A new era in bankruptcy: Key highlights of the new law on financial restructuring and bankruptcy
On 1 May 2024, Federal Law Decree No. 51 of 2023 concerning Financial Restructuring and Bankruptcy (the “New Law”) came into effect in the UAE. The New Law repeals Federal Decree-Law No. 9 of 2016 on Bankruptcy (the “Old Law”). The New Law introduces significant changes for creditors and debtors by providing a framework where distressed companies can be rescued at the earliest opportunity while at the same time striking a balance between the interests of the creditors.
The New Law, like the Old Law, will apply to onshore companies in the UAE but not to companies registered in the Dubai International Financial Centre (DIFC) or the Abu Dhabi Global Markets (ADGM), which have their own standalone insolvency laws and courts. The New Law establishes standalone bankruptcy courts and a bankruptcy unit to assist the court and expands the ambit of reviewable transactions by the courts and the liability of directors.
Until new regulations and resolutions are issued under the New Law, those issued under the Old Law will remain in effect to the extent they do not conflict with the New Law. Executive Regulations to the New Law are expected in the coming months.
Preventive settlement
The New Law introduces the concept of preventive settlement, a court-supervised process initiated by the debtor which allows it to continue commercial activities and meet its debts and liabilities. To undertake preventive settlement, a debtor must submit a preventive settlement proposal at a meeting of its creditors, and the proposal must be for approval by creditors having two-thirds of the value of the debt represented at the meeting (provided at least half the company’s creditors are present at the meeting). Once approved, the settlement agreement is binding on all creditors, including creditors who abstained from engaging in the negotiation procedures.
Preventive settlement is analogous to the process of preventive composition under the Old Law. However, preventive settlement allows a debtor to continue managing its business and assets as usual without the appointment of a trustee.
Key features of the preventive settlement proceeding include:
1. Debtor in possession: Once the proceedings are open, the debtor retains the ability to manage the business and its assets, provided that no actions are taken that are detrimental to the interests of the creditors. This is akin to a Chapter 11 proceeding in the United States.
2. Moratorium: Following the commencement of proceedings, a three-month moratorium on creditor claims comes into effect. This may be extended with leave from the bankruptcy court provided that the total moratorium period does not exceed six months in total.
3. New financing: A debtor is permitted to obtain additional financing during the preventive settlement process if stipulated in the proposal or approved by creditors representing two-thirds of outstanding debt. Security may also be provided in respect of the financing; however, security taken over any assets already secured by a pre-existing debt must be ranked subordinate to the pre-existing security unless the existing creditor consents to the new security ranking pari passu or senior to the pre-existing security.
4. Amendment and termination: A preventive settlement proposal may be amended during the implementation process with two-thirds’ creditor approval as set out above. In certain cases—such as the debtor’s failure to adhere to the terms of the proposal, a serious error by the debtor in managing its property or business or the debtor being convicted of a crime or having a criminal case opened against them—a creditor may file a motion with the bankruptcy court to terminate preventive settlement proceedings.
New bankruptcy courts
The New Law provides for the creation of new bankruptcy courts at both the federal and local level. These courts are intended to manage and adjudicate preventative settlement, financial restructuring and bankruptcy processes. The dedicated court system is expected to improve the speed and efficiency of restructuring and insolvency cases in the UAE. All claims, legal proceedings, grievances and actions which are pending before the courts under the Old Law and which were not adjudicated prior to 1 May 2024 will be transferred to the new bankruptcy courts.
The new bankruptcy courts are expected to play an active role in bankruptcy proceedings, such as overseeing the management of assets and business of debtors so as to ensure progress of the proceeding and having the power to meet with creditors to discuss any matters being considered by the courts. The decisions by the new courts are immediately enforceable without a requirement to be served. Enforcement may not be challenged or stayed unless the bankruptcy court decides to reverse or stay execution (either sua sponte or at the request of an interested party) or the Court of Appeal is hearing a challenge.
Insolvency test
Under the Old Law, the test for insolvency involved a cashflow and balance sheet test, where the debtor is able to submit to a preventative settlement procedure, financial restructuring or bankruptcy if (a) it has not ceased to pay its debts for a period of more than 30 consecutive working days due to the instability of its financial position, or (b) its assets do not cover its liabilities.
Alternatively, a debtor could submit to a financial restructuring or bankruptcy procedure under the Old Law if (a) the debtor has ceased to pay its debts for a period of more than 30 consecutive days due to the instability of its financial position, or (b) its assets do not cover its liabilities.
Under the New Law, no such distinction exists. Article 15 allows a debtor to submit to the Bankruptcy Department an application for the initiation of preventive settlement, or bankruptcy proceedings, not later than 60 days after the cessation of payment date or from the date on which it becomes aware of information confirming that it would be unable to pay off its debts when they fall due, unless any of the creditors or regulatory authorities has submitted an application for initiating the proceedings within the aforementioned period. However, an application will not be rejected for failure to submit within the 60-day period.
Liability of directors and management
Under the Old Law, if a company was declared bankrupt and its assets were insufficient to cover at least 20% of its debts, the court could order one or more of the company’s directors or managers to pay the remainder of the company’s debts in limited cases. This applied where, in the two years preceding the company’s cessation of payments, its directors or managers committed certain specified acts that detrimental to the company’s financial situation, such as paying the debts of some creditors with intent to cause damage to other creditors or disposing of assets at a price below their market value in order to avoid bankruptcy proceedings. In such cases, directors or managers could be held liable for an amount proportional to their mistakes.
Under the New Law, liability is expanded to include not only directors and managers but any person responsible for the actual management of the company and those in charge of the liquidation. In addition to the acts enumerated in the Old Law, such persons may be held liable if they more generally mismanaged the company in a manner that led to its financial deterioration.
In addition, the New Law imposes a two-year limitation period (from the issuance of the judgment declaring the entity bankrupt) for proceedings initiated against the aforementioned persons. Furthermore, such individuals may not be found liable if they can demonstrate that they took all precautionary measures that a reasonable person could take to reduce the potential losses or if they had documented their objections to the relevant action.
Conclusion
The New Law marks a significant evolution in the UAE’s approach to financial restructuring and bankruptcy. By introducing preventive settlement procedures, establishing specialized bankruptcy courts and expanding the liability of directors and management, the New Law aims to create a more robust and efficient framework for addressing financial distress. This law not only provides greater protection for creditors but also offers debtors a clearer path to restructuring, balancing the interests of all parties involved.
Authored by: Abhishek Banerji, Ellen Ray
