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How Insolvency Laws can help Businesses in the UAE

Updated on October 26, 2015

UAE is a fast-growing financial hub in the Middle East, hosting a number of domestic and international companies. However, despite its progressive economy, UAE still has a number of legislative hurdles that need to be addressed to provide a business-conducive environment for those looking to expand operations in the region.

Insolvency
Insolvency

What is Insolvency?

A company is considered insolvent when it is unable to satisfy financial dues in a timely manner. It occurs due to business and operational downturns, poor management, adverse economic or seasonal variations or poor financial management.

Types of insolvency

Insolvency occurs in two ways, primarily.

  • Cash-flow insolvency or actual insolvency: This occurs when a company lacks the required liquidity to meet its financial obligations. Cash insolvent companies usually have funds tied up in illiquid assets. Operational setbacks usually result in poor cash flows thereby making it hard to meet short and medium-term debt obligations.
  • Balance Sheet insolvency or technical insolvency: This occurs when a company lacks the required asset value to cover debt i.e. its liabilities are greater than its assets. This often leads a company to bankruptcy.

How Insolvency differs from Bankruptcy

Often used interchangeably, insolvency doesn’t necessarily mean a company is bankrupt. However, a company which is bankrupt is insolvent. Insolvency is a precursor to bankruptcy but at this stage a company can enter into negotiations with its creditors to resolve its adverse situation. Insolvent companies may institute measures which lead to a business turnaround or recovery thereby preventing a company from going bankrupt.

Often used interchangeably, insolvency doesn’t necessarily mean a company is bankrupt.
Often used interchangeably, insolvency doesn’t necessarily mean a company is bankrupt.

Benefits of Insolvency Regulations

Regulated insolvency proceedings contribute greatly towards a stronger financial environment and more stable economy. It greatly supports banks, the main source of corporate funding, in recovering amounts loaned to troubled companies through court-mandated debt restructuring programs. The benefits of UAE’s insolvency laws will depend on what kind of provisions it incorporates. Some of the general benefits of effective insolvency legislation include -

  • Equitable treatment of creditors to prevent marginalisation of a certain class of creditors’ e.g. foreign creditors.
  • Organised proceedings so that companies and creditors know what to expect in case of insolvency, as opposed to unregulated settlement procedures with uncertain outcomes.
  • Supervision of proceedings by an appointed authority.
  • Effective restructuring of debt to help companies recover and avoid bankruptcy.
  • Writing off or settling debts in a regulated manner thereby enhancing stakeholder confidence.
  • Time-bound processes to ensure timely settlement of debts and avoid long-drawn negotiations.
  • Transparency, preventing irregular settlement of debts or fraud which can occur when a company is in financial trouble.
  • Minimisation of the stigma attached to insolvency as it is viewed as a routine business process and not management failure.
  • Efficiency of capital markets; creditors are more willing to lend to companies knowing their interests are safeguarded during troubled times.
  • When entire sectors face crises, as UAE experienced during the 2008 global downturn, an effective insolvency process can draw creditors to bear insolvency costs thereby reducing public financial burdens.

Insolvency can free businesses from the captivity of debt!
Insolvency can free businesses from the captivity of debt!

Insolvency in the UAE

For a long time, insolvency did not figure in UAE’s financial landscape. Pre-2008, when the country was experiencing a huge economic upswing, investors considered UAE a very safe place to function in. Advantageous tax laws and projections for a bright future drew investments in on a large scale. However, the 2008 global crisis changed everything and insolvency, how to deal with it and bankruptcy become keywords in financial day to day life. Going bust, became, quite literally, the order of the day. Eventually, however, the economy did find its way out of troubled waters with many projects either on hold or scrapped. UAE was forced to face a number of situations. Key among them, how to deal with companies that can’t cope.

Despite such large-scale adversities, though, change has been slow in the UAE and financial gurus worry that in the absence of much needed reforms, the region will not achieve the kind of financial progression it desires. 7 years later, UAE still doesn’t have concrete insolvency and bankruptcy laws. The insolvency reform bill was thought to be ready for implementation late last year but even mid-way through 2015, it still hasn’t been finalized. An insolvency law can help minimise large-scale damage by providing avenues to help companies in trouble revive themselves rather than lose business altogether.

Currently, to settle dues, creditors and owners or directors of failing businesses often negotiate out-of-court agreements between themselves. This is usually time-consuming and, being unregulated, doesn’t necessarily provide the best results for those involved. It has been reported that insolvency settlements can take as much as 3 years and only about a quarter of dues are ever recovered.

Domestic businesses that fail to perform well have long since felt the sting of being termed ‘business failures’ as opposed to those that faced financial difficulties. The stigma associated with a business being financially unviable, even if its for genuine reasons, makes it difficult for business owners/directors to survive or operate successfully in the future. This is usually because stakeholders lose confidence in the business. Raising funds or borrowing is a difficult affair for insolvent companies trying to recover as courts are more prone to order liquidations than rehabilitation. Another factor making it difficult for debtors to escape financially adverse situations are laws that see debtors jailed if they are unable to repay debts.

International businesses find the absence of insolvency regulations an impediment to business in UAE, fearing unhealthy exits during downturns. Richard Branson, who heads the globally renowned Virgin Group is famously quoted as being ‘flabbergasted’ with the lack of legislation regarding insolvency and bankruptcy in UAE.

UAE’s Insolvency Reform Bill

The need for insolvency legislation was greatly pronounced during the global financial crisis of 2008 - 2009 which saw businesses in UAE unable to repay creditors. This led to a major loss of investor confidence. It was during this time that the Dubai World Tribunal was set up and highlighted the need for insolvency and bankruptcy rules. As UAE tried to recover from the crisis, the need for insolvency and bankruptcy laws gained centre stage as foreign businesses shied away from expanding in a region that did not have adequate provisions in place.

Under the new law, insolvency is to be dealt with in three different ways viz.

  • Financial deregulation to deal with out-of-court settlements between companies and creditors
  • Preventive Composition of Bankruptcy to deal with the process of restructuring a company’s debts under the supervision of courts and an appointed supervisor.
  • Bankruptcy to deal with bankruptcy proceedings under an appointed supervisor’s authority.

The bill is meeting quite a bit of criticism, though, from large corporates who feel it has been devised to suit small businesses and traders. However, experts believe the establishment of a law is more important at this stage than not having any laws at all. The draft bill has already cleared most hurdles and is expected to be implemented soon. Glaring or not so obvious failings of this bill are bound to come under the scanner for revisions once implemented. However, the existence of the bill will provide the required impetus to enhance economic stability.

Economic Growth

Dubai and Abu Dhabi are the two cities highlighted in the financial arena as they have seen the maximum amount of investment over the years.

Free zones in UAE are meant to promote business and economic growth. The latest, the Abu Dhabi Global Market Square, is one such zone which aims to attract businesses. With so much being pumped into the financial system of the region, the need for effective legislation becomes more pressing. Rules regarding how businesses are to function in these zones and also exit from these zones will determine whether companies are willing to establish themselves here.

Expo 2020 furthers draws attention to UAE. Trying to attract global interest and hoping to position itself as a global financial hub, UAE will have to create a robust legal and institutional framework.

It is evident that while insolvency is generally considered negatively in the business world, there is a necessity for and definite benefits from it. UAE has certainly felt the need for bankruptcy regulations and as the region progresses towards becoming a stronger financial, economic zone, it won’t be long before the bill becomes a reality.

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