UAE passes federal bankruptcy law - what has changed?

Financial Services Alert

This article was originally published on MEED and is reproduced with permission.

The UAE has succeeded in creating a dynamic economy known for its entrepreneurial spirit. In recent years, however, the rapid development of the business community has outpaced corresponding changes to its legal system.

To address this gap, the Government has passed Federal Law No.9 of 2016 Concerning Bankruptcy, which becomes effective on 29 December 2016 and aims to modernize the country’s approach to business failure.

Effective insolvency regimes aim to maximize return on capital and establish predictable systems to support the investment cycle. The new law does so by expanding options within the familiar frameworks of protective composition, restructuring and liquidation. In addition to eliminating certain deterrents, significant improvements over existing law are evident from three key changes.

Accelerated timelines

According to the World Bank, the average UAE insolvency proceeding is resolved in 3.2 years, nearly twice the time required in OECD high income nations. The new law contains specific, short timeframes allocated to the courts, applicants, trustees and experts to ensure that processes proceed swiftly through each stage. These timeframes are welcome and ambitious, though it remains to be seen whether parties will be able to stay on deadline.

Focus on business rescue

The new law moves closer to US and English systems by allowing a court ordered moratorium to stay actions against the debtor during composition and restructuring procedures. Related provisions also afford wide-ranging powers to bankruptcy trustees to ensure business continuity and prevent value-erosion.

In addition to adding a moratorium, the new law makes business rescue viable by allowing security cheques to be suspended following creditor approval of a restructuring plan. Successful restructuring relies on the participation of management. It is common for directors (particularly in SMEs) to provide security cheques to back up personal guarantee obligations arising in a restructuring. This has been a major stumbling block under existing law, as the threat of a prison sentence over a bounced security cheque has proved a potent disincentive for management participation in restructuring. By allowing security cheques to be suspended during court sanctioned restructuring plans, management can concentrate on resolution of the restructuring instead of fretting over jail time.

Super priority funding

The moratorium is meant to provide breathing space for a business, but any benefit from that space is likely lost without working capital. The new law introduces super priority funding to address this issue. Previously, financiers have been reluctant to lend to struggling businesses for fear that new lending will rank pari passu with existing heavily distressed debt. Affording super priority to new lending makes it viable for new funds to be injected, and increases the likelihood of value preservation and successful restructuring.

It's too early to tell whether the new law will be a game changer, but it is a clear improvement and should provide comfort to investors. The test will be whether businesses are encouraged, at an early stage, to utilise the legislation to engage constructively with its creditors to preserve value.