Crisis turns spotlight on insolvency law

The laws relating to the insolvency of companies in the UAE may come into sharp focus now as the economic climate has left many employers and contractors and consultants exposed from a financial point of view.

Although the "non payment" difficulties being faced by construction companies have been in the spotlight, sectors connected to it, such as suppliers of goods and materials and the real estate sector, are also struggling with cash flow and may face difficulties in meeting their payment obligations as they fall due.

This article will outline the existing insolvency law set out in Federal Law No 18 of 1993 issuing the Law of Commercial Procedure (the law), looking at the technicalities of insolvency, the legal process and the alternatives for a company facing this situation.



When does a company become insolvent?

There is no definition of insolvency or bankruptcy in the law, but any employer or contractor or indeed consultant can be declared bankrupt when it has ceased or is unable to pay its commercial debts due to of its financial instability.

However, an employer, contractor or consultant will not be technically bankrupt until the court has actually made a "declaration" of bankruptcy, which can be requested by a creditor or the company itself.

Accordingly, a contractor could seek a declaration of bankruptcy if the employer fails to make payment as against a payment certificate as issued by the engineer and where no notice of withholding has been issued by the employer in accordance with the contract.

Further, if an employer or construction company does not declare itself bankrupt within 30 days of ceasing to pay its debts, the directors and/or management of a construction company or developer need to be aware that they may be charged with negligent bankruptcy, which is punishable by imprisonment.

One also needs to bear in mind that the law does not just apply to local employers, contractors and consultants.

The law gives jurisdiction to the UAE courts to hear cases for or against foreign contractors and consultants, irrespective of whether or not they have been declared bankrupt.



Effect of a declaration of bankruptcy

The declaration of bankruptcy will prevent the developer, construction company or consultant from dealing with or disposing with its development rights, property, assets, concluding transactions or paying its debts. Instead, a trustee will be appointed to manage the bankrupt's property and business.

The law is drafted so that all action in relation to the bankrupt must be dealt with within the bankruptcy process. Accordingly, any claims ongoing against the employer, contractor or consultant (as the case maybe) will be suspended and no further claims can be brought. Accordingly, a contractor and consultant needs to think very carefully before threatening bankruptcy proceedings in order to enforce an outstanding debt.

A contractor or consultant must also be aware that if he receives any payment from an employer that is effectively bankrupt, he is likely to be deemed to be aware that such a payment is detrimental to other creditors, the effect of which could be the committal of a criminal offence punishable by imprisonment for a director or officer of the contractor or consultant concerned.

The declaration of bankruptcy requires the court to invite creditors by newspaper announcement to submit evidence of their debts. Secured creditors (such as funders) are permitted to realise the secured assets to recover their debts.

The court brings together the verified unsecured creditors – and contractors and consultants are likely to be unsecured creditors – to approve a composition with the bankrupt.

The objective is to find an arrangement for the bankrupt's business to continue while paying off its debts. The creditors can impose conditions on the composition, such as the appointment of guarantors for the debts.

Contractors and consultants whose debts have not been verified by the court or who missed the court deadlines cannot participate in the composition. If those contractors and consultants do not approve the composition, the bankrupt's assets will instead be realised to pay off the contractors and consultants but the employer will not be wound up.



Individuals' liability

The bankruptcy can have potentially onerous consequences for the directors and management of the company.

If the employer or contractor or consultant cannot meet 20 per cent of its debts and the liability of the directors or managers has been established, they may be required to meet all or part of its debts personally.

Any offence whereby they have concealed from, embezzled or deceived the creditors may be considered to be fraudulent bankruptcy, punishable by imprisonment.

There is also a lesser offence of negligent bankruptcy where they have committed acts that are detrimental to the funds available to be distributed to the supply chain.



Protection from bankruptcy

Employer, contractor or consultant may prevent themselves from being declared bankrupt if, within 20 days of ceasing to meet debt, it applies to the court for a protective composition. This is conditional upon the company concerned being able to meet 50 per cent of its debts within three years, and the approval of the creditors.

This enables the debtor to keep control of its assets and management of its business.

The short timeframe for an application in this regard means that an employer, contractor or consultant requiring this protection must be both aware of the law and decisive.



Bankruptcy and liquidation

Bankruptcy differs from liquidation, which essentially requires the company to be dissolved. Generally, the shareholders of a company can agree to apply for its liquidation at any time (but are more likely to do so when it is struggling financially). A liquidator is appointed by the court to administer the disposal of the company's assets and distribution of the proceeds to creditors.

Liquidation can be used as a pre-emptive action by a company's shareholders to avoid bankruptcy and its consequences. However, contractors and consultants can request a company's bankruptcy while the liquidation is ongoing (but before an employer is liquidated entirely), which will suspend the liquidation process. A company that has been declared bankrupt cannot be liquidated. Conversely, a company that has been liquidated cannot be declared bankrupt as it will have been removed from the Commercial Register.



Alternatives to the court process

There have been only two cases of corporate bankruptcy of any note under the existing laws and there does not seem to be any groundswell among employers, developers, contractors, consultants or suppliers to rush to the courts to remedy an insolvent situation. The almost unproven nature of the legislation has led commentators to suggest that it is not fit for the situation that many companies now find themselves in.

Hawkamah, the Dubai-based corporate governance group, recently advised that the UAE's insolvency regime lags behind those of its GCC counterparts and is in need of reform.

All of which may be too late for many contractors and consultants now and impact on commercial activity in the future.

If creditors regard the recovery process under an insolvency regime as inefficient should a debtor default, they will be more reluctant to lend money. Further, entering into inefficient insolvency proceedings may distract employers, contractors and consultants from their main business activity for an unacceptable and detrimental period of time.

As an alternative, it has been proposed that employers and their contractors and consultants can come to private composition arrangements with their creditors. On the face of it, this may appear practical as the parties are likely to be efficient at agreeing the debt and how it should be paid.

However, this would carry with it two legal problems: If either the employer or the contractor/consultant decides not to perform its obligations as agreed under this composition, the arrangement is unenforceable in court because the parties have clearly been trying to circumvent the applicable law by entering into the arrangement, essentially making the arrangement not worth the paper it is written on.

Further, if a creditor is excluded from this process, whether by accident or design, there is nothing to prevent it from going to the court and putting in a request for bankruptcy. The court may charge the directors or officers of the employer, contractor or consultant (as the case may be) for negligent bankruptcy and may regard unfavourably the participating creditors when it comes to assess their debts as part of the formal bankruptcy proceedings.



Conclusion

The unforgiving nature of the bankruptcy process means that each potential party to it – employer, contractor, consultant, supplier and its management and directors as well – need to be very aware of the imperative to take swift action when a company stops meeting its payments.

A company should be ready to pre-empt its bankruptcy being declared and a creditor should be ready to act if another creditor requests a debtor company's bankruptcy or to request the debtor's bankruptcy. Whatever the potential weaknesses of the existing insolvency regime, it remains the applicable law and so all actions by employers, contractors and consultants should be in accordance with it. 



- Andrew Greaves is partner in the projects and construction team and Nick Boyd is a Senior Associate in the corporate team with the legal firm Trowers & Hamlins

 

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