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The ‘change of legal status’ from sole establishment to limited liability company (‘LLC’) is a common ‘licence’ transaction introduced by various relevant licensing authorities in the UAE. There are two major situations where the concept of the change of legal status is implemented: the first is the sale of a business (sole establishment) to third parties who intend to continue the business under limited liability form; and the second is when the owner aims to continue the business under limited liability status. It is purported to be a practical solution to ensure the continuity of the licence’s ‘existence’ at the commercial register.
Notwithstanding the concerns regarding the validity of the terminology and the legal basis of the concept, this article will focus on the implementation of ‘change of legal status from sole establishment to LLC, with special consideration given to the general liabilities associated with the transaction. The first section of this article will tackle the practical application of the concept, and the second section will focus on the liability implications.
This section will discuss the main legal provisions that govern the concept of change of legal status from sole establishment to LLC, and the purpose of introducing such a procedure by the licensing authorities.
The transformation from sole establishment to LLC is not an established concept under a specific regulation in UAE, however it is a practical procedure that was introduced by the concerned licensing authorities in the various Emirates, with the ultimate purpose of keeping the same trade licence number for the business entity once the change of legal status from sole establishment to LLC is effected. The benefit of keeping the same trade licence number is to maintain a practical continuity for the business in its relationships with third parties, and in particular with governmental authorities, as the licence number constitutes the principal means by which businesses are identified. Accordingly, the establishment’s cards, establishment’s accounts, etc. with the various authorities (such as immigration, labour office, Etisalat) do not need to be closed upon the conversion transaction. Instead only a simple amendment is required in order to reflect the change in the trade name and the status. Actually, the conversion transaction can be considered as a combination between two legal procedures as explained below:
Article (39) provides that:
“business premises constitute a group of tangible and intangible assets allocated for the practice of Commercial Activities”
Furthermore, Article (40) provides that:
“The main elements in the sole establishment are divided in two different categories which are as follows:
Thus, compliance with the provisions of 1993 law that govern the transfer of ownership of the sole establishment (represented by its tangible and intangible elements) constitutes a major requirement in the process of converting a sole establishment to a LLC. The essential consequence for not complying with the provisions of 1993 law is the exposure of the owners to additional liability towards third parties.
The transfer of ownership of the sole establishment involves two main steps: namely the registration of the disposal transaction in the commercial register; and the notification of the disposal (publication).
Pursuant to Article (42) of 1993 law, in order to be valid, any agreement related to the transfer of ownership of a sole establishment must be legalised and registered in the commercial register.
The registration of the disposal in the commercial register shall be deemed completed upon performing the following procedures, as specified under Article (45) of 1993 law:
Hence, in the case of a failure to fulfil the requirements of the registration as mentioned above, including the publication of the summary of the transfer of ownership agreement in two Arabic local newspapers with an interval of one week between the two publications, the transfer of ownership shall be considered invalid. The invalidity in this case will be applicable among the contracting parties and in relation to third parties, in accordance with the provision of Article (44) of Law 1993.
Following the registration of the disposal in the commercial register, the person to whom the title to the business premises has devolved (the purchaser of the sole establishment) shall perform additional obligations in accordance with Article (47) of 1993 law as follows:
Therefore, in the case of the failure to fulfil the notification of disposal by the purchaser, both the disposing party and the purchaser will remain jointly liable for any debts. It is worth mentioning that, in practice, it is possible to complete the conversion of a sole establishment to a LLC without completing the notification of disposal requirement, however, a question as to joint liability on the part of the disposing party and the purchaser (the shareholders in the newly formed LLC) may arise.
The change of legal status from sole establishment to a LLC originated from a procedural practice adopted by various licensing authorities in the UAE, and can be viewed as a combination between two legal procedures creating a limited liability company as well as transferring the ownership of a sole establishment.
Conceptually, the aim of introducing the change of legal status from sole establishment to a LLC is to move from the position of unlimited liability to the status of limited liability. It is worth mentioning that the ‘change of legal status’ transaction involves essential provisions regarding the transfer of ownership of the elements of the sole establishment, with specific requirements related to the notification of creditors and publication. Therefore, special consideration should be given to the accurate fulfilment of the notification and publication requirements during the transaction; otherwise, the parties (seller/purchaser) may remain jointly liable for any debts related to the business. It is worth noting that such notification and publication requirements amount to, in general, an obligation on the part of the purchaser, hence, in practice, the licence of the sole establishment can be amended to reflect the new LLC status, even before the completion of the notification and publication requirements.
Moreover, in any event the Seller shall be liable for any debts related to the sole establishment and which may have arisen prior to the notification of the disposal unless it is discharged from such debts by the creditors.
Al Tamimi & Company’s Corporate Structuring team regularly advises on liabilities related to corporate structuring. For further information, please contact Ali Bachrouch (email@example.com) or Odai Mismar (firstname.lastname@example.org).