A Quarterly Newsletter from the UAE and Oman member firms of the PKF International Ltd.

VOL 17, Issue 4 October 2015


A look at some provisions impacting limited liability companies

Federal Law No. 2 of 2015 Concerning Commercial Companies (the “Law”) came into force on 1 July 2015. The Law, which repeals Federal Law no. 8 of 1984 (in effect since 1 January 1985), was in the pipeline for several years and reportedly went through several changes before being issued in its present form.

While we await issue of the Executive and Ministerial Regulations which, hopefully, should clarify many matters in the Law which, presently, are a cause for concern, we take a look at how some of the changes in the Law impact existing limited liability companies (“LLC”).

While broad-based data is not available, anecdotal evidence indicates that a significant number of LLCs in the UAE are beneficially owned and operated by expatriates, with the UAE national partner(s) functioning only as nominee shareholder(s) to comply with the requirement in the old (and the new) law that every company incorporated in the UAE must have one or more UAE national shareholders whose share in the company in the aggregate must not be less than 51% of the company’s capital.

Generally, in all such LLCs, the capital required to run the business was wholly provided by the expatriate investor(s) who entered into a variety of shareholder and other agreements with the UAE national to derive comfort that their investment was secured.

Clause 3 of Article 227 in the old law provided that “profits and losses shall be equally divided amongst the shares unless it is otherwise stipulated in the memorandum”. This enabled the beneficial owners of the business to incorporate profit sharing clauses in the MOA, duly attested by the notary public, skewed heavily in their favour.

In many cases, the company MOA also defined the profit available for distribution as the net profit after charging all costs and expenses incurred by the company in the ordinary course of business, including partners’ remuneration and fees. Thus, by including clauses for payment of remuneration and management fees to the partner(s) managing the business, or entering into separate agreements in this respect, investors ensured that the profit finally available for distribution to the national shareholder was restricted to the minimum, generally equal to the agreed lump-sum amount.

In many instances loan and share assignment agreements were also entered into between the expatriate and national shareholders whereby the national shareholder(s) confirmed that their acquisition of the shares in the company was financed by the expatriate shareholder and, consequently, confirmed either that the expatriate shareholder was the beneficial “owner” of the shares or that the national shareholder(s) assigned the shares in favour of the expatriate shareholder.

The old law required all LLCs to hold a general meeting of all partners at least once a year, within four months of the end of each financial year. Article 245 provided that a partner may give a proxy to another partner who is not a manager to attend the general meeting and vote on his behalf. Further, Article 250 stated that a partner who is a manager may not participate in voting on resolutions absolving him from the responsibilities of management. Obviously, these articles posed a problem for LLCs in which 49% of the shares were held by a single expatriate partner who was also the company’s manager.

Many investors did not bother to define and structure the actual relationship with the UAE national and thus entered into agreements which either did not state the basis of profit distribution or stated that profits would be shared between the shareholders in the ratio of their contribution to the capital. However, in all such companies the profit was, and continues to be withdrawn, wholly by the expatriate shareholder(s) while the national partner(s) receive only the agreed lump sum amount.

Also, many of these companies did not bother to comply with the requirement to hold an annual general meeting to conduct the business specified in the law.

Defining the relationship The Law (Article 79: Transfer or Pledge of Shares in a Company) provides that “A partner may ‘transfer’ or pledge his share in the company to another partner or to a third party. Such transfer or pledge shall be made in accordance with the terms of the company’s MOA and under an official document in accordance with the provisions of this Law. Such transfer or pledge shall not be valid against the company or third parties until the date of its entry in the Commercial Register with the Competent Authority”

Since the Law does not contain any other restriction with respect to the pledge of shares, the beneficial owner(s) can enter into agreements for the pledge to them of the shares held by the national shareholders, although it is a bit early to predict how the Competent Authority would view agreements covering the pledge of share(s) held by the national shareholder(s) in favour of the expatriate shareholder(s), when presented for registration. (Note: As an aside, since pledge of shares in LLCs to third parties is also permitted, this will assist LLCs to raise financing from lenders by offering the shares as additional security.)

The Law allows (Article 95) a Partner to delegate another partner who is not a manager or any other party that the MOA permits to be appointed to represent a partner. This allows the expatriate partner flexibility in the convening and holding of annual general meetings.

While the section of the Law dealing with LLCs does not include a specific provision relating to sharing profits or losses (like Article 227 in the old law) the matter is dealt with in clause 1 of Article 29: Distribution of Profits and Losses which states “If the company’s MOA does not stipulate the proportion of a partner’s share in the profits or losses, the share shall be pro rata to his stake in the capital”. Clause 3 of the Article further states “If it is agreed in the company’s MOA that one of the partners is to be deprived of the profits or exempted from loss, such MOA shall be deemed void”.

Further, clause 2 of Article 30: Distribution of Profits states “If the company distributes any profits in violation of the provisions of this Law and the resolutions issued thereunder, such partner or shareholder shall repay any profits received by him in violation of such provisions”.

These Articles should also be read in conjunction with Article 363: Distribution of profits in violation of the Law which states that “Any manager or director that may distribute to the shareholders profit in breach of the provisions of this Law or the company’s MOA or AOA, and any auditor that may approve such distribution while aware of such contravention, shall be punished by imprisonment for a period between 6 months and 3 years and/or a fine between AED 50,000 and AED 500,000″.

Accounting records and retention
The Law requires (Article 27: Accounts of the Company) that every company shall apply International Accounting Standards and Practices while preparing its interim and annual accounts to give a clear and accurate view of the profit and losses of the company. The Law also requires (Article 26: Accounting Records) all companies to retain the accounting records at the registered office for a minimum period of five years. Failure to do so will attract the provisions of Article 348: Failure to keep Accounting Records which imposes a fine of at least AED 50,000 but not more than AED 100,000 and Article 349: Failure to keep Accounting Records for the Period Determined in the Law which imposes a fine of at least AED 20,000 but not more than AED 100,000.

In conclusion ..
Investors who do not structure their MOA or AOA properly but have legacy “side” agreements denying the national partner their registered share in the profits will run afoul of the various Articles referred to above.

Hitherto, concerned parties closed their eyes to the situation but given the changing business and regulatory environment in the UAE, as evidenced in part by the provisions in the Law, investors would do well to obtain professional advice to ensure compliance.

All existing companies are required to amend their Memorandum of Association (MOA) and Articles of Association (AOA) to comply with the provisions of the Law on or before 30 June 2016, although this period may be extended for one more year by the UAE Federal Cabinet on a reference from the Minister of Economy. It should be noted that, subject to penalties provided in the Law, a company which fails to comply with this provision shall be deemed dissolved.

Nonetheless, before effecting necessary changes to the LLC’s MOA, we consider it advisable to await issue of Ministerial regulations which, it is anticipated, will clarify many of the provisions in the Law.

(This article is compiled by our Abu Dhabi based partner, B.R.Sudhir.)