a company, which includes creditors. These Articles state that a director owes duties to all parties that have an interest in the affairs of the company, defining these parties as:

• The company.
• The shareholders.
• Third parties in relation to acts of fraud, abuse of power, mismanagement, and violation of law or the company’s articles.

There is a consensus in the market that in situations where insolvency is a concern, directors should be especially aware of

their duties towards the company’s creditors.

Directors’ duties in the critical financial period vary depending on whether the company is an LLC or a JSC, as follows:

• Should the losses of a JSC reach 50% of its issues share capital, the board of directors must call a general meeting of the JSC to decide whether to dissolve the JSC prior to expiry of its term or continue business activity. This must take place within 30 days of the filing of relevant financial statements showing this position. Should the board fail to invite the general assembly to convene, any concerned party may file a motion to seek dissolution of the JSC (Article 309 (1), CCL).
• If the losses of an LLC reach 50% of its share capital, the managers are required to refer the issue of dissolution to a general assembly of the partners. A resolution to dissolve may then be passed by the same majority as required to change the MOA on the LLC (Article 308 (1), CCL). If the losses reach 75% of the LLC’s issue capital, a resolution to dissolve may be passed by partners holding on 25% of the capital (Article 308 (2), CCL).

Examination of Directors’ Pre-Insolvency Actions During Insolvency Proceedings

The UAE Federal Decree-Law No. 51/2023 (the “Bankruptcy Law”) on Financial Restructuring and Bankruptcy has been issued on 31 October 2023 and comes into effect 1 May 2024, repealing Federal Decree-Law No. 9/2016 (the “Old Law” ). The Bankruptcy Law aims to enhance economic activity and stability by offering a framework for early rescue of distressed companies, balancing stakeholder interests, and improving insolvency and restructuring processes. The Bankruptcy Law will  apply to onshore companies, excluding those in the Dubai International Financial Centre (“DIFC”) or the Abu Dhabi Global Market (“ADGM”), which have their own insolvency laws.

In an insolvency context, the court oversees proceedings and procedures. A court-appointed trustee, with the assistance of any experts (if needed), primarily carries them out.

The trustee is responsible for a variety of tasks in carrying out the preventive settlement or the bankruptcy proceedings. Also, trustees can examine the directors’ actions before the proceedings being instituted (see Duties of Insolvency Officials to Investigate Pre-Insolvency Transactions and Director Conduct).

While trustees have no explicit obligation to examine directors’ duties leading up to the proceedings, this examination often tends to naturally form part of the trustee’s assessment of the company, and in determining what receivables the company can claim.

Potential Claims Against Former Directors

Shareholders’ Claim Against the Company

The CCL states that a company has the right to initiate proceedings against the board of directors, claiming damages (caused by faults of the board) suffered by all the shareholders (Article 165, CCL). Practically, the company must show a causal link between a director’s action and the claimant’s damages to succeed on this claim. The general assembly must adopt a resolution specifying who should initiate the proceedings on behalf of the company (Article 165, CCL). Any number of shareholders, regardless of the size of their shareholding in the company, can suggest this action in the shareholders’ meeting. The voting on this action usually requires a simple majority of the total votes, subject to any higher threshold included in the articles of association (Article 188, CCL).

Personal Liability of Directors

Pursuant to Article 246 of the Bankruptcy Law, if the company is declared bankrupt, the Bankruptcy Court may, at the request of the trustee, the Unit (if the debtor is subject to a supervisory body), or a creditor, require the members of the board of directors, managers, individuals responsible for the company’s actual management, or those involved in liquidation (in procedures conducted outside the scope of the Bankruptcy Law), to pay an amount proportionate to the error attributed to them. This payment will be used to cover the company’s debts if it is proven that any of the following acts were committed within the two years prior to the company’s suspension of payments:

• Engaging in commercial practices with uncalculated risks, such as selling goods below market value to raise funds with the intent of avoiding or delaying bankruptcy proceedings.
• Entering into transactions involving the disposal of assets without compensation, or with inadequate compensation, and without a clear or proportionate benefit to the company.
• Paying off a creditor’s debts with the intent to harm other creditors.
• If, after the company’s bankruptcy, it is found that its assets are insufficient to cover at least 20% of its debts, and it is proven that those responsible mismanaged the company, leading to its financial deterioration.

The Bankruptcy Law provides for a two-year clawback period from the date of cessation of payment and extends the liability to any individuals responsible for the actual management of the company – a major change under the Bankruptcy Law.

However, courts will not hold directors personally liable for these transactions where they either:

• Did not participate in the decision.
• Took all possible precautionary measures to reduce the potential loss that would adversely affect the company and its creditors.

Under the Old Law, the Dubai Court’s decision involving the bankruptcy of Marka Holdings PJSC demonstrated the liability imposed on a company’s managers and directors in an underfunded bankruptcy (see BSA Ahmad bin Hezeem & Associates, “Marka Bankruptcy Update”). In this case, the court held the managers and directors personally liable for AED448 million, representing the entirety of the company’s debt and referred the matter to the public prosecutor for further assessment. The decision also notes that this liability may be based on Article 162 of the CCL, which imposes liability on managers and directors for mismanaging the company (see Directors’ Duties and How Directors’ Duties Change in the Pre-Insolvency Period). The facts in this case involved the purported failure of the managers and directors to provide the financial statements, commercial books, or inventory lists, which would constitute a significant aggravating factor, if established.

Company Transactions That Can Be Challenged and Unwound if the Company Becomes Insolvent

When a company is undergoing the bankruptcy procedure (not preventive settlement), the management of the company is, in effect, transferred away from the directors to the court-appointed trustee.

The Bankruptcy Law provides for a clawback period, of six (6) months preceding the date of cessation of payment, which in turn may extend to two years preceding the date of initiation of proceedings for transactions involving insiders or related parties. During the clawback period the court may unwind certain transactions (Article 148, Bankruptcy Law).

These transactions include:

• Donations or gifts, except for small gifts that are customarily accepted.
• Any transactions in which the debtor’s obligations are significantly unbalanced with the obligations of the other party, whether these obligations are in kind or cash.
• Payment of the debts before the due date, regardless of the method of payment, or in a method that is different from the method usually followed to settle such type of debt. Creating a commercial paper that has not yet matured in exchange for payment shall be considered paid before the due date, unless there are commercial considerations justifying the same.
• Payment of outstanding debts other than the agreed-upon consideration. Payment through commercial papers or bank transfer shall be considered the same as payment in cash, unless there are commercial considerations justifying the same.
• Arranging any type of new guarantee on its assets to guarantee the payment of a previous debt, unless there are commercial considerations justifying the same.

Duties of Insolvency Officials to Investigate Pre-Insolvency Transactions and Director Conduct

As mentioned, the court oversees insolvency proceedings through a court-appointed trustee.

The trustee’s duties, as set out under the Bankruptcy Law, are more procedural in nature. Broadly, the trustee’s duties relate to:

• Making necessary publications.
• Inviting creditors to submit their debt documents to investigate their claims (and accept or reject claims).
• Preparing a report on the debtor company’s business and evaluating the debtor’s assets (for which the trustee must gather information (see Powers of Insolvency Officials and Office Holders to Require the Production of Information, Documents, or Assets When Investigating)).
• Preparing a restructuring plan and keeping the court updated on the progress of the restructuring.
• Coordinating the procedure with interested creditors.
• Ensuring the sale of the debtor’s assets according to the approved restructuring plan and depositing sale proceeds into the court designated bank account.
• Distributing the sale proceeds according to the Bankruptcy Law (Chapter 7).

Article 50 of the Bankruptcy Law allows the trustee, the debtor, or any creditor to ask the court to determine the scope of the trustee’s powers in relation to any specific matter, if the overall procedure is not disrupted.

While the trustee is not obliged to investigate the directors’ actions before the insolvency proceedings, this investigation may often flow naturally when the trustee is assessing the debtor’s assets, business, and communications (see Examination of Directors’ Pre-Insolvency Actions During Insolvency Proceedings). A trustee appointed in bankruptcy proceedings is subject to the general duties of experts under Federal Decree-Law No. 21/2022 on the Regulation of Expertise Before the Judicial Authorities.

Powers of Insolvency Officials and Office Holders to Require the Production of Information, Documents, or Assets When Investigating

The Bankruptcy Law grants the insolvency official (the trustee) powers to require production of information, documents, and assets. These powers may impose obligations on the debtor or third parties.

Some of these key powers of trustees are set out below:

• The trustee must, immediately on their appointment to handle the management of the debtor’s business, receive and review the debtor’s correspondences related to its business (Article 45(1), Bankruptcy Law).
• The debtor shall provide the trustee with any additional details that it has not notified the Bankruptcy Administration of, whether about its creditors or debt amounts, and details of any contracts under implementation and any pending or ongoing judicial procedures to which the debtor is a party, within the time period specified by the trustee (Article 95, Bankruptcy Law).
• The trustee may request any data or information related to the debtor’s assets or business from any person (Article 95, Bankruptcy Law).
• The debtor may not be discharged from the remainder of the debt in accordance with Article (248) of the Bankruptcy Law in case the debtor hides any information or documents that the Bankruptcy Law requires it to submit, or it was ordered by the Bankruptcy Court to submit them, but refrains from submitting them, or it submitted misleading documents or information (Article 250, Bankruptcy Law).

Conclusion

Directors of companies facing financial distress must navigate a complex legal landscape, balancing their duties to the company, shareholders, and creditors. The Bankruptcy Law provide a clear framework for directors’ responsibilities and liabilities during insolvency proceedings. Directors should be particularly cautious during the pre-insolvency period, as their actions will be closely scrutinized, and failure to adhere to legal obligations may result in personal liability. It is critical for directors to seek timely legal advice to ensure compliance and mitigate risks as their company navigates financial difficulties.