Shareholder disputes revisted
In the present economic climate, shareholders in limited liability companies (LLCs) are looking more closely at their rights and obligations. This seems to be particularly so if one of the shareholders is not involved in the running of the company. As a consequence, there may be a dispute brewing and now may be a good time to review the current legal position and what are often common arrangements between the shareholders.
Shareholdings
Typical arrangements are as follows:
The company was incorporated as an LLC in the Emirate of Dubai. For the purposes of ascertaining the term of the company and the terms of its related licence, the period starts on the date of first registration in Dubai.
A minimum of 51% of the share capital is required to be owned by UAE nationals pursuant to Article (22) of the UAE Federal Law No (8) of 1984 concerning Commercial Companies (Companies Law).
Common corporate structureThe LLC is currently constituted of two shareholders, the UAE shareholder who holds 51% in the share capital of the company and the foreign shareholder which holds 49% in the share capital of the company. Typically, protection of the interests of the foreign shareholder are contained in the company's Memorandum of Association (MoA) and other legal documents.
The following is an overview of the provisions that may be included in the company's MoA and other legal documents in order to protect the interests of the foreign shareholder.
Profit and Loss Allocation
The MoA provides that 80% of the profits and losses of the company is allocated to the foreign shareholder and 20% is allocated to the UAE shareholder. Such allocation is permitted by the Companies Law pursuant to Article (227) and is recognised by the relevant UAE government authorities. In practice, the UAE government authorities do not permit a profit allocation less than 20% to UAE shareholders.
Management
The MoA includes provisions that the management of the company is vested with the foreign shareholder, to run the day-to-day business of the company, to appoint and remove the general manager, open bank accounts, etc.
The resolutions taken in annual and extra ordinary general assembly meetings of the shareholders shall not be valid unless adopted by shareholders representing, say, at least 75% and 100% of the shares in the share capital of the company respectively. In any event, any resolutions of the company shall not be valid without the consent of both the foreign shareholder and the UAE shareholder.
Recent amendments to the Companies Law enable local and international shareholders in an LLC greater flexibility with respect to minimum share capital requirements and related operational factors.
Side Agreement
In view of the Companies Law requirement to have a minimum 51% of the shares in UAE companies owned by UAE nationals, the foreign shareholder will often have entered into a "side agreement" with the UAE shareholder.
The side agreement probably provides for the following:
Only the foreign shareholder has contributed to the share capital of the company and accordingly owns all the share capital of the company.
The foreign shareholder is the sole owner of all the assets and the trade name of the company and is the actual agent with respect to distribution agreements and commercial agencies of the company.
The UAE shareholder is the custodian and trustee with regard to the 51% shares registered in his name.
The UAE shareholder will waive/give up any shares held by him in the share capital of the company in case of liquidation of the company (whether in the form of in kind dividends or public auction proceedings or amicably).
The entire profits and losses in the company will be earned/borne by the foreign shareholder except for an agreed percentage of the net profits of the company (agreed percentage).
The UAE shareholder will not claim any right to the profits generated by the company except for the agreed percentage.
The UAE shareholder acts only as the local sponsor for the company to obtain and renew the licences, visas and work permits relating to the company and its employees.
The UAE shareholder is entitled to an annual fixed fee (fixed fee) at the beginning of each financial year for acting as the local sponsor for the company in addition to the agreed percentage.
The UAE shareholder is entitled to 10% interest on undistributed amounts of the agreed percentage at the end of the financial year, to the extent that the company did not distribute profits in the relevant financial year.
The foreign shareholder, represented by an individual, is appointed as the manager of the company.
Anti-Fronting LawIn November 2004, the UAE enacted the Commercial Anti-Fronting Law (the Law). The Law was originally intended to come into force on 15 November 2007. However, the UAE Cabinet's Resolution No. 229/12, issued in 2007, deferred the enforcement of the Law until 31 December 2009.
The Law, in essence, states that "fronting" is prohibited and fronting is defined as "enabling a foreigner - whether a natural or artificial person - to undertake any economic or professional activity, which he is not permitted to carry out under the effective laws and decrees of the UAE, whether undertaken on his own account or in venture with others; or enabling him to evade obligations applicable to him".
This broad definition is a key provision of the Law as it is the foundation of its scope and application. Article (2) of the Law prohibits fronting for any foreigner whether a natural or artificial person and whether by use of the name, commercial licence or commercial register of the fronter, or by any other means in light of the definition of fronting stated above. It follows that the Law seeks to prevent the use of side arrangements with UAE nationals (including in respect of 51% shareholdings in companies) and may render such arrangements invalid.
The Law imposes fines and imprisonment for violations. The company involved will be deregistered from the commercial registry with respect to the activity involved and its licence will be revoked.
It is likely that the implementation of the Law will be further deferred from 31 December 2009 in order to come into effect (in its current form or an adopted version) in parallel with the planned amendment to the Companies Law which may allow some business activities to be either wholly owned by foreigners and/or to reduce the minimum ownership of UAE shareholders to less than 51%.
New Companies Law
Assuming that the new Companies Law is issued in due course, any attempt to cancel or change the structure of side agreements may have significant consequences. For instance, if the UAE shareholder refuses to transfer shares registered in his name to the foreign shareholder or to a nominated third party. This is especially so if the foreign shareholder does not hold a valid power of attorney (similar to that described below) from the UAE shareholder in relation to the 51% shares, enabling signature on his behalf, or if such power of attorney is revoked.
Such side agreements cannot be notarised; nevertheless, they hold considerable moral weight. It should also be noted that third parties (eg banks, creditors, etc) are not on notice of the existence of such arrangements and are not bound by their terms.
Legal precedents
Hadef & Partners is aware of recent precedents whereby the Dubai Courts have recognised the existence of such side agreements taking into consideration the wording and structure of such agreements, in addition to testimonials from third parties with respect to the ownership of the 51% shareholding. The Dubai Courts have issued various decisions in relation to such agreements, and such judgments are final and are not subject to appeal. Neverthless, the matter of enforceability of side agreements remains uncertain.
Liquidation
If, however, in spite of adopting the types of provisions set out above, a dispute does develop and is not capable of resolution, the only course available will be liquidation of the company.
The possible options are:
Voluntary liquidation commenced by resolution by all the shareholders of the company and by the signing of a shareholders' resolution in the presence of a notary public in Dubai to that effect; or
Involuntary liquidation through court order in case the UAE shareholder is not willing to cooperate and sign the shareholders' resolution; or
The UAE shareholder retains his 51% shares in the company and the foreign shareholder transfers its shares to a new shareholder selected by either party.
Concluding thoughtsKeeping on top of your company's legal position at the strategic and operational levels is commonsense. As the economic situation unfolds, the potential for shareholder disputes to grow out of control is more and more likely. Shareholder disputes can take months to negotiate and settle. Often, the only solution is the liquidation of a successful and profitable company.
A significant new way of handling disputes will be via the soon to be established centre for amicable settlement of disputes in Dubai as announced by Law Number 16 of 2009; giving company shareholders a new option to settle before a dispute reaches the Dubai Courts.
By Michael Dark
© Hadef & Partners 2009
