Ten Reasons why you should not consider filing for Bankruptcy
No lawyer or financial adviser will disagree that if a business engages in a full and formal bankruptcy process, then ultimately there is a high chance that the business will end up in the grave yard.
If a company is declared bankrupt in the UAE, significant legal, commercial and economic repercussions will follow; it will likely lose all of its cash and other assets, while its creditors are unlikely to get back all of their debts. A merchant who applies for bankruptcy is unlikely to be in position to manage a business or be on a board of any corporation for many years.
The bankruptcy process is a legitimate legal process, designed by the legislator and recognized under the law, which is available to businesses which are unable to pay for their creditors or (in certain circumstances) to the creditors of such businesses who don’t receive payments they are due.
However, as we will discuss in this article, there are many reasons why the bankruptcy route should only be considered where a business has exhausted all possible alternatives.
How the bankruptcy process works in the U.A.E.
The UAE Federal Bankruptcy Law No.9 of 2016, as amended by Law No.23 of 2019 (the “Bankruptcy Law”) governs all bankruptcies on the federal and local level in the UAE and is overseen by the Ministry of Finance. It applies to onshore and offshore companies (both trading and professional services), except where there is a specific offshore law that governs bankruptcy (as is the case in DIFC and ADGM, for instance), and to individual merchants (the subject of the bankruptcy being the “Debtor”).
The Bankruptcy Law provides various different options which either the Debtor or its creditors may consider, including protective mechanisms designed to avoid full bankruptcy proceedings, including the following:
1. Preventive Composition
Preventative composition is the first ‘light touch’ step that may be considered in the pre-bankruptcy pathway. It is intended to give a financially distressed (but still solvent) Debtor breathing space to reach settlements with its creditors while it is still in the early stages of such financial distress. This option is only available on the condition that the Debtor has not defaulted on any debts owed to creditors for more than 30 days.
Only the Debtor can make an application to the court for protective composition and, if granted, a composition trustee will be appointed by the Courts to reschedule the Debtors’ debts and enter into a settlement plan with the Debtors’ creditors (known as a “Preventative Composition Plan”). The creditors must vote to approve the Preventative Composition Plan in order for it to be valid (broadly speaking, creditors holding at least two thirds of the outstanding debts will pass the vote) and the implementation of the Preventative Composition Plan must not exceed three years, unless an extension of this period is approved by creditors holding at least two thirds of the outstanding debts pursuant to the Preventative Composition Plan.
If the Preventative Composition Plan is approved by the court and the creditors, the trustee will supervise the plan throughout its implementation period and all court actions and legal proceedings against the Debtor will be suspended.
2. Restructuring Process
The restructuring process begins as a bankruptcy application to the court in relation to an insolvent Debtor, which can either be brought by the Debtor itself or by any of its creditors who has debts of more than AED 100,000 which have been due and unpaid for over thirty days despite written notice.
The court will appoint a bankruptcy trustee (and sometimes other experts) who, while preparing a report about the Debtor’s business, may assess the possibility of restructuring the Debtor’s business and whether a restructuring scheme should be submitted to the creditors. A restructuring scheme is very similar to a Preventative Composition Plan (known as a “Restructuring Plan”) in terms of how the creditors’ meetings are held and the creditors’ votes required to approve the Restructuring Plan. The bankruptcy trustee’s report must include a statement on the Debtor’s ability to continue as a going concern. The implementation of a Restructuring Plan should not exceed five years, although this period may be extended for an additional three years if approved by creditors holding at least two thirds of the outstanding debts which remain pursuant to the Restructuring Plan.
All criminal and civil proceedings against the Debtor, including criminal actions relating to bounced cheques, are suspended pending approval of the Restructuring Plan.
If the court accepts the Restructuring Plan, and it is approved by votes of the creditors, the restructuring process will start which will hopefully allow the Debtor to resume its activities going forward or possibly to sell the business as an ongoing concern.
If the court nullifies the preventive composition or restructuring procedure, or terminates a Protective Composition Plan or a Restructuring Plan, then the court will then proceed with the formal bankruptcy of the Debtor. It is also possible for either the Debtor or its creditors to apply directly for full bankruptcy proceedings, without any reference to the restructuring process.
The courts may entitle the Debtor, under the supervision of the court appointed bankruptcy trustee, to continue its business until the bankruptcy is declared, particularly in circumstances where it is best to try to sell the business as ongoing concern.
Through the bankruptcy, the trustee, under the supervision of the Courts, will start selling the assets of the business, to liquidate the business gradually through a very speedy process to pay for the creditors and the costs.
During the bankruptcy proceedings, all scheduled debts will be immediately due, and the Courts will provide the trustee with the power to terminate any contracts to help liquidate the business. The Bankruptcy Law does not specifically provide for the suspension of judicial proceedings against the Debtor during the bankruptcy process (it only does so in the case of preventative composition and restructuring). However, it is not clear why this rule shouldn’t apply in bankruptcy cases and it is likely to be a matter that the court may exercise its discretion on.
What is the effect of the bankruptcy proceedings?
- To liquidate the Debtor by selling all its assets in order to pay all of its creditors, as well as the costs of the proceedings. The Bankruptcy Law has provided that certain debts and expenses shall have priority, with any debts that are mortgaged or subject to any other security being paid before any other preferential debt.
- A merchant or the owner of the business will typically be prevented from being directly involved in the managing of the business, from applying for any further debts or granting any security over the assets or the business during the time of the proceedings. It is the court appointed bankruptcy trustee that will have absolute power over the company and the business under the supervision of the courts.
- All court proceedings will be suspended, including execution proceedings, with the exception of those debts which are secured by mortgage or considered to be preferential debts. In the case of preventive composition and restructuring, this will include any criminal proceedings for bounced cheques, and the creditors of the bounced cheques will then be receiving their debts as part of the bankruptcy proceedings, similar to any other creditors.
- Certain transactions which were carried out by the Debtor prior to the bankruptcy and up to two years prior may be nullified, set aside and reversed in favor of the creditors. The managers or the board of directors of the Debtor could also be personally liable for certain debts if the assets of the Debtor are not sufficient to satisfy all of its creditors, particularly where the managers or the board of directors have committed gross negligence or they were involved in a speculative risky transaction which caused the company to lose money.
- The Bankruptcy Law provides for very harsh punishments of imprisonment and/or fines for any party who has tried to deceive the creditors, misuse the bankruptcy proceedings or dispose of or hide the Debtor’s assets (including those who helped the Debtor in disposing their assets or hiding them) and provide the judicial authority with full powers to have access to all records and documentation relating to the Debtor and its business.
- The parties who were involved in the management of the Debtor will not have any rights or power to be part of any managerial or board position for five years following the bankruptcy.
Why should a business try to avoid the bankruptcy proceedings?
- Loss of going concern: bankruptcy proceedings are designed to sell and dispose the assets of the Debtor and effectively dismantle the entire business to satisfy the payment of its creditors. Although there is still a chance that the business will continue as an ongoing concern, this is not the aim of the process and, even if it does, it is typically destined to be sold to a third party. Accordingly, the natural process of such proceedings is the liquidation of the business, dismantling of the assets and termination of the employees, as well as breaking of most of the contracts in which the business has entered into.
- No way back: if the protective composition or restructuring process are nullified or terminated by the court for any reason, the only alternative option under the Bankruptcy Law is to continue with the process to formal bankruptcy. It is therefore unlikely that there will be a way back of out of this process once started, unless the Debtor is able to immediately pay all its creditors at once and satisfy their debts in full.
- Limited recovery: given the nature of such proceedings, it is unlikely that creditors will ever be able to recover all money that they are due. Forced liquidation of a business will rarely result in full recovery.
- Court involvement / loss of control: all of the options under the Bankruptcy Law involve the appointment of a trustee and, to varying degrees, supervision by the court over the process and running of the business, as well as the involvement of the creditors in the final settlement or restructuring proposal. Naturally, this means that the owners and managers/directors of the Debtors will lose control over how the business is run, what contracts they can keep and what contracts they will need to terminate. It will be up to the trustee and the court to decide on terminating the contracts and for sure most of the contracts will be subject to termination and acceleration of payments. With such involvement, it is inevitable that the business will suffer in different ways, including loss of talented employees; inability to get any facility extension from the banks; and difficulties in entering into any new contracts with customers and/or suppliers.
- Full disclosure and lack of privacy: all of the processes under the Bankruptcy Law require full disclosure and full transparency of all of the Debtors affairs and financial information. Such disclosure and transparency mean that it may not be suitable to the local community in the UAE to go through any of the three options. The Bankruptcy Law provides that the trustee will provide a full disclosure of the information about any of the processes in the local newspaper in Arabic and English including the size of the debt and the name of the creditors, as well as inviting other creditors to join the process through the publication. Such process is far from discreet and all affairs of the business, the problems and challenges that the business is facing, as well as the names and addresses of the creditors and the amount of the liabilities, will all be in the public domain. This may cause irreparable damage to the Debtors’ reputation, as well as the reputation of its owners and managers/directors. This is something that no business will welcome under any circumstances.
- Time pressure: although the amendments to the Bankruptcy Law introduced in 2019 enable the cabinet of ministers to adjust time periods, most of the standard time periods provided in the Bankruptcy Law for the various processes are very short, forcing a very accelerated procedure whereby things have to be done within days, which can be extremely difficult to meet.
- Risks to owners and managers: the bankruptcy process puts the owner, management and the board of directors of the Debtor under a big risk. As stated above the Bankruptcy Law applies to commercial business, small and big, public companies as well as professional service and civil companies. Some of those businesses may not have kept proper books and records of their dealings. Even if they have kept the required books or records, they may have been involved in speculative business that makes some of their activities high risk. Not keeping proper records or being involved in high risk activities puts the owners and/or management under the risk of criminal proceedings whereby not only could they be prosecuted personally but they could also be liable personally to cover the shortfall in the debts owed to creditors, even where the Debtor is a limited liability company.
- Secured debts: the Bankruptcy Law provides that any debts secured by a mortgage will not be subject to bankruptcy proceedings. A creditor that has a mortgage over the Debtor’s assets may, by obtaining court consent, proceed in getting a judgement and executing a judgement against the Debtor. Therefore, in many circumstances, such a debt may consume the entire assets of the Debtor and there may not be an incentive to pursue any of the three options mentioned above, as the entire assets of the Debtor may will be foreclosed by the creditor who has a mortgage.
- Forced bankruptcy: the Bankruptcy Law provides, in the case of preventive composition where the Debtor is attempting to reach a settlement with its creditors, that such an application will only be considered where the Debtor has not been in default on any of its debts for over thirty days, otherwise the courts will immediately proceed to restructuring or bankruptcy. It is hard to imagine that any business would consider utilizing the option of preventative composition under the Bankruptcy Law unless they are having difficulties in paying their creditors (which will almost certainly occur after such debts have been outstanding for more than 30 days), particularly in the knowledge that if the application was rejected by the court, they may be subject to bankruptcy proceedings.
- Implications beyond the bankruptcy process: Article 138 (4) of the Bankruptcy Law makes the entire bankruptcy process unattractive and potentially meaningless, unless the legislator had a different intention behind the meaning of this article (which is not entirely clear). It reads:
“Upon closing the procedures declaring bankruptcy and liquidation of the Debtor’s Assets, every creditor whose debt was accepted but not repaid in full may execute against the Debtor’s Assets to recover the outstanding balances of their respective debts. Acceptance of the debt referred to in Paragraph 1 of this Article shall be considered a final judgment concerning such execution.”
This could mean that, even after completion of the bankruptcy proceedings, the Debtor is not off the hook and may still be chased for any outstanding debts indefinitely. It is also not clear how this could be applicable if the Debtor has been fully liquidated. My understanding is that there is some discussion about revising certain provisions of the Bankruptcy Law and such a revision is certainly welcomed.
Of course no country wants to encourage any of its businesses to go through bankruptcy proceedings unless it is very much a last resort. It is no doubt that it will be detrimental to any country’s economy if a number of businesses file for bankruptcy and indeed the Bankruptcy Law does provide that the courts can delay the bankruptcy proceedings for a year if they believe that it is not in favor of the UAE economy to proceed with the immediate bankruptcy of the entity Debtor in question. That is perhaps why if you go ahead through the Bankruptcy Law you will find it to be a very unattractive process. However, as it is also a process available to creditors to apply against a defaulting debtor, so this is a very powerful tool that a creditor can use against the Debtor to expedite payments or to reach an acceptable settlement.
I am aware of a few isolated cases in Dubai and Abu Dhabi that have been filed pursuant to the Bankruptcy Law, predominantly by creditors. Such cases remain at an early stage and it remains to be seen how those will play out in practice. However, early indications are that neither the courts, nor the general business community in the UAE, are encouraging of the bankruptcy route. While it is useful that there is a formal process available to debtors and creditors pursuant to the Bankruptcy Law, for the reasons listed above I believe that it is best used as a negotiation tactic by businesses to try to reach amicable payment settlements wherever possible, rather than invoking the legislative process.
Essam Al Tamimi
Chairman & Founder
Al Tamimi & Company