This is the second edition of our new regular newsletter designed to address interesting legal topics in the Middle East. In this edition, we take a look at some of the legal issues facing a buyer of assets from a company in financial difficulties in the UAE, as well as some regional legal news items.

• Top tips for buyers of assets from distressed sellers in the UAE

• Recent legal developments in the Middle East

Top tips for buyers of assets from distressed sellers in the UAE

Periods of economic uncertainty create opportunities for investors who wish to acquire assets at values lower than their historic prices.  This article considers some of the issues which arise under UAE law and generally for such investors, when dealing with insolvent, or near insolvent, entities.

The importance of establishing the seller's state of solvency

There are different extents to which a seller may be "distressed".  It is important to establish the seller's status as soon as possible in any transaction. The directors may merely be worried that the company may not be able to meet future financial commitments.  Alternatively, payment obligations may have become due and payable and not paid and, as a result, an insolvency process may have started.  A liquidator or a bankruptcy trustee may have been appointed or, in a protective composition scenario, a voluntary arrangement may have been agreed between the debtor and its creditors.  Therefore, from a buyer's perspective, it is important at the outset to establish the seller's status as this will affect its ability to deal with the buyer in the sale of the asset.

In the UAE, it should be noted that there is no searchable insolvency register to assist a buyer in this process.  Albeit a time consuming task, local daily newspapers can be trawled for announcements which must be published in an insolvency event by law.

Implications of transacting with an insolvent seller

The principal concern is the possibility of a transaction being set aside. In a bankruptcy scenario, the bankruptcy trustee has the power to set aside sales at an undervalue if they occur after the date of suspension of payments (see below as to the importance of obtaining valuations). Also, if, after a sale has taken place, the seller is subsequently declared bankrupt, that sale may be unwound where the sale was harmful to a bankrupt's creditors and the buyer was aware that the seller was insolvent at the time of the purchase.

In many Western jurisdictions, directors may potentially be liable for wrongful trading. UAE law is not so heavily regulated and directors of companies selling assets may not be aware of the boundaries between lawful and unlawful trading activities.  In the UAE, a director may be sentenced to prison where he disposed of assets of the company after suspension of payments if the intention was to remove those assets from creditors.  Although the duties of the seller company's directors are not directly relevant to the buyer, it may involve negative publicity for the buyer if the transaction subsequently came under scrutiny.

One further point to note is where the seller is a listed company, it will be subject to exchange disclosure requirements. Although negotiations with potential buyers per se do not trigger a requirement to make disclosure, if information of a potential transaction leaks into the public domain and may have an effect on the seller's share price, an obligation to disclose would be triggered.  Prior notice of such a transaction to creditors may cause them to commence insolvency proceedings, which may put that transaction in jeopardy.  It will also clearly expose the negotiations to other interested parties.
 

Valuations are necessary

Due to the potential risks of sales being attacked by the seller's creditors as transactions at an undervalue, it is important that the buyer obtains a robust valuation of the relevant asset from an independent third party valuer to protect itself against such claims.
 

Terms of the SPA

A buyer would ordinarily seek protection from the seller by way of contractual warranties in the sale contract as to certain factual matters, as well as contractual assurances that the seller will do everything to perfect the transaction so that the buyer receives full legal title to the asset.  The remedy for breach of these clauses is usually contractual damages to compensate for the claimant's loss. Such clauses may be worthless where the seller is, or may soon become, insolvent due to the risk of there being no monies to pay any award.  This makes good due diligence all the more important; it may also be factored into the purchase price and, if it is, the valuer should, if appropriate, refer to this in its valuation.

Restrictions on an insolvent seller's ability to dispose of assets

Where the seller is in a protective composition, the seller is not permitted to sell any property outside of the ordinary course of business, without obtaining the judge's permission and any such sale would not be binding on the seller's creditors.  Arguably, this means that if the assets are real estate and the seller's business is property investment, then properties within its portfolio are required for its ordinary commercial activities and could continue to be sold. But, depending on the nature of the seller's business, it would always be prudent to consider if the judge's permission is needed for the sale to proceed.

Similarly, in a bankruptcy situation, seals are placed on the assets if a bankruptcy order is made and any disposals made on the day of the judgment, or after that date, will be void. In the case of real estate assets, the sale is only binding if registration of the sale has been completed at the relevant Lands Department by the time the bankruptcy judgment is made.

The importance of legal due diligence to ascertain security interests over the assets

On any sale, a buyer will want to check that it will receive unencumbered title to the assets on transfer.  It becomes more important on a distressed sale due to the increased likelihood of outstanding obligations and debts to third parties, whose rights may have been protected against the assets. 

Under UAE law, it is possible for a lender to register rights against land and buildings with the Lands Department, in the form of a land mortgage.  It should also be noted that a protective composition or a judicial composition (pursuant to a bankruptcy order) may be registered at the Lands Department in relation to real estate assets, as can priority liens over the property by contractors and building engineers in respect of amounts owed to it under the building contracts for construction of that property.
 

It is also possible to register rights over certain other assets, such as vehicles, vessels and aircraft.  A potential buyer of these types of assets in the UAE will need to inspect the registers.  Share pledges are also possible over shares in a joint stock company and a buyer of shares in this circumstance should seek to inspect the company's share register. 

Another form of security which may be taken by a financial institution with a presence in the UAE is a business mortgage which in some emirates can be registered on the commercial register maintained by the competent authority for that emirate (Dubai and Abu Dhabi both have registration systems in place). A business mortgage can be taken over stock and other movables, receivables and financial instruments, and should specify the mortgaged assets.

Other security in the UAE tends to be on the basis of a specific pledge over an asset, where some form of possession (constructive or actual) by the lender or a third party is generally required.  Specific legal advice should be sought to help establish whether a particular asset has been pledged.

One practical point to note is that none of the registers mentioned above are publicly searchable and so the co-operation of the seller or a court order will be needed to inspect them as part of the due diligence process.

Foreign ownership rules

Depending on the nature of the asset, there may be foreign ownership restrictions which need to be taken into consideration by an overseas buyer of distressed assets in the UAE.  In relation to real estate assets, there are restrictions on overseas entities acquiring real estate in the mainland UAE, outside of designated free zones or investment areas.  With regard to share acquisitions, the Commercial Companies Law states that the capital in any entity established under that law must be owned as to at least 51% by UAE nationals (although the position is slightly different if the overseas investor is a GCC national by virtue of GCC co-operation treaties). 

(Nick Turner, Alice Rogers and Justine Reeves)

Recent legal developments in the Middle East

Dubai World - special tribunal is open for business

The special tribunal created to hear claims related to the financial difficulties of Dubai World and its subsidiaries is "fully operational", according to the tribunal's registrar, although it is also reported that no claims have yet been filed by creditors of the group.  The tribunal has its own webpage on the DIFC Courts website at www.difccourts.ae

See our briefing on the Dubai World tribunal here.

Qatar - relaxation in the foreign ownership rules

The Qatari Emir has passed a law amending the Qatar Investment Law.  The new law (Law No. 1 of 2010) has extended the categories of business in which overseas investors are entitled to own up to 100% of the capital by the following four types of business: 

• consultancy services;

• information technology;

• services relating to sport, culture and entertainment; and

• distribution services.

The list already includes industry, healthcare, education, tourism and the exploitation and development of natural resources and energy.  Note, however, any application by a foreign company to wholly own one of these types of business, in practice, is still subject to the discretion of the Ministry of Business and Trade.  Amongst the conditions which the Ministry will apply are that the business must be of benefit to the State of Qatar and consistent with its development plans. 

The general foreign ownership position in Qatar under the Investment Law is that foreign investors can own up to 49% of the capital but the areas of commercial agency, banking and insurance are restricted to Qatari nationals.

New commercial courts in Saudi Arabia

The Supreme Judiciary Council in the Kingdom of Saudi Arabia has approved the establishment of specialised commercial courts in the main cities of Riyadh, Jeddah and Dammam.  A new commercial courts circuit will also be created within the general courts system in certain other cities, including Makkah and Medina. 

The judicial system is undergoing significant reform in Saudi Arabia and these developments are part of that process.  In recent years, the courts system has been divided into two branches: the Shari'ah courts and the Board of Grievances.  The Shari'ah courts comprise the general courts and the criminal courts.  The general courts hear certain civil cases between private parties.  The Board of Grievances adjudicates (i) between Saudi government agencies and private parties and (ii) in certain commercial disputes between private parties, and is also the forum in which proceedings for enforcement of foreign judgments and arbitral awards are heard. 

The Supreme Judicial Council supervises the Shari'ah judiciary, as well as administering the promotion, transfer and training of judges.  It also has jurisdiction to resolve conflicts arising between the final judgments of the Shari'ah courts and the Board of Grievances.

(Justine Reeves)

The content of this article does not constitute legal advice and should not be relied on as such. Specific advice should be sought about your specific circumstances.

Herbert Smith LLP, Gleiss Lutz and Stibbe are three independent firms which have a formal alliance.

© Herbert Smith LLP 2010