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BSA Bankruptcy Series

In the following series of articles, Barry Greenberg provides the reader with a comprehensive look at bankruptcy proceedings in the UAE, from beginning to end.

The series consists of:
  • Part 1: Procedures before filing bankruptcy
  • Part 2: Suspension of the Debtors' obligations in Bankruptcy
  • Part 3: Bankruptcy: Settlement with creditors

Procedures before filing bankruptcy

The rise in the number of companies facing severe financial distress is an unavoidable fact in today’s market. In response, the UAE enacted a new Bankruptcy Law – Federal Law No. 9 of 2016 - which has provided new avenues whereby distressed companies can remediate an insolvency scenario. The new law seeks to enable a paradigm shift as to the treatment of indebted entities to a “rescue culture”, in line with the practices of other international commercially prominent jurisdictions such as the US and UK. Accordingly, the law provides for a process in which the injection of new capital can be arranged, while at the same time claims based on existing debt can be both managed and mitigated, using a set legal process.

The Bankruptcy Law was also amended in late 2020 in response to the Covid pandemic to provide for various forms of enhanced debtor protections, including suspension of the requirement to file in cases of insolvency, expedited claims relief and settlement procedures, and a suspension of any bankruptcy proceedings filed by a creditor.

A company considering filing for protection under the Bankruptcy Law should take steps prior to filing, so as to ensure that the process goes as smoothly as possible.

The first step is to make a robust risk assessment to determine whether the filing is necessary, in view of the fact that such is not without some significant risks.

Importantly, pursuant to Bankruptcy Law Article 144, if the debtor’s assets are insufficient to satisfy at least 20% of its debts, the Court may obligate members of the board or managers to pay these debts, in cases where their responsibility for the company’s loss is evident, pursuant to the provisions of the CCL. Evaluation of whether the company had been appropriately managed in accordance with the CCL must thus be made at this juncture.

Also note that the directors or managers may face criminal prosecution in the event of a host of improper actions were taken prior to the filing or thereafter. These include circumstances where in some circumstances, liability may even extend to the shareholders themselves, if they have been found to have been involved in improper actions related to the debtor company’s management.

These prohibited actions include such of the type that may be expected to attract criminal sanctions, including fraud, embezzlement, bad faith disposal of assets, and the making of false declarations. However, they also include making payments to one creditor to the detriment of others while the debtor is in an insolvent state, as well as other actions which if rising to the level of “gross negligence”, may lead to such scrutiny.

Thus, the risk assessment needs to include making both a clear-eyed estimate of the debtor’s net asset value in liquidation as well as an unbiased consideration of whether the debtor company’s management has engaged in any of the prohibited acts set forth in Title 6 of the Bankruptcy Law.

Once this is done, and assuming the debtor makes the decision to file, the appropriate documents and approvals must be obtained for submission to the court to institute the case. The court filing must include, among other items, the debtor’s incorporation documents and commercial books, nomination of a trustee to take control of the company once the case is opened, identification in detail of all creditors and assets, as well as a report setting forth the debtor’s expected cash flows for the next 12 months, and a memorandum containing a brief description of the company’s economic and financial situation.

Marshalling all of these items and preparing the filing may take some time, so the debtor that is seriously considering filing a bankruptcy case needs to commence the diligence and the document gathering processes with all deliberate speed.

Suspension of the Debtors' obligations in Bankruptcy

A debtor that files for relief, or that is subject to a creditor’s filing to place the debtor involuntarily into bankruptcy under the UAE Bankruptcy Law – Federal Law No. 9 of 2016 (the, ‘Law’) – is provided with certain protections as to its ongoing obligations to satisfy its existing debts.

The Law was also amended in late 2020 in response to the Covid pandemic to provide for various forms of enhanced debtor protections, Thus, the debtors’ protections will vary, depending on when the case was filed and whether the “Emergency Financial Crisis” (the, ‘EFC’), which been declared to exist by the Council of Ministers, for the period effective from 1 April 2020 through 31 July 2021, remains in effect. During the existing EFC, the additional debtor relief includes the suspension of the requirement to file in cases of insolvency, expedited claims relief and settlement procedures, and a suspension of any bankruptcy proceedings filed by a creditor.

More generally speaking, and without regard to the EFC considerations, in the event of a filing, the debtors’ financial obligations are not eliminated. However, should a restructuring plan be approved by the creditors, these obligations may be reduced to an amount that would enable the debtor a fiscally viable path to pay the reduced debts and to continue as an ongoing enterprise.

Should the debtor not be able to be restructured and instead is placed into bankruptcy and liquidated, the debtors’ obligations will be discharged upon the completion of liquidation, with some important exceptions, including in the case of an inability to satisfy at least 20% of the debt or where the debtor had engaged in specified acts of misfeasance which caused the insolvency. In these unfortunate circumstances, the debtors’ manager may be held personally liable for some or all of the debtors’ obligations.

When the case is accepted, the Court will appoint a trustee who shall be responsible for the running of the debtors’ business until the restructuring is approved or the debtor is liquidated; however, the trustee will delegate most managerial tasks to the debtor. Payment of claims is generally in the purview of the trustee, so the debtor is limited in paying its obligations and must defer to the trustee.

In fact, a debtor can be sanctioned should it make preferential payments to one creditor to the detriment of others while in an insolvent state, and thus needs to take great care in allocating its resources in the event of insolvency.

The debtors’ contracts and leases remain in force during the pendency of the case although the trustee may seek to abrogate these in certain circumstances, including where the termination is necessary for the continuation of the debtors’ commercial activities.

The Law provides for a freeze of criminal prosecution for company cheques which bounced prior to the initiation of the proceedings, while the proceeding is ongoing - assuming no fraud is involved. This is a significant change from prior law and provides individuals who executed corporate cheques some protections that previously were unavailable. Civil enforcement claims are also suspended for a period of no more than 10 months post opening of the case or until a restructuring plan is approved, subject to an extension upon leave of Court. Secured parties, however, may apply to the Court during the proceedings to redeem their rights.

The Law also provides for debtor in possession financing, which will allow the debtor to obtain new loans with priority over all pre-existing non-secured debt. This is very helpful, insofar as it may give the debtor a previously unavailable lifeline while providing the incoming lender with greater comfort.

Bankruptcy: Settlement with Creditors

The UAE Bankruptcy Law – Federal Law No. 9 of 2016 (the, ‘Law’) – provides a set of rules for the settlement of creditor claims.

Where the debtor is restructured pursuant to a Preventive Composition scheme under Title 3 of the Law, or a more formal reorganization under Title 4, the settlement of claims will be subject to the approval of a specified majority of the creditors, via ratification of the debtor’s reorganization plan. If a majority of the holders of two thirds of the ordinary debt do not approve of the reorganization plan, that plan will be rejected. Secured creditors do not participate in the vote to approve the plan; however, their rights cannot be prejudiced by a plan and they in general retain the right to commence action to recover their security during the course of a bankruptcy proceeding.

Ordinary creditors’ seeking their due amounts pursuant to a restructuring plan likely will not recover the full amount owed, with the extent of the reduction being set forth in the plan specifics. The plan will be formulated by the Court appointed trustee with the debtor’s assistance, after a careful review of the debtor’s liabilities, assets, and possibility of the debtor’s return to fiscal viability. The trustee will seek to permit the creditors to receive as close to full value of their claims as possible, while balancing the need to keep the debtor in business, if such is practicable.

Those creditors voting on the proposed restructuring plan need to consider that reality as they cast their votes. While creditors may be dissatisfied by the proposed reduction in their collectible amounts, that recovery amount will almost certainly be significantly larger than what they would recover should the debtor be liquidated, which is what will most likely occur if the creditors reject the plan.

From the time at which the Court opens the procedures, the debtor’s management is overseen by the trustee, who may affirm or reject the debtor’s continuing contracts and leases as circumstances warrant but may require leave of Court to do so.

Should the debtor be liquidated, the Law sets out the order in which debts are to be paid. Debts secured by moveable or immoveable property shall be given priority over all other debts, except for the trustee’s fees and costs incurred in the sale of such secured assets. Following this, the order of privileged debts is: 1) judicial fees or expenses, including trustee and experts’ fees, 2) end of service gratuities, wages and salaries for no greater than 3 months, 4) alimony, 5) amounts due to government agencies, 6) debtor’s advisor’s fees, including legal consultants, and 7) fees costs and expenses incurred after the opening of the procedures for the purpose of maintaining the debtor’s continuity of business during that period.

All of the debts in each privileged category must be settled prior to the payment of the next category of debts. Once all secured and privileged debts are satisfied, then ordinary debts are paid. Should the sale of the secured property be insufficient to satisfy the secured debt amount, the remainder of the secured debt shall be treated as ordinary debt. In each case of similar classes of debt, payment will be made on a pro-rata basis if insufficient funds are available to pay the full amount owing in that class.

Debtors must exercise extreme care in self-administering which debts they intend to pay if they are in a state of insolvency but have not filed for protection under the Law. The debtors’ managers and directors can be personally held both civilly and criminally liable for making payments to creditors to the detriment of other creditors while the debtor is insolvent.

Authored by Barry Greenberg, Of Counsel
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