December 09, 2020
On 23 November 2020, it was announced that the president of the United Arab Emirates (the “UAE”), Sheikh Khalifa bin Zayed Al Nahyan, issued Federal Law No. 26 of 2020 (the “Decree”).
The Decree introduces landmarks reforms to foreign ownership and investment in the UAE in a continued move to liberalise the UAE economy and regulatory environment, with the long-awaited removal of the requirement for at least 51 per cent UAE national ownership in UAE “on-shore” companies (i.e. companies established in the UAE other than in a free zone), save for certain strategic activities which are to be determined, and other substantial amendments to Federal Law No. 2 of 2015 on Commercial Companies (the “Companies Law”).
The Decree repeals the provisions of the Companies Law which had previously required a UAE national to own at least 51 per cent of a UAE “on-shore” company, all branches of foreign companies to appoint a UAE service agent and for the majority of the board of directors (the “Board”) and chairman of UAE public joint stock companies (“PJSCs”) to be UAE nationals.
Thereafter, foreign investors may, in theory, own up to 100 per cent of a UAE company, provided that the company does not undertake any activities with a “strategic effect” contained on a list to be determined by the UAE Cabinet in due course (with a minimum UAE national shareholding and/or Board representation potentially being applied in respect of such activities).
In addition, the Decree introduces a number of other significant changes to the Companies Law, including:
In addition, the Decree outlines a number of new UAE Securities and Commodities Authority (“SCA”) rules which are likely to be issued in respect of the conditions, controls and procedures relating to capital reductions, share buybacks, the “strategic investor” regime, related party transactions (including relevant definitions), the issuance of bonds, sukuk and other debentures, the evaluation of in-kind contributions and the regulation of underwriting activities.
The amendments to the Companies Law introduced by the Decree come into force on 2 January 2021, save for the key reforms which repeal the requirements in respect of UAE national ownership of UAE “on-shore” companies, the appointment of a UAE service agent and the nationality of the Board and chairman of PJSCs, which shall come into force six months after the publication of the Decree in the UAE’s Official Gazette.
Companies are required to comply with the amended Companies Law by 2 January 2022. Companies which fail to comply within this period are at risk of fines of AED100 being imposed for each day of non-compliance and being subject to dissolution in accordance with the provisions of the Companies Law.
Foreign Ownership Restrictions
After years of speculation and the recent introduction of Federal Law No. 19 of 2018 on Foreign Direct Investment (the “FDI Law”) to remove barriers to greater foreign ownership in UAE “on-shore” companies conducting “Positive List” activities, the Decree finally repeals the requirement for a UAE national to hold at least 51 per cent of a UAE “on-shore” company.
In theory, foreign investors may own up to 100 per cent of a UAE “on-shore” company once this change comes into force, provided that the company does not undertake any activities with a “strategic effect” contained on a list to be determined by the UAE Cabinet in due course.
The Decree contemplates a committee being established by the UAE Cabinet to determine and recommend a list of activities with a strategic effect to the UAE Cabinet—with the potential that requirements for a minimum UAE national shareholding and/or Board representation being imposed in respect of UAE “on-shore” companies conducting such activities. There is currently no indication as to when this committee will be established or when this list will be published by the UAE Cabinet.
Although it is unclear at this stage which strategic activities will be contained on this list, it may be the case that there is a degree of alignment with the “Negative List” of activities identified in respect of the FDI Law, which requires UAE national ownership of at least 51 per cent in respect of commercial activities in the oil & gas, insurance, banking, military and defence, utilities, publishing, commercial agency, telecoms and other sectors.
Additional amendments have also been made to the Companies Law to implement this change in approach to foreign ownership, with sole-shareholder LLCs permitted to be held solely by a non-UAE national.
Notwithstanding the repeal of UAE local ownership requirements under the Companies Law, certain restrictions on foreign ownership under sector-specific law and regulation in the UAE will continue to apply until such time as they are also subject to reform (for example, a cap of 40 per cent on foreign ownership currently applies to banks in the UAE under Article 76(1) of Federal Law No. 14 of 2018 Regarding the Central Bank & Organisation of Financial Institutions and Activities).
In addition, the UAE Cabinet is empowered under the Companies Law (as amended by the Decree) to grant exemptions on a case-by-case basis from any UAE national ownership or Board representation requirements (whether imposed under the strategic activities list referred to above or by sector-specific law and regulation).
There is no indication at this stage as to whether there will be an easing of other foreign investment restrictions, including restrictions on non-UAE nationals owning land or holding long-term leases in the UAE outside of designated areas or free zones.
Existing foreign investors in UAE companies who have previously sought to structure around foreign ownership restrictions (whether by the use of a UAE nominee arrangement, offshore trust structure or otherwise) may soon look to consider the contractual arrangements they have in place and the steps required to unwind these structures. In addition, any UAE companies which impose restrictions on foreign ownership or Board nationality requirements under their articles of association or memorandum of association will need to amend their articles of association or memorandum of association (as applicable) to remove these provisions in order to benefit from the changes introduced by the Decree—however, this should only be once the list of activities with a strategic effect has been published.
UAE Service Agent for Branches of Foreign Companies
The Decree repeals the requirement for a branch (or a representative office) of a foreign company to have a UAE national service agent. Although, in practice, this role has typically been limited to administrative functions such as assisting with licensing and visa requirements, this has resulted in additional cost (such as annual service fees) for foreign companies operating in the UAE through branch (or representative office) structures.
UAE Nationality Requirements of Boards and Chairman of PJSCs
In a move that is expected to be viewed favourably by international investors, the Decree repeals the requirement for the majority of the Board and for the chairman of PJSCs to be UAE nationals (subject to any requirements imposed in respect of strategic activities in the list referred to above). This amendment enables PJSCs considering an initial public offering (“IPO”) to select from a wider pool of candidates for the purposes of their Board compositions as they ready for IPO, with the potential for greater Board diversity and Boards with broader experience and expertise.
Foreign Direct Investment Law
The Decree repeals and supersedes the FDI Law, the key elements of which had only been finalised in March this year with the issuance of the “Positive List” setting out the activities in which up to 100 per cent foreign ownership was permitted (subject to certain criteria being satisfied).
Initial Public Offering
The amendments to the Companies Law implemented by the Decree now permit any PJSC that IPOs on a UAE stock exchange to sell existing shares comprising up to 70 per cent of the share capital of the PJSC as a secondary offering of shares to the public as part of the IPO (this was previously limited to 30 per cent)—a higher percentage can be sold with the prior approval of SCA.
The Decree introduces long-overdue amendments to the prospectus liability regime, bringing the UAE in line with international market practice and removing a key barrier to more active participation by international banks in UAE capital markets transactions. Advisors (including legal counsel, underwriters and auditors) and other parties involved in the public offering of securities are no longer jointly liable for the accuracy of information contained in a prospectus, with prospectus liability imposed only on the Founders’ Committee and Board.
Advisors and other parties involved in the public offering of securities are required to perform their duties with the care exercised by a diligent person, with each such party’s liability limited to the duties performed by such party.
In addition, liability in respect of the accuracy and completeness of information (including documentation and reports) submitted to the regulators no longer extends to advisors and other parties involved in an IPO process. Such liability is now limited to the Founders’ Committee of the PJSC.
Indemnities, guarantees and any other compensation provided to underwriters in respect of any public offering or subscription of shares in a PJSC are now exempt from constituting financial assistance. This change will be welcomed by underwriters who had previously required additional indemnities from shareholders in the event that an indemnity from a PJSC was found to be a breach of the financial assistance regime under the Companies Law.
Founders of PJSCs are now subject to a six-month lock-up in respect of any shares retained by them on IPO (including any new shares issued during this lock-up period) under the Companies Law—this was previously a two-year lock-up period. This lock-up may be in addition to any further lock-up contractually agreed with the underwriters.
Notwithstanding the introduction of the six-month lock-up period referred to above, founders of PrJSCs remain subject to a lock-up period of one year from the date of registration in the commercial register with the competent authority (prior to the publication of its balance sheet and profit and loss statement).
Regulation of Underwriting Activities
The Decree confirms that SCA will issue new rules to regulate underwriting activities conducted in the UAE.
Corporate Governance Rules
The Decree introduces a reference to the Minister of Economy issuing corporate governance rules applying to UAE companies (save for PJSCs which are instead subject to the SCA Board Chairman’s Decision No. 3 of 2020). This replaces the previous provisions of the Companies Law which only refer to these rules applying to PrJSCs with more than 75 shareholders. The intended purpose of this change appears to expand the scope of the corporate governance rules to be issued by the Ministry of Economy to also cover LLCs and all PrJSCs. We expect further clarity on this change once the aforementioned corporate governance rules are issued.
General Assembly Meetings
Amendments have been made to provisions of the Companies Law applying to the General Assembly Meetings, which introduces closer alignment between JSCs and LLCs. In particular, the following key amendments have been made:
in each case, unless a higher quorum requirement is specified under a company’s memorandum of association.
Authorised Share Capital
The concept of authorised share capital of a PJSC has been removed from the Companies Law. This had previously given the Board flexibility to increase the share capital of a PJSC up to the authorised share capital limit without seeking additional approval from the shareholders of the PJSC.
Share Capital Issuances
As a result of the removal of the concept of authorised share capital referred to above, any increase in the share capital of a PJSC now requires approval from the shareholders at a General Assembly Meeting (with the Board then authorised to issue shares within three years of such approval).
In the case of LLCs, shareholders may now request that the UAE courts approve an increase in the issued share capital of an LLC if: (i) a resolution to approve a capital increase at a General Assembly fails to pass; and (ii) it is at risk of liquidation or unable to pay its debts as they fall due (as evidenced in a report prepared by its finance manager or representative).
Reduction of Share Capital
The substantial rules and conditions applying to the reduction of the share capital of JSCs have been removed from the Companies Law, with reference instead made to a JSC complying with separate rules to be issued by SCA.
The “strategic investor” regime under the Companies Law (which disapplies pre-emption rights in respect of the issuance of shares by a JSC to a strategic investor) has been simplified, with the removal of conditions requiring a strategic investor to: (i) carry out similar or complementary activities to the JSC; and (ii) have issued at least two balance sheets for the last two financial years. In addition, the Decree introduces reference to the strategic investor regime being subject to any conditions or rules issued by SCA.
There is currently no indication as to when SCA rules relating to the strategic investor regime will be issued and the extent to which these will align with the previous regime under the Companies Law.
Conversion of Bonds and Sukuk to Shares
The entitlements of persons who are issued shares in a JSC following the conversion of bonds or a sukuk to dividends distributed in the financial year of such conversion occurring are now subject to the relevant prospectus and terms of such bonds or sukuk. Previously, the Companies Law did not recognise that such entitlements could be disapplied or varied under the relevant prospectus or terms of the bonds or sukuk.
In addition, the Decree now clarifies that pre-emption rights do not apply in respect of any shares issued on conversion of bonds or sukuk.
The Decree clarifies that approval of the General Assembly is required in respect of a share buyback by a JSC (subject to share buybacks being limited to up to ten per cent of share capital)—although this requirement for General Assembly approval was not previously provided for in the Companies Law, this was already a requirement imposed by SCA in accordance with SCA Board of Directors Decision No. 40 of 2015.
Notwithstanding SCA Board of Directors Decision No. 40 of 2015 (which contains additional rules and regulations applying to share buybacks), the Decree indicates that additional controls and procedures for share buybacks may be issued by SCA.
Subject to a special resolution of the shareholders of a JSC approving a share issuance, pre-emption rights are now disapplied on an issuance of shares by a JSC to the shareholders or partners in a target company as consideration for the acquisition of shares in that target company.
Compliance with SCA Public M&A Rules
Amendments to the Companies Law require an offeror of a PJSC which shares have been offered to the public or are listed on a stock exchange in the UAE to comply with Decision of the Chairman of the SCA Board of Directors No. 18 / R.M of 2017 or any other relevant decisions issued by SCA from time to time (“SCA Public M&A Rules”).
These amendments build the framework of the squeeze-out regime set out in the SCA Public M&A Rules into the Companies Law, with the squeeze-out threshold (which is currently 90 per cent plus one share under the SCA Public M&A Rules) to be as determined by SCA from time to time.
The Decree also implements amendments to the Companies Law which provide for certain penalties to be applied in the event of a breach of the SCA Public M&A Rules (including a fine between AED100,000 and AED10,000,000).
Memorandum of Associate of LLCs
The memorandum of association of LLCs is now required to include dispute resolution provisions to cover disputes arising in relation to the LLC’s business between: (i) the LLC and any of the directors; or (ii) the partners in the LLC.
The Decree removes the restriction which only permitted JSCs to carry out investment activities relating to third party funds. Following this amendment, LLCs are now permitted to carry out investment activities relating to third party funds.
Limits on the number of Shareholders in PrJSCs
The number of shareholders in a PrJSC is no longer subject to a maximum limit (this was previously capped at a maximum of 200 shareholders).
Appointment of Auditors
The limit on the number of years the same auditor can be appointed has been increased from three years to six years, provided that the partner in the audit firm in charge of such audit is changed after three years.
Liability of the Board and Executive Management
The liability of members of the Board under the Companies Law to a JSC/LLC, its shareholders or third parties in the case of fraud, abuse of power or breach of the Companies Law or a JSC/LLC’s articles of association or any error in management has now been extended to impose the equivalent liability on members of the Executive Management team. Dissenting members of the Board will continue to avoid liability in respect of such matters (provided such objection was recorded in writing in the Board minutes).
For these purposes, the Executive Management team is comprised of each of the General Manager or the Executive Director or the Chief Executive Officer of the JSC/LLC, and their deputies, and anyone occupying an executive-level position, and those who have been appointed by the Board.
Liability is only imposed on the Executive Management team to the extent any fault or error arises as a result of a decision made by them.
Disqualification of Members of the Board and Executive Management
Any member of the Board or Executive Management team is now automatically dismissed from their position if convicted by a final court judgment of fraud, abuse of power or entering into related party transactions or transactions where there is a conflict of interest, in each case in breach of the Companies Law.
In these circumstances, such member of the Board or Executive Management team is also disqualified from serving on the Board of any other JSC/LLC or in an executive function for a period of three years following the date of such final court judgment.
Related Party Transactions
Any related party transaction with a value in excess of five per cent of the share capital of a JSC shall be subject to controls and conditions to be issued by SCA. This is in addition to the existing requirement for such related party transaction to be approval by the General Assembly.
In addition, new disclosure requirements have been introduced in respect of related party transactions involving JSCs as follows:
The Decree repeals the definition of “related party” under the Companies Law, with new rules to be issued by SCA which shall define related parties, conflict of interest transactions and determine additional obligations applying to related parties and related party transactions.
In the case of LLCs, the Decree provides that the UAE Cabinet (following a recommendation from the Minister of Economy) shall issue a decision in respect of the application of JSC related party provisions to LLCs. Under Ministerial Decision No. 272 of 2016, LLCs are not currently subject to the approval requirements applying to JSCs in respect of related party transactions. At this stage, it is unclear if approval requirements (whether by General Assembly or otherwise) or the new disclosure obligations referred to above will apply to LLCs under any decision issued by the UAE Cabinet.
Claims Against Related Parties by Shareholders
The Decree provides that a shareholder may bring a claim on behalf of a JSC and in its own name for any breach of the related party provisions under the Companies Law (or any other applicable law), subject to the satisfaction of certain conditions (including such shareholder, jointly or by itself, holding at least ten per cent of the share capital of the JSC).
Any shareholder may, by itself or jointly with other shareholders, bring a claim in its own name against any related party for a breach of the related party provisions under the Companies Law (or any other applicable law). No conditions apply to a claim being made by a shareholder in such circumstances.
Claims Against Company, Board or Execution Management by Shareholders
The Decree repeals the existing provisions related to the right of a shareholder to bring a claim against the Board of a JSC (if not filed by a JSC) and replaces it with a broader right which enables a shareholder to bring a claim against the JSC, its Board or its Executive Management team in the event of it incurring damages as a result of any breach of the Companies Law.
In addition, a shareholder now has the right to recover all costs related to the litigation (which is limited to legal expenses and advocacy fees) once a final judgement is issued by the competent court (whether or not a shareholder’s claim is successful) if supporting documents are provided in respect of such costs and provided that the claim is not made on unfounded or insufficient grounds with the intention to harm the relevant defendant, the JSC or its shareholders or for the purposes of defamation, extortion or to affect the price of the JSC’s shares in the market.
Losses of JSCs
The Decree provides further clarity on the procedures applying in the event a General Assembly is to be convened for the purposes of determining whether to continue or wind-up and liquidate a JSC which is subject to losses of an amount equal to at least half of its issued share capital.
The amendments to the Companies Law now provide that:
Loans to Directors
Financial institutions under the supervision of the UAE Central Bank are now exempt from the prohibition on loans (or guarantees or collateral granted in respect of loans) being granted by a JSC to any member of the Board of the JSC.
Non-Shareholder Directors of JSCs
The cap on the number of non-Shareholder directors appointed on the Board of JSCs has been removed (this was previously no more than a third of the number of directors as determined by the articles of association of the JSC).
Valuation of In-Kind Contributions
The direct liability of valuers in respect of the valuation reports prepared for in-kind contributions for JSCs has been repealed, with only the Founders’ Committee and the Board (if any) being liable for the accuracy, adequacy and completion of the statements and information contained in the valuation report.
The Decree introduces a requirement for valuers to perform their duties with the care exercised by a diligent person. Notwithstanding the amendments to the Companies Law, we do not anticipate a departure from current market practice in respect of valuers seeking to disclaim liability to the fullest extent permitted by law in respect of their valuation reports.
Amendments to the Articles of Association or Memorandum of Association
The requirement to obtain DED approval for amendments to the articles of association or the memorandum of association of JSCs has been repealed and replaced with a requirement to only file an amended copy of such articles of association or memorandum of association with the DED.
The amendments to the Companies Law introduced by the Decree come into force on 2 January 2021, save for the key reforms referred to under Foreign Investment and UAE Nationality Requirements above which shall come into force six months after the publication of the Decree in the UAE’s Official Gazette.
Companies subject to the Companies Law are required to comply with the amendments provided in the Decree by 2 January 2022. Companies which fail to comply within this period are at risk of fines of AED100 being imposed for each day of non-compliance and being subject to dissolution in accordance with the provisions of the Companies Law. The Decree does not distinguish between significant and technical non-compliance for the purposes of these potential penalties.
As outlined in Key Highlights of the Decree above, the amendments to the Companies Law indicate that a number of new SCA rules are to be issued in respect of the conditions, controls and procedures relating to capital reductions, share buyback, the “strategic investor” regime, related party transactions (including relevant definitions), the issuance of bonds, sukuk and other debentures, the evaluation of in-kind contributions and the regulation of underwriting activities.
The Decree introduces landmark reforms to the foreign direct investment regime, which, alongside other on-going legislative reforms and recently announced visa and social reforms, signals a concerted effort to liberalise the UAE economy and regulatory environment. This continues a bid to attract increased foreign direct investment and further promote and strengthen the UAE’s position as an internationally competitive business and financial hub. The other significant amendments made to the Companies Law (including those which more closely align the regulatory regime applying to capital market transactions with international best practice) only serve to further support this purpose.
Whilst further guidance from the UAE Cabinet is expected in due course in respect of any strategic activities which may remain subject to foreign ownership restrictions, the key reforms implemented by the Decree are expected to be a pivotal step in further removing barriers to foreign direct investment.
Special thanks to Senior Legal Adviser to Shearman & Sterling LLP Andrew Steele for his contribution to this client publication.