This article is part of the series Governance, in crisis.
Bashar Malkawi
Professor of Global Practice in Law
University of Arizona
Synopsis: The impact of COVID-19 on businesses emphasizes the need for insolvency systems that incorporate friendly rules for debtors and creditors not only in the short-term but also in the long-term.
Keywords: Insolvency, small and medium size enterprises (SME), COVID-19, restructuring, United Arab Emirates (UAE)
Like many other jurisdictions these days, the United Arab Emirates (UAE) has become a pro-restructuring jurisdiction. Previously, UAE insolvency law was seen as draconian with jail terms for defaulted debtors. Compared to the previous 1993 provisions on bankruptcy in the Federal Commercial Code – which included no less than 255 articles dedicated to insolvency and bankruptcy procedures – the UAE insolvency law of 2016 and then that of 2020 is groundbreaking in many aspects. The law introduced a new regime “agreement for settlement procedure” which can be helpful in rejuvenating businesses. The law created major provisions on creditors’ committees and debtor-in-possession financing, something the old law did not provide.
Those changes are timely considering the current COVID-19 global health pandemic and the fact that small and medium-sized enterprises (SMEs) account for more than 94% of the total businesses in the UAE and employ more than 86% of the private sector’s labor force. Similarly, in OECD countries, 95% of enterprises are SMEs and account for 60-70% of employment. At city level, in Dubai, for example, SMEs represent nearly 95% of all businesses in the city; provide jobs for 42% of the labor force, and contribute about 40% of the city’s GDP. SMEs are key players in the UAE economy. SMEs encourage both innovation and economic sustainability. As a matter of domestic policy, governments worldwide support SMEs. The UAE Central Bank announced a plan to provide aid in the short and medium term for SMEs, which includes support to the tune of DH100 billion (equivalent to $27 billion).
The Legislative Guide on Insolvency Law was prepared by the United Nations Commission on International Trade Law (UNCITRAL) provides for the key elements that ought to be included in any insolvency regime. Thus, an effective insolvency law must have the following key provisions. It should clearly outline its applicability and commencement standards. In addition, the law should prescribe the treatment of assets of the debtor entity upon commencement of the proceedings. The law should also indentify and provide for the rights and obligations of the key participants in any proceedings such as debtors, insolvency representatives, and creditors including secured creditors. By virtue of their first-in-line position, secured creditors have the most to win if reorganization plan fails. Ideally, a reorganization plan works for the benefit of both unsecured and secured creditors. The UAE bankruptcy law checks all the boxes.
In reality, however, the annual number of the corporate bankruptcy cases handled by UAE courts remains limited. After few years in existence, one can envisage some scenarios for this state of affairs and lack of effective use of the law. Many businesses may be hesitant to use the system out of lack of understanding of its provisions which revolutionized the culture of bankruptcy from selling defaulted party assets, as the norm, to focusing on reorganization. Another explanation is that courts are used for fair distribution, the pari passu principle, in judgment execution in lieu of bankruptcy proceedings. The execution order by courts gives the right to seize and sell any assets of the debtor. In addition, voluntary and involuntary winding up in company law can be seen as an alternative mechanism to address corporate distress. Finally, cultural factors could help explain the limited number of court cases. Stigma among peers associated with default and bankruptcy can play a factor in the UAE and, for that matter, across Arab countries more broadly.
Many issues remain to be addressed to have a holistic bankruptcy regime. For example, there are no specialized insolvency judges who are trained and appointed to apply the law. The same applies for bankruptcy office-holders. In terms of coverage, the law does not apply to non-profit entities such as educational or religious or scientific institutions. The law also lacks early warning mechanisms which aim at a prompt detection of the financial distress of an enterprise, as well as a quick adoption of more suitable remedies. These mechanisms can be activated by control bodies such as statutory auditors, supervisory board, internal control committee or external auditors. Directors should have due regard to the need to take steps to avoid insolvency. Furthermore, the UAE law does not provide for a possibility of a cross-class cram-down, the power to impose the plan on any dissenting creditors considered fair, equitable and in the interests of creditors.
The UAE insolvency regime serves as prototypical jurisdiction for other developing countries to follow. The UAE regime requires over time adopting substantive legal, practical, and cultural changes. It must be borne in mind that an insolvency regime should be designed not to punish businesses and their management. Rather the task of an insolvency regime is to revitalize the distressed business by restructuring its debt. In general, insolvency is not a moral failure but rather an economic failure.