Navigating Insolvency in The UAE: Bankruptcy Law Explained

Small and medium enterprises (SMEs) often face financial challenges in the UAE. One of the most daunting scenarios is insolvency. This article will give you an overview of the bankruptcy law in UAE and also debunk some misconceptions associated with it.

What Is Insolvency?

Insolvency refers to a situation where a company cannot fulfil its financial obligations and pay off its debts. UAE’s legal system provides a special insolvency regime to deal with companies that have become insolvent or are likely to become insolvent, i.e., Federal Law No. 9 of 2016, as amended (“Bankruptcy Law”). 

The Bankruptcy Law was established to simplify and streamline insolvency procedures. The legislation:

• Offers protection to companies, directors, and managers in the event of insolvency;
• Facilitates debt settlements in feasible instalments;
• Allows for asset liquidation without imposing personal liability on directors or managers;
• Empowers courts to supervise the entire insolvency process;
• Promotes financial rehabilitation through mechanisms like Preventive Composition to help businesses negotiate settlements with creditors.

The Bankruptcy Law allows the debtor company to pay debts via a settlement plan or apply directly for bankruptcy.

Sameer A. Khan

What Is Preventive Composition?

The Bankruptcy Law allows the debtor company to pay debts via a settlement plan or apply directly for bankruptcy. If a company is facing financial hardships (but not yet insolvent) and requires assistance to reach a settlement with its creditors, it may apply to the Court for Preventive Composition. 

A company can also apply for the same if it has been insolvent for less than thirty consecutive business days. Once the application for Preventive Composition is submitted, a court-appointed expert prepares a report on the financial position of the debtor company, which must include its opinion on whether the company’s assets are sufficient to execute Preventive Composition. 

If the Court accepts the application, it appoints a trustee to oversee the restructuring plan. The trustee must prepare an inventory of the company’s assets and a record of all its creditors. The company and the trustee then work together to prepare a draft Preventive Composition scheme, which is submitted to the Court. 

The draft scheme shall include the following:

• The possibility of the debtor company’s business to re-generate profits.
• Activities of the debtor company that must be suspended or terminated.
• Terms and conditions of settlement of any liabilities.
• Any performance bonds that may be requested from the debtor company.  
• Any proposal to purchase all or part of the business of the debtor company.
• Grace periods and payment deductions.
• The possibility of converting the debt to share capital.
• Any proposal to consolidate, create, redeem, sell, or replace any necessary guarantees to implement the draft scheme.
• The scheme implementation period.

The Court must then review the draft scheme within ten days of its submission. If approved, the trustee shall invite the creditors (within five business days) for a meeting to discuss and vote on the draft scheme.

Bankruptcy Proceedings

A company can directly file for bankruptcy under the Bankruptcy Law if it has ceased payment of due debts for over 30 consecutive business days. It can be due to financial hardships, or the debtor’s assets are insufficient to cover its due liabilities at any time. 

A creditor or a group of creditors may also make a bankruptcy application where the total amount of their debts is not less than AED 100,000, provided the debtor company has been formally notified to pay the debt and it failed to do so within thirty consecutive business days from the date of notification.

Once the bankruptcy application is submitted, a court-appointed expert prepares a report on the company’s financial position, which must include its opinion on whether restructuring (similar to Preventive Composition) would be possible and whether the company’s assets are sufficient to cover the costs of the restructuring process. 

When Preventive Composition or restructuring is inappropriate, the Court may order liquidation. The liquidation process is undertaken by one or more court-appointed trustees. The trustee liquidates all the debtor’s assets and distributes the proceeds amongst the creditors according to the order of priority specified in the Bankruptcy Law.

Debunking Common Misconceptions

A prevalent thinking among SMEs in the UAE facing bankruptcy is to replace existing directors or managers with new ones (preferably those who can easily leave the country) in order to shield them from personal liability for the company’s debts. 

However, there are better ways of dealing with insolvency. If the procedure under the Bankruptcy Law is followed, the directors and managers would likely avoid personal liability.

When Can Directors and Managers Be Held Liable?

The directors and managers may face personal liability under the Bankruptcy Law. However, their liability is not automatically engaged. 

To be personally liable, they must have contributed to the losses that rendered the company insolvent by committing certain acts such as disposing of assets at lower than market value, disposing of property without consideration, or against insufficient consideration. 

The directors and managers can also be held criminally liable under Bankruptcy Law when they are found guilty of any act involving fraud, embezzlement, forgery, or gross misconduct.

The Right Approach to Insolvency

Instead of seeking shortcuts or evasive tactics, companies facing financial distress should file proceedings under the Bankruptcy Law. It provides a comprehensive legal framework for financial restructuring and liquidation of companies.