The United Arab Emirates' new insolvency law
July 2012 | 10QUESTIONS | BANKRUPTCY & RESTRUCTURING
FW speaks with David Stark at Deloitte Corporate Finance Limited about the United Arab Emirates' new insolvency law.
FW: What is your understanding of the purpose of the proposed new law?
Stark: The new law is designed to provide a consistent framework under which companies in financial distress can reach a resolution to their predicament, be it by way of a consensual negotiated agreement with its creditors or through a more formally administered procedure. The driving concept is to provide a method by which stressed and distressed companies can either come to a place where they are able to resume trading profitably and to the advantage of all parties, or be wound up and liquidated in a controlled manner. Ultimately, companies that spend protracted periods of time in a distressed state tie up capital that therefore cannot be circulated around the local economy which in turn suppresses liquidity and growth. A law that allows this capital to be redistributed whilst encouraging corporates to admit the existence of difficulties will therefore benefit the economy as a whole.
FW: Why introduce it now?
Stark: In the Middle East the concept of restructuring is fairly new. The phenomenal growth of local economies over the past few years has introduced businesses – and sometimes governments – to the major international debt markets and that has brought with it exposure to global macroeconomic trends. The most recent global financial crisis signalled the first instance that many businesses and lenders in the region have had to face up to the idea that their businesses may not keep growing and that their debts may not be repaid in full and on time. With respect to legal frameworks, many Middle Eastern jurisdictions, including the United Arab Emirates (UAE), had not previously considered the possibility that businesses would fail, or be unable to repay debts, meaning that the appropriate legislative frameworks had not been put in place. While the UAE does have an insolvency law, the general consensus amongst the legal community is that the outcome of any cases heard under the existing law would be highly uncertain and take a protracted length of time to resolve. This leads to an uncertain environment for banks and other creditors with regards to their contingency and enforcement options, should consensual discussions with a struggling business not bear fruit. Ultimately uncertainty is likely to result in reduced lending and a general suppression of liquidity in the local economy. A case in point is Dubai World which, in November 2009, caused shockwaves throughout the financial world with the surprise announcement that it could not pay the Nakheel Sukuk amortisation of $3.5bn due in December 2009. Aidan Birkett, ex-head of Deloitte UK Corporate Finance, was immediately appointed as chief restructuring officer (CRO) for the group. However, there remained insufficient time to pull together the crisis management plan required. This led to surprise in the banks and a collapse of confidence in the region. Ultimately a special court within the Dubai International Financial Centre (DIFC), the ‘Dubai World Tribunal’, had to be established to hear these cases, based on principals adopted by other countries.
FW: When can we expect it to come into force?
Stark: As with any new law, the key to successful implementation will be to get it right first time and not require significant amendments post-enactment. To this end, in our opinion, the UAE government is going to great lengths to ensure that the right law is developed for the region rather than just ‘copying and pasting’ from other jurisdictions. Experts from across the world have been assisting the UAE government, providing input into the advantages and disadvantages of the laws their countries apply while, as you would expect, other experts are helping to ensure that any new statute meets Sharia’a requirements. The new laws will also need to be both practical and enforceable and so the Ministries of Justice and Finance will also have a significant input into ensuring that the right law is released first time. In summary, whilst a date of late 2012 has been talked about in some quarters I wouldn’t be surprised to see any such law delayed, but it should be worth waiting for.
FW: So has the new law been entirely drafted from scratch?
Stark: No, not entirely. The underlying principals all loosely based on the processes used in a number of jurisdictions including the UK, the US and France, which have then been shaped to make them more appropriate for the local region including ensuring that they are consistent with Sharia’a principles. Local lawyers have assisted the government in drafting the law with help from international lawyers with experience in other regimes. My team and other professional advisors have been asked to provide commentary to various government departments and bodies such as UNCITRAL and INSOL have been consulted. Obviously one challenge that the law makers will face is the conversion to Arabic of a law that we understand was initially penned in English, as ultimately this will be administered by the local courts which, unlike the DIFC courts, do not conduct hearings in English.
FW: What are the key processes under the new law?
Stark: The new law will introduce three main concepts which have been termed ‘Financial Reregulation, Preventative Composition of Bankruptcy and Bankruptcy’. The first of these, ‘financial reregulation’ sets out the processes under which an out of court agreement can be achieved between the debtor and its creditors with the help of an assistant. ‘Preventative composition of bankruptcy’ is a restructuring process overseen by the court and an independent supervisor. This is a debtor in possession procedure which appears to be similar to a US Chapter 11 process or the Company Voluntary Arrangement (CVA) procedure in the UK. It allows the debtor to retain control of the business with the protection of the court for a period of time while consensual solutions are sought. Finally, ‘bankruptcy’ covers a process available to insolvent businesses where they are controlled by a bankruptcy supervisor, rather than the debtor. The process provides for either the restructuring of the business or the liquidation of its assets. The law also sets out provisions around the insolvency of individuals.
FW: What are the key differences you have seen between restructuring in the Middle East and Europe?
Stark: Europe has been through many cycles of boom and bust and the approach to restructuring has been developed and augmented over time, both in terms of the mindset of stakeholders – both companies and banks – and in terms of legal frameworks. Restructuring is viewed as a normal part of a business life cycle, the result of entrepreneurial risk-taking. It is without stigma and is not necessarily seen as the ‘fault’ of management unless factors such as wrongdoing are present. The environment for restructuring in the region is less mature than it is in Europe and the US, for example, where the Insolvency Act in the UK and Chapter 11 in the US are well-established regimes that offer a degree of comfort that a predictable legal outcome can be expected. Comfort in the lender’s security position gives them and the company a base from which to negotiate.
FW: What are the key features of the restructuring market in the Middle East region?
Stark: To date, a lot of the restructurings that have taken place have been dubbed in some quarters as ‘extend and pretend’ arrangements – that is, ones in which the borrower and lenders have not acknowledged that there is a serious issue that requires a significant restructuring but have rather just ‘termed out’ the debt, extending the maturity date to reduce capital repayments, often coupled with lowering interest rates to reduce the borrower’s financing costs. Whilst this has the advantage of protecting the lender’s profit and loss accounts by allowing them to justify taking no provisions, what it ends up doing in most cases is burdening the lender with sub-prime lending whilst potentially locking in the financial underperformance in the borrower. This lending may underperform basic inflationary levels and tie up capital preventing the lender from capitalising on opportunities to lend to more profitable customers. This cycle of stagnation and tied up capital could ultimately choke both the lenders and the system resulting in regional economic depression and a failure to recover and grow. However, in recent months we have seen banks taking a more proactive approach to restructuring where the root causes of underperformance are being addressed. This, I believe, is in part due to the UAE Central Bank taking an increasingly proactive approach to ensuring banks adequately provide in distressed situations.
FW: If you could ensure that one thing was enshrined in the new law what would it be?
Stark: The key to a successful law is one which provides a relatively high degree of certainty for all parties involved. Once a framework is in place that offers greater certainty as to the likely outcome given various different scenarios, investors can be more confident about placing funds in the region. Furthermore, stakeholders can be educated as to the likely outcome of various courses of action on all parties and this in turn provides the basis for consensual negotiations to be concluded in a much shorter timeframe. One cannot measure the merits of the carrot without being exposed to the potential of the stick. What I don’t want to see is a new law which results in protracted court disputes and uncertainty around the actions taken by all those involved, including the incumbent directors and any office holder appointed to manage the company’s’ affairs. Such an outcome will be to the detriment of all those involved as uncertainty and lack of action are key drivers in value erosion for all stakeholders.
FW: What is your outlook for the region?
Stark: Restructurings will continue to happen apace, but it is also important to realise that there is not a requirement for corporates to wait until the very last minute to take action and seek help. We have been working with many high profile corporates and family business in the region to implement what we term ‘performance improvement’, or for want of a better description, ‘restructuring avoidance’ whereby we assist businesses facing the very early warning signs of stress to avoid the need for restructurings further down the line. This may be through early proactive cash and working capital management or through financial reporting or operational improvements. When it comes to communications with lenders, corporates will do well to recognise that there is a move away from the previous approach of lending based on name, with numerous bilateral facilities. In distressed situations it may be the case that a business faces a collective group of lenders rather than individual lenders and may not be dealing with their previous relationship manager. A robust, measured approach to negotiations must therefore be adopted involving significant preparation. It is clear that the type of restructuring solutions reached in the region will continue to develop. The ‘extend and pretend’ approach that we’ve seen in the past, where the terms of facilities are simply lengthened, will no longer address the key problems many businesses face, nor will they necessarily offer the best long term solution. To enhance business value and ensure continuity, a sustainable focus on rectifying internal business performance, rather than relying on friendly banks, is crucial.
FW: Overall, what has been the reaction of practitioners to the provisions outlined in the new insolvency regime? What impact do you expect it to have on business activities in the UAE going forward?
Stark: The practitioners that I have spoken to are enthusiastic about the prospect of the region adopting a structured framework to deal with distressed businesses and are looking forward to the benefits it will bring. Personally I see this having a very positive impact on business activities in the UAE and can it see it providing a high level of confidence to external investors who are looking for a safe haven for their capital.
David Stark is managing director of Restructuring Advisory Services at Deloitte Corporate Finance Limited. Mr Stark joined Deloitte in 1993 and in 2011 transferred from the UK – where he was a partner – to Dubai in order lead Deloitte’s Restructuring Advisory Services practice in the Middle East region. Over the last 17 years he has gained a broad range of restructuring experience including leading the restructurings of Nakheel and Limitless in the UAE. He can be contacted on +971 50 658 4057 or by email: firstname.lastname@example.org.
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