Contributed By Afridi & Angell
The United Arab Emirates (the UAE) financial market continues to face challenging times as a result of the recent downturn in key sectors, such as real estate and hospitality. Banks have continued to exercise caution in lending to the private sector, particularly small and medium-sized enterprises ("SMEs") – which have seen a marked increase in defaults – retail and off-plan real estate lending, where some market commentators expected further correction to real estate prices through 2020, largely due to the ongoing oversupply of completed real-estate properties in the local market.
Despite a modest increase in 2018, the price of oil remains stubbornly low – compared to the highs of 2008 – and governments have continued to withdraw funds held with local banks in order to plug shortfalls in their domestic budgets, resulting in some banks issuing sukuk or undertaking rights issues, in an attempt to maintain their liquidity requirements. The government continues to invest heavily in key infrastructure projects, especially those related to the Expo 2020. However, the decrease in income and economic activity has resulted in a notable spike in infrastructure projects being funded using public private partnership ("PPP") type structures, particularly in the case of smaller projects in the individual emirates.
The lending market continues to see a growing trend for acquisition, refinancing and working capital financing through dual-tranche (conventional and Islamic finance) structures. Islamic finance products continue to be popular among asset-rich borrowers, particularly the ijara financing structure – similar to the conventional sale and leaseback financing structure – which has enabled borrowers to use existing assets (usually real estate) to fund working capital requirements, whilst continuing to have, use and access relevant assets. Banks and financial institutions have increasingly sought working capital funding through the commodity murabaha structure, which is similar to purchase and deferred payment funding.
In the aftermath of the 2008 financial crisis, the UAE Central Bank ("the Central Bank") implemented a number of changes to the bank supervision regime.In January 2009, the Central Bank announced that all banks in the UAE must provide details of each loan in excess of AED10 million to the Central Bank to enable the Central Bank to scrutinise the asset quality of the banks. In February 2009, the Central Bank created an online unit to settle disputes among banks. Banks may now lodge a complaint directly with the Central Bank through this online process. Upon receipt of a complaint, the Central Bank will investigate the complaint and notify the disputing banks of its decision within eight weeks. However, matters that are already before a judicial process and major financial problems or criminal cases are outside the purview of this online complaint system. The Central Bank believes that this initiative will help them to monitor better the issues faced by banks in the UAE.
Whilst UAE borrowers have sought to diversify their sources of funding beyond investment grade loans, they have found alternatives in the form of Islamic financial products. In particular, companies have sought to issue sukuks (a form of structured product) in order to meet part of their funding needs. While the trend in Western markets may have reversed from loans to bonds as the major vehicle for funding, in the UAE conventional loans continue to retain the lion's share of the financing market.
Although alternative credit providers have always been a fixture in the local financial landscape (particularly in financing the SMEs market), their prominence has not grown as substantially as in Western markets.
There is an ever-growing demand for shari'a-compliant financing products, both from businesses and the sizable Muslim population in the Gulf Cooperation Council (GCC). Islamic financial institutions are expanding their catalogue of financial products in an effort to attract a wider (non-Muslim) customer base. In particular, Islamic financial institutions have been quite successful in promoting the ijara structure (sale and leaseback), which has been popular with business customers.
In March 2017, the new UAE Federal Law No 20 of 2016 ("the Pledge Law") came into force, heralding a new regime for the registration of security over movable assets in the UAE; this introduced a whole new regime for registering a security interest over movable assets, distinct from a pledge (which requires conveyance of possession) and other existing forms of mortgages. The Pledge Law significantly enhances a bank’s ability to take a registered security interest over movable assets in the UAE. The Pledge Law also addresses a number of limitations under the existing UAE laws, including the limitations on the types of movable assets that can be given as security, the requirement to have a UAE licensed bank act as security agent in connection with a mortgage over the assets of a company and the requirement to take possession (actual or constructive) of the pledged assets, in order to perfect the security. The Pledge Law also introduces new categories of movable assets that can now be provided as security, including future assets, effectively creating a floating charge.
The Pledge Law provides a broad definition for “movable” assets and provides an non-exhaustive list of tangible and intangible property over which mortgages can be created under the Pledge Law, including:
Another key feature of the New Law is the proposal to make certain information relating to the registered mortgage available to the public.
The Pledge Law also provided some guidance on assets that cannot be mortgaged under the Pledge Law, including:
Whilst the Pledge Law came into effect in 2017, details regarding the exact mechanism for registering the mortgages (including details regarding the format of the mortgage contract, the identity of the authority that will be responsible for registering/maintaining the security register and the registration fees) were issued on 1 March 2018 as Cabinet Decision No 5 of 2018 and expanded and supplemented by Cabinet decision No 42 of 2018 (together the "Implementing Regulations").
Once the mortgage is registered in the register (to be established in accordance with the Implementing Regulations) in accordance with the provisions of the Pledge Law and Implementing Regulations, it will be effective against third parties and no subsequent security interest can be created over the relevant mortgaged asset. The parties to a mortgage can also register an "in principle" acceptance to create a mortgage right over existing or future movable property.
UAE Federal Law No 2 of 2015, on commercial companies – as supplemented by Ministerial Decision No 272 of 2016 (the "Companies Law"), which came into effect at the end of June 2015 – also places certain restrictions on financial assistance by UAE public joint stock companies (see below, 5.4 Restrictions on Target).
The introduction of VAT (at 5%) in 2018 may impact on economic growth in the UAE. Some bank fees and charges will also be subject to VAT, thus increasing the overall cost of financing to borrowers.
Licensing requirements in the UAE
The principal governmental and regulatory policies that govern the UAE banking sector – except in the Dubai International Financial Centre ("DIFC"), where the regulatory authority is the Dubai Financial Services Authority ("DFSA") – are: UAE Federal Law No 10 of 1980 concerning the Central Bank, the Monetary System and the Organisation of Banking (the "Banking Law"); UAE Federal Law No 18 of 1993, as amended (the "Commercial Code"); UAE Federal Law No 6 of 1985 concerning Islamic banks, financial establishments and investment companies (the "Islamic Banking Law"); and the various circulars, notices and resolutions issued by the board of governors of the UAE Central Bank from time to time, which deal with various aspects of banking including bank accounts, maintaining of certain reserve ratios, capital adequacy norms and reporting requirements to the UAE Central Bank.
While the Central Bank is the principal financial services regulator for banks and financial institutions in the UAE, such entities are also subject to additional registration and licensing requirements at the federal and emirate levels. The Companies Law also governs all commercial companies incorporated in the UAE and all foreign companies with branch offices in the UAE. The Securities and Commodities Authority ("SCA", also commonly referred to as "ESCA") also has some oversight functions in certain specific areas, particularly in relation to listed securities, and ESCA’s role with regard to fund regulation is expanding.
The Banking Law is the primary legislation giving the Central Bank the authority to regulate financial services in the UAE. The Banking Law provides that the Central Bank has the power to license and regulate a wide variety of financial institutions, including those seeking to provide financing in the UAE. In particular, those institutions are as follows:
Each of the entity structures listed above, if incorporated in the UAE, requires a UAE national to hold at least 51% of its shares; however, for finance companies, commercial banks and investment banks, the minimum UAE national shareholding is 60%. All commercial banks incorporated in the UAE must be established as public shareholding companies under the Companies Law and must be majority-owned by GCC nationals.
Branches of foreign banks may engage in commercial banking in the UAE but must be licensed by the Central Bank and must maintain separate accounts for their UAE operations. The Banking Law also provides for the establishment and regulation of financial and monetary intermediaries (ie, foreign exchange dealers and securities broker-dealers), and representative offices of foreign banks. The licence issued to a bank or other institution specifies the particular types of banking business it is licensed to do. Foreign banks operating in the UAE may have no more than eight branches.
Branches of foreign banks are licensed as commercial banks and routinely provide financing to local entities.
Non-resident banks grant bilateral credit facilities and also participate in non-dirham syndications in the UAE. They are not deemed to be resident, domiciled or carrying on business in the UAE, and are not liable to pay tax in the UAE merely on account of such bilateral facilities or participation in syndications. The confidentiality of customer information by banks is not specifically provided for under the Banking Law, but the principle is recognised as a customary banking practice and, implicitly, under certain regulations issued by the Central Bank. The Central Bank has wide powers to obtain information.
The large number of foreign and local banks caused the Central Bank of the UAE more than 30 years ago to establish a virtually complete moratorium on new banks, both foreign and local, although the moratorium has been relaxed slightly in recent years to allow a few GCC and Pakistani banks to establish branches in the UAE. Furthermore, a number of Islamic banks and financial companies have been set up.
Licensing requirements in the DIFC
To provide any financial service from within the DIFC, an individual or entity must be authorised by the DFSA. In particular, a lender must seek a licence for arranging credit in order to offer financing from the free zone and must be structured as any one of the following entities:
Unlike the rest of the UAE, the DIFC imposes no requirement for majority ownership by a UAE national, and 100% foreign ownership is permitted. However, as with the entities incorporated in the UAE, a regulated lender in the DIFC must appoint directors and make periodic filings regarding, among other things, its capital adequacy.
The DFSA has adopted a regulatory approach modelled, at least in part, on the Financial Services Authority in the UK. The DFSA does not grant banking licences per se; it authorises financial service providers to undertake specific financial services. The relevant financial services in respect of banks would include providing credit and accepting deposits. There are approximately 100 international banking institutions with a registered presence in the DIFC. Of these, a substantial number of institutions have not applied for the authorisation to accept deposits. This reluctance on the part of various institutions to be a "true" bank can be traced back to two reasons. First, DIFC entities were historically not able to deal with retail customers; this restriction was lifted several years ago, but the business model of the vast majority of institutions within the DIFC has been to focus on corporate clients or high net worth individuals. Secondly, banks have been reluctant to apply for the "accepting deposits" authorisation as they remain unable to deal in dirhams or accept deposits from the UAE markets. Most of the banks that have set up in the DIFC have done so as branches of overseas companies; this has been done for capital adequacy reasons. Recently, it has been the policy of the DFSA to encourage banks to incorporate new subsidiaries within the DIFC and capitalise those subsidiaries to an acceptable level.
There are no restrictions on cross-border lending.
There are no restrictions on guarantees from domestic and foreign-registered companies. Guarantees must be in writing and specify the amount secured by the guarantee.
Security over immovable property cannot be granted to foreign banks unless they have a commercial banking licence in the particular emirate where the immovable property is located, with the exception of the DIFC (see below). In practice, foreign banks lending to UAE borrowers normally appoint a local bank as its security agent to hold such immovable UAE security. Security over movable property can be granted to non-resident foreign banks, except in the following cases:
There are no exchange controls restricting payments to foreign lenders, except for restrictions on transactions involving Israeli parties or currency. The UAE dirham (AED) is fully convertible and there are no restrictions on the movement of funds (denominated in dirhams, US dollars or otherwise) into or out of the UAE. The dirham is pegged to the US dollar.
There are no restrictions on the use of proceeds from conventional loans and/or debt securities, save as contractually agreed. However, in relation to Islamic facilities and/or the proceeds from the issuance of sukuk, such proceeds must be used in accordance with the principles of shari’a. Shari’a compliance must be adhered to throughout the term of such Islamic facility and/or issuance of sukuk (as applicable).
The concept of the facility and security agent are recognised in the UAE. The facility agent acts on the instructions of (and on behalf of) the lenders and/or the instructions of the majority lenders (as per standard Loan Market Association). The security agent can enforce the security in the courts of the UAE, as agent of the lenders.
The UAE is a civil law jurisdiction that does not provide for the creation of trusts. The concept of trust is recognized in the DIFC.
Debt can be transferred through participation agreements. Under a participation agreement, a pledgee or registered mortgagee continues as the pledgee or registered mortgagee but transfers all or part of the loan, on a funded or unfunded basis. Participation may be disclosed or undisclosed, depending on the terms of the participation agreement.
There is no restriction against conducting a debt buy-back in the UAE. In practice, a borrower is permitted to buy-back the outstanding debt in conventional financing. In Islamic facilities, debt prepayment generally requires the consent of the Islamic financier(s).
Neither the Companies Law nor the rules and regulations applicable in the UAE’s exchanges (ie, the Abu Dhabi Stock Exchange, the Dubai Financial Market and NASDAQ Dubai) provide a separate set of rules governing the acquisition of public companies in the UAE. Accordingly, there is no express requirement that certain funds must be used in acquisitions.
In the DIFC, a financial free zone in the emirate of Dubai, acquisitions are governed by the Takeover Rules Module of the DFSA Rulebook, which also does not prescribe the use of certain funds.
Although an offeror does not need to confirm that funds are in place for an acquisition, Central Bank Circular 25/2005 (as amended by Circular 2418/2006) restricts the amount of debt financing that may be used to acquire shares. In particular, it provides that, in an initial public offering (IPO), any debt financing provided to the subscribers cannot exceed 10% of the nominal value of the shares to be acquired, unless either the company or the bank receiving the subscription funds agrees to refund excess subscription funds to the lending bank (in which case, the lending limit would be 50% of the nominal value of the shares). Also, loans extended against the pledge of allotted shares in a public subscription of a newly established company may not exceed 70% of the book value of the shares. Finally, borrowers may utilise debt financing to acquire up to 50% of founder shares in a private company and 80% of the shares in a company that has been operating for at least five years.
There is no withholding tax in the UAE.
The principal difference in the treatment of local and foreign commercial banks is that local banks are not subject to any taxation on their income, whereas foreign banks with branches in the UAE are subject to tax at the emirate level. Additionally, a foreign bank may not establish more than eight branches in the UAE. The tax paid by banks varies from emirate to emirate; it also varies within each emirate where certain banks are allowed to make annual payments of an agreed sum without reference to the level of profits or losses. Generally, foreign banks are required to pay a tax of 20% on net profits arising in the particular emirate.
Most branches of foreign banks are located in Dubai. The government of Dubai issued Regulation No 2 of 1996 ("Regulation No 2") setting out guidelines to be used by branches of foreign banks in calculating income tax due to the government of Dubai from taxable income arising from the conduct of business in the emirate of Dubai.
Foreign banks operate in the emirate of Dubai pursuant to special arrangements with the government. Generally, foreign banks are required to pay 20% of their net profits to the Government of Dubai as income tax. Regulation No 2 enumerates the permissible deductions that foreign banks may take in determining taxable income. For example, a foreign bank may not deduct more than 2.5% of its total revenue in any year for head office charges and regional management expenses combined. Furthermore, centralised or shared expenses (including regional management expenses) of foreign branches of banks operating in Dubai may be deducted on a prorated basis. Head office expenses must be reflected in the Dubai branch’s books and certified by the external auditors of the bank’s head office.
The guidelines also set out acceptable methods for calculating "doubtful debts", losses, amortisation of assets and capital expenditures. Losses may be carried forward and set off against taxable profits in the next tax year. Losses, however, may not be deducted from a previous year’s tax obligation.
Branches must file an annual tax declaration together with audited financial statements. The financial year for foreign banks operating in Dubai must be 1 January to 31 December. Taxes are due and payable to the Dubai Department of Finance no later than 31 March of the following year. The penalty for late payment has been fixed at 1% for each 30-day period that such payment is in arrears.
Value Added Tax (VAT)
Note that VAT was introduced in the UAE on 1 January 2018. All fee-based (but not margin-based) services offered by banks in the UAE are subject to VAT at 5%. Subject to certain conditions, non-resident banks offering services in the UAE are also required to apply VAT.
Registration fees are payable to the local emirate authority to register the security. Fees vary, depending on the authority, and form a percentage of the secured amount (for example, 0.25% of the value of the loan, for a real estate mortgage). These fees can be costly.
Enforcement of a security interest triggers court fees, prescribed by the relevant courts. If a secured asset is sold by public auction, a public auction fee is also payable.
Notarial fees for documents required to be notarised are 0.25% of the secured amount, capped at AED15,000.
Certain Islamic finance structures can be registered with local authorities, resulting in a limitation on fees and charges for such financing. For example, an ijarah financing (similar to a sale and leaseback structure) may require two sales of assets – for example, in the care of real estate (once from the borrower to the lender and then from the lender back to the borrower and the end of the term of the financing). Each transfer shall be subject to a land transfer equal to 4% of the value of the relevant real estate. However, if the ijarah financing is registered with the local land department then the 8% land transfer fees may be reduced to 4%, plus an ijarah financing registration fee (usually 0.25% of the value of the financing).
As per Article 76 of the UAE Commercial Code (Federal Law No 18 of 1993, as amended), a creditor is entitled to receive interest on a commercial loan at the rate of interest stipulated in the contract. If such rate is not stated in the contract, it shall be calculated according to the rate of interest current in the market at the time of dealing, provided that it shall not exceed 12% per annum.
The limitations for banks are that interest in excess of 12% per annum, compound interest, and interest in excess of principal are not enforced. Unlike other emirates, these limitations are not usually followed by the Dubai courts.
The creating of security interests in the UAE (outside the free zones) is principally governed by:
There are several free zones in the UAE and each free zone has its own regulations for creating security interests by entities licensed within that zone and/or over property located within it. However, in relation to free zones, we have restricted this review to the creation and enforcement of security interests in JAFZ, the first free zone in the UAE, around which the laws and procedures of most other free zones are modelled. For security interests created in the DIFC, see below.
The general forms of security over assets include: (i) real estate; (ii) tangible movable property; (iii) bank accounts; (iv) financial instruments; (v) claims and receivables; (vi) cash deposits; and (vii) intellectual property. These forms of security and related formalities are outlined below.
Real estate constitutes land and permanent structures on land that cannot be moved without suffering damage or alteration. The most common categories of real estate and real estate interests over which security can be granted are:
Mortgages over freehold land are generally registered with the land department in the relevant emirate; for example, in Dubai, this would be the Dubai Land Department. In addition, some free zones provide their own mechanism for registering a mortgage over freehold/leasehold interest relating to property located within that free zone.
There are three types of mortgage over real estate in the UAE, a mortgage over:
A mortgage is defined in the Civil Code as a contract by which a creditor acquires the right to be satisfied from the proceeds of the sale of the mortgaged real estate in priority to unsecured creditors and other secured creditors of the debtor. To have effect, a mortgage must be registered. The time of registration of the mortgage determines priority among mortgages over the same real estate.
The mortgagor must be the owner of the mortgaged property. It is not essential that the mortgagor be the principal obligor of the debt that is secured by the mortgage; the mortgagor can be a guarantor of the debt.
Legislation now exists in Dubai that, among other things, governs the registration of property and security interests by expatriates in certain demarcated zones. The Dubai Land Department has exclusive jurisdiction to register the following three types of title in the name of foreign nationals and foreign-owned companies in certain demarcated areas:
The developer must register any disposition of an off-plan property in the Interim Register, which is maintained by the Dubai Land Department. The disposition of a completed property must be registered in the Real Property Register, also maintained by the Dubai Land Department. Both parties must attend the Dubai Land Department to complete registration. A disposition that is not registered in the Interim Register or the Real Property Register is invalid. Each unit owner (defined as a person who is registered with the Dubai Land Department as the owner, including the tenant under a long-term lease, of a flat, villa, house or other real estate) can create a mortgage over that unit in favour of a bank or financial institution.
The following are permitted:
Law No 19 of 2005 was amended in February 2007 to permit non-UAE nationals to:
In JAFZ, a mortgage can be created over a building constructed on leased land.
Formalities – Real Estate
Mortgages over real property must be both:
In the JAFZ, all land is owned by the Government of Dubai. The JAFZ Authority (JAFZA) leases land for construction of office premises and warehouses. Under the provisions of the standard lease agreement between the JAFZA and a lessee, the lessee can assign its rights under the lease in favour of a lender. All assignments of lease rights must be registered (using prescribed forms) with JAFZA.
Security in the DIFC
The DIFC is unique among the free zones as it has an entirely separate body of laws and regulations. The relevant security laws include:
To perfect a security interest in the DIFC, it must be filed in the Security Registry. If the security holder is a natural person, he must submit the following information to the registrar:
The Security Regulations also govern attachment, perfection and enforcement of a security interest in financial property.
Account holders can pledge eligible securities held in the Central Securities Depositary (CSD) of Nasdaq Dubai by submitting a pledge instruction to the CSD in favour of a pledgee. The CSD designates pledged eligible securities as being held to the order of and controlled by the pledgee. Nasdaq Dubai will not accept any instructions from the account holder unless otherwise instructed by the pledgee.
Tangible Movable Property
Tangible movable property includes:
Under the Commercial Code, all property that is not classified as immovable is considered to be movable property. Tangible property includes goods, inventory, stores and machinery. The Commercial Code provides for the creation of the following types of security interests over tangible (and intangible) movable property. In addition, following the implementation of the Pledge Law it is now possible to register a security interest over movables assets, in accordance with the provisions on Implementing Regulations.
A business/commercial mortgage is a mortgage of movable assets of an entity. It can only be created in favour of banks or other financial institutions. The definition of a business mortgage/commercial includes:
The mortgaged assets must be described in as much detail as possible. If they are not, only the following intangible property is deemed mortgaged (Commercial Code):
Real estate owned by the business is not covered by a business mortgage. However, the landlord of the premises has a lien over the mortgaged assets in the leased premises for unpaid rent (subject to a maximum of two years' rent) in priority to the mortgagee's rights.
Unlike the business/commercial mortgage, the chattel mortgage, also known as a commercial pledge, cannot either:
A chattel mortgage is a pledge over movable property. A chattel mortgage can be created over:
The UAE is a signatory to:
Security over movables under the Pledge Law
The following assets can be registered in the emirates movables collateral registry, created under the Pledge Law:
Security over movables in JAFZ
A business/commercial mortgage can be created by a JAFZA-licensed entity over its business and/or specific assets can be registered with the JAFZA.
Formalities – Tangible Movable Property
To be valid and effective, a business mortgage must be registered in the Commercial Register (only the emirates of Dubai and Abu Dhabi currently register business mortgages in the commercial register). Once registered, the mortgage is valid for five years.
To create a chattel mortgage, possession of the pledged asset must be transferred to the pledgee or a third party (that is, the bailee).
A mortgage over a vessel can be created by a notarised instrument that must be registered in the register of ships (in the jurisdiction where the vessel is registered). Vessel mortgage in the UAE is created under the Commercial Maritime Law No 26 of 2981 (as amended by Law No 11 of 1988) (Maritime Law). The Maritime Law permits the mortgage of a vessel if its total tonnage exceeds ten tonnes. A vessel being mortgaged in the UAE must be registered with the National Transport Authority (NTA). A UAE vessel mortgage must be created once both:
A mortgage over an aircraft registered in the UAE can be created by submitting a copy of the executed aircraft mortgage agreement to the UAE General Civil Aviation Authority (GCAA). However, the UAE Federal Act No 20 of 1991 promulgating the Civil Aviation Law (Civil Aviation Law) does not specify the formalities for the creation and registration of mortgages over the UAE-registered aircraft. However, in practice, the GCAA notes a mortgagee's interest over a UAE-registered aircraft. Once the mortgage is perfected, the GCAA issues a certificate of registration confirming the details of the owner, the operator and the financing bank as mortgagee. In addition to the registration of the mortgage with the GCAA, banks and financial institutions also require the registration of an additional security over the aircraft (airframe and engines) at the International Registry pursuant to the Cape Town Convention on International Interests in Mobile Equipment 2001 as adopted under UAE law. Such registration is effected through the GCAA, which acts as an Authorised Entry Point in relation to the International Registry for the UAE.
Security over movables under the Pledge Law
It is possible to register a mortgage in the emirates movables collateral registry, in accordance with the following requirements under the Implementing Regulations:
Applicants will also need to pay a registration fee of between AED50 and AED200, depending on the type of registration.
Shares are the most common financial instruments that may be pledged as security. It is now possible to mortgage shares in a UAE limited liability company.
A commercial pledge can be granted over both:
Security over shares under the Companies Law
The Companies Law regulates the creation of mortgages and pledges over shares of public shareholding and private shareholding companies.
Under the Companies Law the shares of a private shareholding company may be pledged and perfected through registration. However, as at the date of this chapter the UAE governmental authorities have not created a register for such share pledges.
Pledge over shares in the Jebel Ali Free Zone (JAFZ)
The Implementing Regulations No 1/92 (Free Zone Establishment Regulations) and Implementing Regulations No 1/99 (Free Zone Company Regulations) provide for the creation of a pledge over shares of free zone establishments and companies respectively.
Formalities – Financial Instruments
A commercial pledge is created by endorsing the relevant instrument indicating that the instrument has been pledged and perfected by delivery of the relevant instrument to the pledgee.
Claims and Receivables
The most common types of claims and receivables over which security is granted are receivables, income and insurances. This security can be registered under the Pledge Law.
Formalities – Claims and Receivables
Under UAE law, an assignment of rights requires only notification from the assignor to the third party, confirming the assignment to the assignee. Where this is not possible or practical (for example, the assignment of income for a retail business), the banks may require such income to be deposited into a collection account that will be covered by a pledge of the account. This security can also be registered in the emirates movables collateral registry, in accordance with the Implementing Regulations.
The most common form of security over cash deposits is a pledge. This security can be registered under the Pledge Law.
Formalities – Cash Deposits
The UAE does not recognise the concept of a floating charge, therefore, a pledge over an account relates to the sums standing in the pledged account on the date of the pledge agreement. Consequently, banks usually require the pledge to be amended on a periodic basis or at the request of the bank, so as to pledge the new sums standing in credit in the pledged account. This security can also be registered in the emirates movables collateral registry, in accordance with the Implementing Regulations.
It is not common to grant security over IP in the UAE. IP rights are generally only pledged by a commercial mortgage.
The concept of security over future assets does not exist in the UAE. However, an interest similar to a floating charge can be created over movable assets under the Pledge Law, provided that the pledges over the relevant movable assets have been registered in accordance with the Implementing Regulations.
A parent company can guarantee, or grant a security in respect of, a loan given to a related company (that is, a company in the same corporate group), subject to two conditions:
A subsidiary can also guarantee, or grant a security in respect of, a loan to its parent, subject to the conditions above and the provisions outlined below in 5.4 Restrictions on Target.
Under the Companies Law it is not possible for a target (other than a limited liability company), or any of its subsidiaries, to provide any financial aid (eg, loans, guarantees, etc) that would assist a purchaser in acquiring its shares. The Companies Law has been in effect for just over one year and there is uncertainty regarding the mechanism for enforcement of this prohibition, and on how the UAE courts will view agreements that violate this prohibition.
Within the DIFC a company cannot provide financial assistance for a person to acquire shares in the company, or a holding company of that company, unless the financial assistance falls within certain exemptions provided for in the DIFC Companies Law.
The Companies Law prohibits: (i) a company from making a loan of any kind to a director of the company and from guaranteeing the payment to a director of a loan made by any person to that director (including his spouse, children or relatives up to the second degree); and (ii) a company from making a loan to another company, if a director of the lending company holds (including any shares held by his spouse, children or relatives up to the second degree) over 20% of the share capital of the borrowing company.
Most unregistered securities, particularly movable assets, are generally released by passing possession of the security asset back to the security provider, but can also be released with a release and discharge letter from the secured party. For registered securities (such as a land mortgage or vehicle charge) it may be necessary to follow the procedure of the relevant regulatory authority. There may also be additional requirements for securities registered with free zones.
Generally a lender that perfects its security – either through physical possession (in the case of moveable assets) or registration – shall have priority over other creditors in an insolvency.
The two common methods of subordination are:
Please see 7.5 Risk Areas for Lenders, below, regarding survivorship of subordination agreements following insolvency.
Registering a mortgage over movable assets under the Pledge Law would make the security effective against third parties and priority would be determined from the date of registration, unless the parties agree otherwise. For example, an earlier accounts pledge will be overridden by a later competing pledge which is registered in the emirates movables collateral registry, in accordance with the Implementing Regulations.
The creation, registration and enforcement of various types of securities such as pledges, mortgages over real estate and chattels, assignments and guarantees are determined by provisions contained in both federal (UAE) and local emirate laws.
At the federal level, the creation and enforcement of various types of securities is contained in the UAE Civil Code (the Law of Civil Transactions promulgated under Federal Law No 5 of 1985), the UAE Commercial Transactions Code (Federal Law No 18 of 1993) and other security-specific laws of the UAE – for example, the recently enacted UAE Companies Law (Federal Law No 2 of 2015) contains provisions relating to pledges over shares, the UAE Federal Maritime Law (Law No 26 of 1981) contains provisions relating to mortgages over vessels, etc.
At the emirate level, each emirate has its own practices and procedures, the most developed of which are in the emirate of Dubai. For example, several Dubai laws have been enacted with regard to the creation, registration and enforcement of real estate in Dubai (which provisions are not applicable in the other UAE emirates). The various free zones in the UAE, including the Dubai International Financial Centre (DIFC), have specific laws, rules and practices applicable in the relative free zone. Under UAE law, security can only be created over assets that are in existence or can be clearly identified at the time of creating the security. Accordingly, it is not possible to create a floating charge over assets. The closest security to a floating charge is a commercial or business mortgage over the business assets of a UAE company which can be registered with the Department of Economic Development in the respective Emirate. It is not possible to assign future unidentified receivables as security, but receivables from an existing and identifiable source may be assigned. The UAE does not have a uniform real property law.
Each emirate has its own laws in relation to real property. In Dubai, a freehold interest can be mortgaged and the security registered with the Dubai Land Department. However, the mortgagee can only be a bank licensed with the UAE Central Bank. Dubai also has special laws allowing enforcement of land mortgages. Emirates such as Sharjah restrict foreign ownership to certain Arab nationalities. Dubai allows foreign ownership in certain designated zones while Abu Dhabi only permits certain nationalities to own freehold land (nationals of the GCC states are allowed to own full freehold title) in designated zones. Abu Dhabi has yet to implement the necessary procedures to complete mortgage registration formalities in the designated zones. Therefore, in order to verify whether there are any existing mortgages over properties in the designated zones, enquiries must be made with the developer. However, the accuracy of such enquiries will solely depend on the accuracy of the developer’s records. The UAE has a number of commercial registers where security interests may be recorded depending on the type of asset or entity against which the charge is recorded. There is no system to search for a registered charge over an asset or against any person or entity. Furthermore, the authorities do not allow general public searches of the available register and such information is only provided to the grantor of the charge.
With regard to enforcement, a suit in the relevant court in the UAE has to be filed and a UAE court order obtained. The relevant court procedures will be applicable with regard to the filing of a complaint, defence and other pleadings, documents in support and compliance will be required with any orders made by the court with regard to time limits, the appointment of an expert to investigate questions of fact and other relevant procedures. The court must be satisfied that all relevant requirements contained in the security document and/or the relevant laws have been complied with (for example, the serving of relevant notices) by the party seeking enforcement. Although remedies are available in principle, enforcement in practice can sometimes take a long time and court decisions can be unpredictable, especially since the UAE does not have the concept of binding precedent. Furthermore, all proceedings before UAE courts are conducted in Arabic and all evidence and submissions need to be submitted in writing with little or no oral advocacy in civil matters.
With regard to a choice of governing law provisions in a contract, UAE law recognises the principle that the parties to a contract may choose the governing law of the contract. Article 19 of Federal Law No 5 of 1985 (Civil Code) provides, in pertinent part, as follows:
“(1) The form and the substance of contractual obligations shall be governed by the law of the state in which the contracting parties are both resident if they are resident in the same state, but if they are resident in different states the law of the state in which the contract was concluded shall apply unless they agree, or it is apparent from the circumstances that the intention was, that another law should apply.” [unofficial translation]
In practice, however, if an agreement with a foreign governing law provision is presented to a court in the UAE for interpretation or enforcement, such a court may well apply UAE law, regardless of any contrary choice of law by the parties, unless however a party insists that a foreign governing law provision be applied. In such instances, the foreign governing law will have to be established as a matter of fact.
With regard to a choice of jurisdiction provision in a contract, provided that (i) the jurisdiction of the dispute is not exclusively reserved with UAE courts, and (ii) the UAE courts may assume jurisdiction as a matter of law, UAE law recognises the principle that the parties to a contract may agree on the jurisdiction of a certain court to hear a dispute.
Disputes which are reserved exclusively for the jurisdiction of UAE courts include: real estate action, as specified in Article 32 and under Articles 34 to 39 of Federal Law No 11 of 1992 (Civil Procedure Law) (as amended); labour disputes (if initial mediation proves to be unsuccessful), as provided in Federal Law No 8 of 1980 (Labour Law); and any disputes between a principal and an agent regarding a commercial agency agreement, as provided in Article 6 of Federal Law No 18 of 1981 Concerning the Regulation of Commercial Agencies.
UAE courts may assume jurisdiction as a matter of law (notwithstanding a foreign jurisdiction clause) in the event the defendant is a UAE national or a resident of the UAE (Article 20 of the Civil Procedure Code). The UAE courts may also assume jurisdiction as a matter of law even when the defendant is not resident/domiciled in the UAE in specific circumstances (as specified in Article 21 of the Civil Procedure Code) if the dispute has certain minimum ties to the UAE, such as actions involving real estate in the UAE, actions related to an obligation that was made, performed or supposed to be performed in the UAE, or related to a contract to be attested in the UAE, and actions where one of the defendants has a residence or domicile in the UAE. These provisions supersede any agreement between parties (Article 24 of the Civil Procedure Code).
Accordingly, whether or not a UAE court will enforce a foreign jurisdiction provision in a contract will depend largely on whether such a provision is consistent with the laws described above.
With regard to waiver of immunity, the doctrine of sovereign immunity does not expressly apply under UAE law. Foreign governments are therefore not immune from being the subject of a lawsuit in the UAE.
Although UAE law does not expressly provide for the immunity of UAE government entities, there may be preconditions that must be satisfied prior to filing a lawsuit against a government entity. For example, Dubai Law No 3 of 1996 (the "Dubai Government Actions Law") outlines the procedure that must be followed to file a civil action against the government of the emirate of Dubai or any of its departments. For example, under Article 3(d), the claimant must first submit the details of the dispute in writing to the Office of the Legal Adviser of the Government of Dubai.
At federal level the ability of government departments to sue and be sued is recognised. For example, Article 92 of the Civil Code provides that the state, the emirates, municipalities, administrative units and public administrations shall be considered juristic persons unless otherwise provided by law. As juristic persons, these government entities can be sued as any other corporation, and are also provided with the right to sue under Article 93(2)(c).
It should be noted, however, that recovery against UAE government-owned assets is prohibited under UAE law. Article 247(1) of the Civil Procedure Law states that it is not possible to confiscate the public properties owned by the state or to one of the emirates. In addition, Article 3 of the Government Actions Law provides that no debt or obligation due by the ruler or the government may be collected through seizure or sale of state-owned assets, regardless of whether a conclusive judgment was issued on such debt or obligation or not.
Enforcement of foreign judgments in the UAE is governed under Federal Law No 11 of 1992 (as amended) (Civil Procedure Law). Article 235 thereof provides that a foreign judgment or order will be enforced in the UAE only if the country issuing such judgment or order will enforce a judgment or order delivered by the courts of the UAE. In practice, this requirement for reciprocity is interpreted by the courts of the UAE as requiring a treaty for such enforcement. The UAE Federal Supreme Court has also held that a foreign judgment or order can be enforced in the UAE even without a treaty if it can be established that UAE court judgments have or can be enforced in the state in which the foreign judgment was issued. Article 235 also provides for some prerequisites for the enforcement of a foreign judgment. Such conditions include that the UAE courts did not have jurisdiction to deal with the matter, that the foreign court which delivered the decision was authorised to do and did so in accordance with law, that the litigating parties were summoned to attend and were properly represented, and that the judgment of the foreign court does not conflict with a decision of the state courts, and does not breach morals or public order.
Enforcement of foreign judgments under DIFC law is possible under Article 7(4) of Dubai Law No 12 of 2004 (Judicial Authority Law), which provides that judgments from jurisdictions other than the DIFC may be enforced by the DIFC courts in a manner prescribed by DIFC laws if the subject matter for enforcement is within the DIFC. Article 24(1)(a) of DIFC Law No 10 of 2004 (DIFC Court Law) adds that DIFC courts have jurisdiction to ratify the judgments of recognised foreign courts. Furthermore, Article 24(2) of DIFC Court Law states that if the UAE has a treaty agreement involving the mutual enforcement of judgments, the DIFC Court of First Instance shall comply with the terms of the treaty. Article 7(2) of the Judicial Authority Law No 12 of 2004 provides that judgments of DIFC courts are to be enforced through the Dubai courts. The DIFC courts can therefore, subject to the above requirements, ratify a foreign judgment which can then be enforced through the Dubai courts. However, lately there have been instances where the DIFC courts have permitted enforcement of a foreign judgment, notwithstanding the absence of a treaty and the subject matter being outside the DIFC. Therefore, one cannot rule out the possibility of a DIFC court acting as a conduit jurisdiction for the enforcement of a foreign judgment. Whether there will be a retrial on the merits or not will depend on several factors, including whether there is a treaty agreement with the country in which the foreign court sits, whether it provides for the mutual enforcement of judgments and the exact wording of the treaty.
By Decree 19 of 2016, the Ruler of Dubai established the Joint Judicial Tribunal (Judicial Tribunal) to resolve conflicts of jurisdiction which may arise between the Dubai Court and the DIFC Courts. The ability to use the DIFC court to enforce a foreign judgment where the subject matter for enforcement is outside the DIFC is an issue that has been considered by the Judicial Tribunal. In determining this issue the Judicial Tribunal has effectively held that the Dubai Courts have general jurisdiction to enforce foreign judgments in the UAE (where the subject matter is outside the DIFC) and that the DIFC Courts must only exercise this power in exceptional circumstances (as in the case where a defendant has assets within the DIFC). Therefore, it is still unclear whether the DIFC court can be used as a conduit jurisdiction to enforce a foreign judgment.
Article 236 applies the same enforcement prerequisites to arbitration decisions delivered in a foreign country to the extent that the decision was rendered on an arbitrable subject matter (ie, a subject matter capable of being arbitrated under UAE law).
UAE law provides that certain disputes cannot be arbitrated. UAE courts consider arbitrability to be a matter of jurisdiction. A tribunal that issues an award on a matter that is non-arbitrable under UAE law is considered to have acted outside the scope of its jurisdiction. Therefore, whether a foreign arbitration award can be enforced in the UAE will depend largely on the subject matter of the dispute, and whether it is arbitrable under UAE law.
For example, Article 203(4) of the Civil Procedure Law provides that it is not possible to arbitrate in matters in which reconciliation is not possible. That would generally include criminal matters, bankruptcy and matters of public policy. Under Article 3 of Federal Law No 5 of 1985 (Civil Code), public policy includes matters related to a personal status such as marriage, inheritance and lineage, and matters relating to systems of government, freedom of trade, circulation of wealth, rules of individual ownership and other rules and foundations upon which society is based, in such a manner so as to not conflict with the fundamental principles of Islamic shari’a. Article 733 provides more subjects, which mostly pertain to Islamic shari’a and potentially usurious transactions, on which compromise cannot be reached as a matter of law, which include usury on credit granted and other credit and debt-related subjects.
UAE law also provides for other subjects which are reserved exclusively for the UAE courts, and are therefore non-arbitrable. For example, under Article 6 of Federal Law No 8 of 1980 (Labour Law), labour disputes must be referred to the UAE courts (if initial mediation proves to be unsuccessful). Similarly, Article 6 of Federal Law No 18 of 1981 Concerning the Regulation of Commercial Agencies provides that any disputes between a principal and an agent regarding a commercial agency agreement must be heard by the UAE courts.
Therefore, any foreign arbitral award rendered on such subjects is unlikely to be enforceable in the UAE. Put another way, any foreign arbitration award rendered on such subjects can be challenged and possibly annulled in the UAE.
The UAE is, however, a party to several international treaties and conventions regarding the recognition and enforcement of arbitral awards. These include: the 1958 Convention on the Recognition and Enforcement of Foreign Arbitral Awards (New York Convention); the Riyadh Convention on Judicial Co-operation between States of the Arab League; the GCC Convention for the Execution of Judgments, Delegations and Judicial Notifications; and the ICSID Convention on the Settlement of Investment Disputes between States and Nationals of Other States (1965).
The UAE ratified the New York Convention in 2006 without making any declarations or reservations. The New York Convention provides a mechanism which allows state parties to enforce arbitration awards made in one country in another country that is also a signatory to the Convention. Accordingly, under Article III of the Convention, UAE courts are required to “recognise” foreign arbitral awards (if issued in another country that is also a signatory to the Convention) “as binding and enforce them”, unless the limited grounds to resist enforcement, provided under Article V(1) can be proven by the party against whom enforcement is sought.
With respect to the enforcement of foreign arbitral awards, Article 24(1)(c) of the DIFC Court Law provides that DIFC courts may ratify a recognised arbitral award. That is confirmed in Article 42(1) of the DIFC Arbitration Law of 2008, regarding “Recognition and enforcement of awards”, which provides that an arbitral award shall be binding on DIFC courts irrespective of the jurisdiction in which it was made. However, Article 44 provides various “Grounds for refusing recognition or enforcement” of an arbitral award; these include, for instance, that the decision was not valid under the law governing the arbitration, one of the parties was not given proper notice, the arbitral procedure was not in accordance with the agreement of the parties, or enforcement of the award would be contrary to the public policy of the UAE.
The ability and willingness of DIFC courts to enforce foreign arbitral awards was confirmed in the two recent cases of Banyan Tree v Meydan Group LLC (Case No ARB 003-2013) and (1) Egan (2) Eggert v (1) Eava (2) Efa (Case No ARB 002-2013).
There is no distinction between a local and a foreign lender with regard to their ability to enforce their rights under a loan or security agreement, as long as the foreign lender has an office or branch in the particular emirate where it wishes to enforce its rights. Otherwise, the foreign lender would normally appoint a local security agent to hold the UAE-located security on their behalf. See above, 3.2Restrictions on Foreign Lenders Granting Security.
The new Bankruptcy Law of the UAE was enacted on 20 September 2016 (Decree Law No 9 of 2016) and provides a framework for the restructuring and insolvency of companies and traders (the "Bankruptcy Law"). The Bankruptcy Law was published on 29 September 2016, giving it an effective date of 31 December 2016, and replaces and repeals the previous legislation contained in UAE Federal Law No 18 of 1993 promulgating the Code of Commercial Practice (the "Commercial Code"). An important feature of the Bankruptcy Law is the introduction of a regime allowing protection and reorganisation of distressed businesses.
Rather than having to proceed directly to bankruptcy proceedings (or at all), the Bankruptcy Law provides for preventive composition, allowing the debtor the opportunity to reach an agreement with its creditors for its debts (while under court protection from individual creditor claims). However, a debtor can only take advantage of this process if it has not been in default for more than 30 consecutive business days and is not already insolvent. During the process, the debtor cannot dispose of any property, stocks or shares, make any borrowings or change ownership or corporate form.
The debtor must apply to the court for the preventive composition by submitting an application containing information relating to: its economic and financial position, details of its movable and immovable properties, employees and creditors, and cash flow and profit and loss projections for the 12 months following the date of application.
The debtor must continue to perform its obligations under any contract, provided the court has not issued a judgment of stay of execution due to the debtor’s failure to perform its obligations. However, the trustee designated to facilitate the preventive composition process does have the right to request that the court rescind any contract if it is in the best interests of the debtor and its creditors, and provided that it does not substantially harm the other contracting party’s interests.
The debtor will have three years to implement the preventive composition arrangement (which will be approved/rejected by the court), which could be extended for a further three-year period provided a two-thirds majority of the unpaid creditors consent to such an extension.
At the request of an interested party, or in exercise of its own discretion, the court may initiate the termination of the preventive composition arrangement and convert it into a bankruptcy proceeding if:
The Bankruptcy Law also gives the court the authority to initiate restructuring procedures. An appointed trustee will develop the scheme with the assistance of the debtor, which will include a timetable of implementation of not more than five years from the date that the court approves such a scheme, which can be extended for a period of not more than three years with the consent of a two-thirds majority of the unpaid creditors.
Under the Bankruptcy Law, there is now a minimum threshold of AED100,000 before a creditor (or group of creditors) can initiate bankruptcy proceedings against the debtor, provided the creditor has adequately notified the debtor of such debt and the debtor has still failed to repay it within 30 consecutive business days of notification). How disputed amounts will be treated by the courts is not addressed in the Bankruptcy Law. This provides a much more debtor-friendly position than under the old regime.
The preventive composition scheme draft is subject to approval by the majority of the creditors. A creditor also has the right to request the court to rescind the preventive composition scheme if the debtor fails to satisfy its conditions or if he dies and its satisfaction becomes impossible for any reason.
Once the preventive composition process has begun, a creditor cannot enforce any guarantees it may have on the debtor’s properties, without prior permission of the court. However, creditors holding debts with a pledge or lien over the debtor’s property may enforce their guarantees whenever such debts become due.
When a bankruptcy judgment is pronounced, all monetary debts owed by the bankrupt become payable, whether ordinary or guaranteed by lien. The court can deduct legal interest (9%) for the period from the date of the judgment until the maturity date of the debt for deferred debt where no interest is stipulated. The court can grant approval to the following categories of person to purchase the debtor’s properties if that would satisfy the creditors interests: (i) spouse, relative by marriage or up to fourth degree relative; (ii) any person who was a partner, employee, accountant or agent of the debtor (within two years prior to the date of judgment); or (iii) any person who works or worked as the auditor following the initiation of bankruptcy proceedings.
While undergoing the preventive composition or restructuring process, a debtor (or the appointed trustee) has the option to apply to the court for the authority to obtain new funding. Any “new” creditor will have precedence over any ordinary outstanding debt owed by the debtor (but providing protections for existing creditors).
In the course of bankruptcy proceedings, preference is given to the following:
The creditors in each class of debts listed above are ranked equally, unless the debtor has insufficient funds to satisfy each creditor ranking equally. In this case, the rank of debts is equally reduced.
Whilst the concept of equitable subordination is not specifically recognised, creditors need to be aware that there is still the two-year rule regarding “voidable” or “fraudulent” preferences. What this means is that transactions made by the debtor during the two-year period preceding the initiation of insolvency proceedings can be reviewed by the trustee to determine whether these should be set aside as having been an “unfair preference”, and the Bankruptcy Law sets out the types of transaction that the court will consider (such as donations or gifts, payment of debts when such payments were not yet due or the creation of any new guarantee on the debtor’s properties). The court will consider whether such a transaction was “detrimental” to the creditors and if the transacting party knew (or ought to have known) when entering into the transaction that the debtor was in financial difficulty and thereafter make its judgment on whether it should be set aside.
The Bankruptcy Law gives a trustee the right, during bankruptcy proceedings, to decide if the revenues generated from the sale of any guarantee-burdened properties would be insufficient to meet its fees (and any related costs of such sale) and can thereafter decide to abort any proposed sale. The creditor only has the right to object to such decision within three business days of receipt of notification from the trustee to the creditor. The court will issue its decision in respect of the creditor’s objection within five business days – the Bankruptcy Law is silent on when such a timescale begins – but without any pleadings being heard from the creditor or trustee; such decision shall be final.
Where permitted under the Bankruptcy Law for the creditor to file a grievance or appeal with the court (eg, in relation to the actions or decisions of the trustee), the court has absolute discretion to consider and issue a decision on such matter. Such decisions are final and the creditor will have no recourse or right of appeal to any other court or governing body.
Where a debtor owns any common properties, the trustee (or any of the co-owners) may request division of such property, even if there is an agreement between the co-owners that does not allow such division.
Upon request by the trustee, the court can order the rescission of any contract that the debtor is a party to, provided such rescission is necessary to enable the debtor to transact his business or if it would fulfil the interests of all of the creditors and not significantly prejudice the other contracting party’s interests.
A creditor will have one year from (i) date of death of the debtor, (ii) striking-off of the trader from the commercial register, or (iii) date of judgment of incapacity, to apply for bankruptcy proceedings against a debtor.
Creditors should also be aware that there is a change in coverage under the new Bankruptcy Law in that professional licence holders are now covered but most public sector entities are not. What this means is that a creditor of a public sector debtor has no assurance that a trustee will be appointed, affording the creditor with fair, rule-based treatment.
Project finance is generally defined as the development of a capital-intensive infrastructure project, which is typically structured on a limited recourse financing basis. In a limited recourse financing structure, the borrower is a special purpose vehicle (SPV) created for the specific purpose of the project, repayment is achieved through the cash flows generated by the project itself, and security is guaranteed principally by the project assets. These structures are found in markets where the local government requires private capital for the development of infrastructure projects.
The parties involved in a standard project finance deal include: the project company itself, which serves as the vehicle to borrow, hold equity interests and carry out the project; the project developer and main sponsor, who leads the development of the project; the other sponsors who take an equity interest in the project; the lender(s) who provide debt financing for the project; and the contractor(s) that execute the project.
Most infrastructure projects in the UAE are carried out by wholly or partially government-owned entities and, to the extent that a government entity is serving as the project developer, the project is typically self-financed. This is the case with almost all of the public-works projects, oil and gas projects, and power plants, including renewable energy. As a result, there is limited scope for pure “project finance” plays within the local market (with certain exceptions), and such structures may be found where there is a policy to develop a capital market (as opposed to a budgetary constraint).
The exceptions to this standard include some power, water and infrastructure facilities structured through public-private partnerships (PPP), and other privatisation initiatives, which are discussed later in this section. Most privately funded real estate and tourism projects are funded on a corporate or full-recourse basis, and are therefore not discussed in this section.
The UAE is a highly regulated market, where the legal framework regulates the activities of each stakeholder in a project finance deal. The regulations differ depending on the nature of the project and its sponsors. Where the project developer is a government-owned entity, it must comply with their relevant enacting legislation. In the case of a private entity, the project must comply with local licensing requirements. Furthermore, commercial project lending must comply with standard banking and financial regulations. Contractors, regardless of the public or private nature of the project, are also subject to local licensing and operating requirements.
This section will focus on the relevant legal framework applicable to project developers, sponsors and lenders in privately funded and PPP-style projects, and to contractors in both government and private projects, with an emphasis on the special considerations that foreign entities need to consider when operating in the region.
PPPs and independent power projects (IPP) are not common structures in the UAE, and there is no applicable federal legislation, though there are emirate-level laws in Abu Dhabi and Dubai.
In Abu Dhabi, the Abu Dhabi Water and Electricity Authority (ADWEA) has used PPP initiatives in transport and other infrastructure sectors, and it has been implementing a long-term programme of privatising the electricity sector. Independent water and power producers (IWPPs) have been established in Abu Dhabi as joint venture arrangements between ADWEA and various international power companies on a build-own-operate (BOO) basis, where the long-term contractual arrangements commit the IWPPs to sell their production to ADWEC.
The major IWPPs include Al Mirfa International Power & Water Company, Arabian Power Company, Emirates CMS Power Company, Emirates SembCorp Water and Power Company, Fujairah Asia Power Company, GulfTotal Tractebel Power Company, Ruwais Power Company, Shuweihat Asia Power Company PJSC, Shuweihat CMS International Power Company, Shams Power Company PJSC and Taweelah Asia Power Company.
The structure of the IWPP ownership is split between ADWEA and the foreign investor, where the majority ownership typically vests with ADWEA. Project companies are usually structured as joint-stock companies incorporated in Abu Dhabi, in accordance with local licensing requirements, which are discussed later in the section. The most common ownership structure is one where ADWEA incorporates an intermediate holding company to own a 60% stake, which in turn is held 10% by ADWEA and 90% by the Abu Dhabi National Energy Company PJSC (also known as TAQA), though some project companies have other structures.
The Shuweihat S2 power plant was commissioned in October 2013, adding a further 1,510 MW to Abu Dhabi’s power generation capacity, and 100 imperial gallons of potable water daily. The electricity and water supply from Shuweihat S2 plant will be purchased by ADWEC under a 25-year power and water purchase agreement.
Dubai recently passed its Dubai Electricity Privatization Law, which allows the private sector to participate in energy generation. The law authorises the Dubai Electricity and Water Authority (DEWA) to establish project companies, by itself or with third parties, to generate electricity.
Dubai also passed a new law pertaining to public private partnerships (the Dubai PPP Law) in November 2015, which regulates partnerships between government agencies and private entities to develop projects in Dubai. The Dubai PPP Law does not apply to projects related to the production of electricity and water, which come within the purview of the Dubai Electricity Privatization Law. There are various structures permitted within the Dubai PPP Law, including concession agreements, build-operate-transfer, build-transfer-operate, build-own-operate-transfer and operating agreements. The authority granting approval for the projects varies depending upon the project cost. Interested private entities can either bid for projects individually or as a consortium and the selected private partner must establish a project company in the form of a limited liability company, to implement the partnership contract. The Dubai PPP Law also contains provisions pertaining to the bidding process, general and specific conditions of contracts, obligations of the project company, etc.
To date, several independent power projects (IPPs) have been launched in Dubai. The first IPP is Al Hassyan 1 IPP, a 1,500 MW gas-fired power plant, for which bids were solicited in December 2011. The project has, however, been deferred indefinitely.
In 2015, a consortium of ACWA Power and TSK Electronica y Electricidad SA won the bid to set up a 200 MW photovoltaic plant (Shuaa Solar PV Project) in the second phase of the Mohammed bin Rashid Al Maktoum Solar Park (Solar Park) on the IPP model. The project has been operational since April 2017.
Subsequently, the Hassyan Clean Coal Project was launched by DEWA and the consortium of ACWA Power and Harbin Electric was awarded the project. In 2016, the major engineering procurement and construction contract for the Hassyan Clean Energy Project was awarded to Harbin Electric International and General Electric. The project is proposed to be operational by 2023.
Another development in 2016 was the selection of the consortium led by the Abu Dhabi Future Energy Company (Masdar), including the Spanish companies FRV (Fotowatio Renewable Ventures) and Gransolar Group for construction of the 800 MW third phase of the Solar Park on the IPP model. The first phase of the project (200 MW) is expected to be operational in the first half of 2018, followed by the second phase (300 MW) in 2019, and the third phase (300 MW) in the first half of 2020.
Pursuant to the Dubai PPP Law, Dubai courts signed a partnership contract with Park Line (a special-purpose company set up by IL&FS Transportation Networks and Next Generation Parking) in May 2016 to develop one of the world’s largest automated car parks within the existing premises of the Dubai courts.
As the fourth phase of the Solar Park, DEWA released an expression of interest in October 2016 to build the largest concentrated solar power project in the world of 700 MW (CSP), based on the IPP model. The project has been awarded to ACWA Power and Shanghai Electric and is proposed to be commissioned in stages, starting from the fourth quarter of 2020.
There are also laws in Dubai, empowering the Dubai Roads and Transportation Authority (RTA) to create PPP arrangements.
Part of the legal framework for a project finance transaction in the UAE involves: obtaining government approvals for the project; complying with registering and filing requirements for the transaction documents; and, for foreign sponsors, meeting local corporate ownership requirements.
Given that the UAE is a federal structure, with powers divided between the federal government and each of the seven constituent emirates, government approvals may be required at both the federal and local level. Relevant federal ministries include the Ministry of Public Works, Ministry of Energy, and the Ministry of Environment and Water. At an emirate level, there are different authorities involved. For example, in Dubai, the relevant authorities, depending on the project, include DEWA, the Dubai Road and Transport Authority and the Dubai Telecommunications and Regulatory Authority (TRA).
Foreign sponsors that do not have a local presence must take into account that the project company will likely have to be a UAE company, subject to UAE law. UAE companies must be majority-owned by a UAE citizen (a UAE national(s) or a company wholly owned by UAE nationals), under the UAE Commercial Companies Law (Federal Law No 2 of 2015, which recently replaced Law No 8 of 1984). The law dictates that a UAE company can only have a maximum of 49% foreign ownership, with the majority 51% stake to be owned locally. However, it is not uncommon for foreign investors to hold more than 51% of the beneficial interest in local companies through side agreements with the local majority-owning partners, whereby management power and economic interest in the shares is transferred to the foreign investor.
PPP structures, however, will clearly define the ownership interest in a project as such structures will be formed in accordance with a direct government policy in such regard.
Free zone companies can be 100% foreign-owned, but are not allowed to conduct business outside the free zones and within UAE proper. Use of such entities as project companies is therefore presently not appropriate.
Contractors also must take into account local licensing requirements. In addition to the basic corporate structuring requirements discussed above, contractors, whether local or international, must be licensed to carry out their activities in the relevant emirate. This licensing requirement applies to all UAE companies, regardless of their activity. The application for construction-related licences is a more cumbersome procedure with different requirements in each emirate. This applies to contractors, subcontractors, architects, civil engineers, project managers and engineering consultants.
The licensing process begins with an application that includes, among other things, proof of experience (past projects, length of experience), demonstration of minimum capital requirements and corporate documentation. Approvals will then be required from the relevant authorities regulating the particular activity, as licences to carry out government projects require additional layers of approval. Additional requirements will apply if there is an environmental impact (discussed later in the section). After the entire procedure is complete, the licence will be issued; the types of licences cover the standard types of construction activities including building contracting, road contracting, marine contracting, electrical power station contracting and others. In some cases, however, licences will not be issued to foreign contractors at all. In these cases, arrangements can be made with existing local contractors to work together on a partnership basis.
Transaction documents in a project finance deal consist primarily of the contractual arrangements between the shareholders, such as the shareholders and subscription agreements, the construction documents and the security package.
The contractual arrangements between the shareholders for a local UAE project company include a memorandum and articles of association, which must be filed with the department of economic development in the relevant emirate. In the context of companies with foreign investors, due to the nature of the arrangements described above, the substantive provisions of this document have minimal impact. Instead, it is the side agreements, and the shareholders and subscription agreement that have importance, and these are not filed. These documents, to the extent that they are between the foreign shareholders, and not the UAE national or UAE national company, can be subject to foreign law; however, it is important to note that, if brought before a UAE court, the court may elect to exercise jurisdiction.
The security package taken by lenders in the UAE is typical of the norm in other jurisdictions, and will be subject to UAE law. It will likely include an asset pledge over plant, machinery and other company assets, which will be registered under the Pledge Law and a legal mortgage over the land or site, which may take the form of a mortgage over sub-usufruct, which is the right to use, enjoy, and occupy land or property belonging to another entity for a fixed term.
The construction documents in a project finance deal in the UAE are, like other jurisdictions, commonly based on one of the International Federation of Consulting Engineers (Fédération Internationale des Ingénieurs-Conseils – FIDIC) forms of contract. However, where contractors are working with a government-owned entity as the sponsor there may be exceptions. For example, in Abu Dhabi contractors must work with the Abu Dhabi Government Conditions of Contract for construction or design and build contracts, which were introduced in 2007 and are based on the 1999 FIDIC Red and Yellow books respectively, with shifts in the risk allocation upon the contractor. In Dubai, many government departments, including the Roads and Transport Authority (RTA) and the Dubai Municipality (DM), have their own conditions of contract, which again are based on the FIDIC form with increased risk transferred to the contractor. Finally, it is not uncommon to have contracts that are not based on the FIDIC template.
As previously discussed, project finance deals are subject to the regulatory oversight of the relevant government bodies. The UAE is a federal system composed of seven individual emirates, and the division of power between the federal and emirate governments is enumerated in the State Constitution of 1971. To that end, there are federal authorities and individual emirate authorities that play roles in any given project.
By way of example, the generation, transmission and distribution of electricity in the UAE is regulated and requires specific licences from the relevant government authorities. In Abu Dhabi, private sector participation in the electricity sector is regulated by Law No 2 of 1998 Concerning the Regulation of Water and Electricity Sector, as amended by Law No 19 of 2007 and Law No 12 of 2009. Pursuant to this law, the Electricity Regulation and Supervision Bureau of Abu Dhabi has the power to: (i) issue licences to conduct regulated activities; (ii) monitor licences and ensure compliance with terms of licences issued; and (iii) make regulations as it sees fit for the regular, efficient, and safe supply of electricity in the emirate. As part of the licensing process, there are fees, charges and registering and filing requirements.
As previously discussed, there is a history of state ownership for most infrastructure projects.
For privately funded projects with foreign sponsors – other than PPPs, whose structure will be formed in accordance with a direct government policy in such regard – a structure needs to be created that complies with local majority ownership requirements (as previously discussed), and financing arrangements are typically on a corporate or full-recourse basis.
Foreign sponsors have different options for structuring their investment into the project. A foreign investor can become a direct shareholder in the UAE project company, and if there are multiple investors, they can create a holding company above the project company level that will serve as the shareholder in the project company. The advantage of the latter structure (for either individual or multiple investors) is that the holding company can be incorporated in a foreign jurisdiction (eg, a straightforward offshore jurisdiction such as the British Virgin Islands), which will enable a smoother process, compared to that of the UAE, for share transfers and other corporate actions; also, if agreed between the parties, disputes regarding the shares can be adjudicated outside of the UAE.
Foreign contractors can enter into joint ventures with local contractors, where the foreign contractor and the local contractor can either set up a holding company to hold their interests in a UAE company that will be licensed to carry out the construction work, or contractual arrangements can exist outside the framework of the UAE company. The advantage of the former position is that the foreign contractor will have a direct interest in the local company. Joint ventures can also be based on partnership arrangements. Smaller projects can also be carried out by a single established local entity, where a foreign contractor is the sole shareholder.
The financing arrangements for privately funded projects are typically financed on a corporate or full recourse basis. This is in contrast to the large PPP-style projects that are typically seen in the power and water sector (discussed above), where traditional project finance limited recourse financing is used. Lenders can be local, international or a syndicate of both, and they generally follow the precedents of the Loan Market Association (LMA). The unique aspect of project finance in the UAE is the use, in some projects, of Islamic financing structures, such as the sukuk, which is a hybrid debt-equity product; see below, section 9 Islamic Finance. As previously discussed, government projects are largely self-financed.
Typically, project financings in the UAE are carried out in the form of long-term loans granted by large international and domestic banks. Tenure of 20 to 25 years for the loans is common. Banks finance up to 75% of the project cost and the remaining funds are contributed by the sponsors of the project, either by way of equity contributions or shareholder loans. Sponsors may also be required to provide undertakings, sometimes supplemented by collateral security such as letters of credit, towards funding any cost overruns that the project may encounter and to ensure completion of the project.
Export credit agency (ECA) financings, while not very common in the past, have of late been gaining popularity for funding infrastructure projects. For instance, ECAs from France and Belgium granted a USD675 million loan to the Dubai Department of Finance to complete phase 1 of the construction of the Al Sufouh Tram project. There are several projects in the UAE that international ECAs have earmarked for debt funding, which include the expansion of the Al Maktoum International Airport and the USD2.45 billion RTA Metro Red Line project connecting the World Expo 2020 site.
While we have recently seen a few power projects opting for project bond financing, these are not very common as yet in the UAE.
The major natural resources in the UAE are oil and gas. The UAE is one of the world’s leading producers and exporters of oil, and the world’s fifth largest gas reserve. The emirate of Abu Dhabi is home to the largest gas production and the vast majority of the country’s oil reserves.
According to the State Constitution of 1971, the acquisition and export of natural resources in the UAE is governed at an emirate level, and not a federal level. Therefore, the individual emirates have the authority to determine how to exploit the natural resources within the emirate.
In Abu Dhabi, oil affairs are governed by the Supreme Petroleum Council in Abu Dhabi, and by the individual Ruler’s Office in each of the other six emirates. Oil production in the UAE today is a public sector activity engaged in by government-owned entities and holders of government concessions, which include the traditional oil majors (BP, ExxonMobil, ConocoPhillips, etc).
The regulation of oil in the UAE is largely addressed by the individual concession agreements and other agreements with the major oil companies, and not general laws and regulations. Some of these agreements date back to the 1930s.
A recent development in this regard is that Abu Dhabi’s 75-year-old onshore oil concession expired on 10 January 2014, ending its existing partnership with BP plc, Royal Dutch Shell plc, Exxon Mobil Corp., Total SA and Portugal’s Patex Oil and Gas. However, in January 2015, the Abu Dhabi National Oil Company (ADNOC) and Total SA signed the new 40-year ADCO Concession Agreement for the ADCO onshore oil fields in the Emirate of Abu Dhabi under which Total SA was granted a 10% participating interest. Subsequently, concessions were also granted to Japan Oil Development Company (5%), South Korea’s GS Energy (3%), BP plc (10%), China National Petroleum Corporation (8%) and CEFC China Energy Company Limited (4%).
Like oil, in Abu Dhabi gas affairs are governed by the Supreme Petroleum Council as well, and in the individual emirates by the Ruler’s Office. Gas is produced by the three major operating companies in Abu Dhabi, all of which are majority-owned by the Abu Dhabi National Oil Company.
Gas is regulated at an emirate level and all activities involving natural gas requires permits issued by the authorities in the relevant emirate.
As with other laws and regulations in the UAE, health, safety and environmental laws exist at a federal and emirate level. Federal laws are meant to prevail over emirate laws in the event of conflict, however this is not always observed in practice. Most health and safety laws are found in the UAE Labour Law, and some are also contained as criminal offenses under the UAE Penal Code.
The relevant health and safety laws are standard provisions that require adequate safety measures to be taken at site, access to safe drinking water and hygienic facilities, and hazardous conditions. An example of emirate-specific legislation is Dubai’s Code of Construction Safety Practice (Guidelines for the Construction Industry in the Emirate of Dubai).
An entity pursuing a project in the UAE must consider if there is an environmental impact and, if so, apply to the Ministry of Environment and Water (a federal authority) to seek a licence. The relevant federal legislation is Law No 24 of 1999 for the protection and development of the Environment ("Environment Law"). There are other federal laws on the books as well. The local authorities, such as the Dubai Municipality, also have their own rules and regulations.
Although the modern Islamic financial industry has only been in existence for the past 40-odd years (compared to the 300-plus years for the conventional finance industry), it has gained a substantial foothold in the global market and is a major component of the financial industry in the UAE. While the use of Islamic financial products has rebounded following the 2008 market downturn, with certain financial products (eg, sukuks) seeing double digit annual growth, Islamic finance still represents less than 1% of the global financial market.
The UAE is one of the largest Islamic banking markets in the world, after Saudi Arabia and Malaysia. According to the UAE Central Bank, as at December 2017, 22.4% (AED550 billion or USD149.73 billion) of all banking assets in the UAE are shari’a-compliant. Realising the potential growth in the Islamic finance industry, in October 2014 the Government of Dubai set the goal to become the global capital of Islamic finance, goods and services within the next decade, and has appointed a team of Dubai’s leading executives to achieve this goal. Various parts of the economy have played a part in establishing Dubai as the leader of the Islamic finance industry, including:
The UAE is a relatively young country and the laws and regulations applicable to financial products and services (including Islamic finance) are rudimentary – often just providing a mandate for the formation of regulatory authorities to govern the provision of the relevant financial products and services in the UAE. Consequently, the detailed rules, regulation and policies relating to financial products and services are left to the discretion of the relevant regulatory authorities. However, UAE Federal Law No 5 of 1985 Concerning Civil Transactions (the UAE Civil Code), recognises the basic Islamic financing contracts, including murabahah (cost-plus financing), mudarabah (trust financing), musharakah (partnership financing) and ijarah (leasing).
The principal governmental and regulatory policies that govern the UAE banking sector, including Islamic banks (except in the Dubai International Financial Centre (DIFC), are: UAE Federal Law No 10 of 1980 concerning the UAE Central Bank, the Monetary System and the Organisation of Banking (the Banking Law); UAE Federal Law No 18 of 1993 as amended (the Commercial Code); UAE Federal Law No 6 of 1985 concerning Islamic Banks, Financial Establishments and Investment Companies (the Islamic Banking Law); and the various circulars, notices and resolutions issued by the board of governors of the UAE Central Bank from time to time. The Islamic Banking Law contains specific provisions relating to the establishment and operation of Islamic banks, and provides that Islamic banks have the right to: (i) carry on all or part of banking, commercial, financial and investment services and operations; (ii) engage in all types of services and operations practised by banks and referred to in the Banking Law, whether those operations and services are conducted for the Islamic bank’s own account or or in partnership with a third party; and (iii) establish companies and participate in enterprises provided that the activities of the latter are in conformity with shari’a.
The concept of a higher shari’a authority was first contemplated under Article 5 of the Islamic Banking Law, which provides that this authority shall incorporate "legal and banking personnel to undertake higher supervision over Islamic banks, financial institutions and investment companies to ensure legitimacy of their transactions accordingly to the provisions of Islamic shari’a law, and also to offer opinion on matters that these agencies may come across while conducting their activities. The opinion of the said Higher Authority shall be binding on the said agencies". In 2017 the UAE Cabinet approved the formation of the board of the Higher Shari’a Authority (the "Higher Authority") to strengthen consistency of the Islamic finance industry across the UAE. At the first meeting of the board of the Higher Authority they identified a number of core objectives, in particular:
As the Higher Authority is a recent development it still remains to be seen how it will interact with, and impact on, the role of other key stakeholders, in particular the shari’a boards currently overseeing shari’a compliance at financial institutions.
Each Islamic bank, financial institution and investment company must appoint a shari’a supervisory board consisting of at least three shari’a scholars specialised in shari’a law and finance, to ensure that its operations and products comply with the rules and principles of shari’a. The sharia’s supervisory boards will review all proposed financial products and related documents, and issue a fatwa (opinion) on the shari’a-compliance of the same. Currently in the UAE, shari’a compliance is be achieved in various ways, including by way of adopting national regulations, voluntary shari’a-compliant standards, and the directives and resolutions of the firms’ internal shari’a supervisory boards. However, it is anticipated that the decisions and regulations issued by the Higher Authority will soon be added to the above list.
Whilst voluntary standards are issued by standard setting bodies – such as the Accounting and Auditing Organisation for Islamic Financial Institutions and the Islamic Financial Services Board – in practice, Islamic banks and financial institutions maintain an internal shari’a supervisory board (generally consisting of three to five shari’a scholars) to ensure that their practices are in line with the requirements of shari’a. However, this may soon change following the Higher Authority's recommending for all banks and financial institutions offering shari’a-compliant products in the UAE to comply with the requirements of the AAOIFI standards with effect from 1 September 2018. It remains to be seen how this recommendation will be implemented in practice, particularly in the context of cross-border syndicated financing where one or more of the syndicated banks are located in jurisdictions which do not have mandatory implementation of AAOIFI standards. Currently the role of the shari’a supervisory board is to review the practices and financial products offered by an Islamic financial institution and issue fatwas, confirming that the Islamic financial institution’s products and services are in compliance with the principles of shari’a. Currently, it is not clear how the Higher Authority's core objectives of issuing fatwas on financial products will impacts any fatwas issued by SSBs and how any inconsistency between the fatwas would be resolved.
While certain governmental entities, free zones and capital markets in the UAE have issued rules and regulations in connection with the provision of Islamic financial products (see 9.1 Overview of the Development of Islamic Finance,above) and certain organisations have established non-binding guidance on shari’a compliance of Islamic financial products, there are still no universal set of binding rules and regulations relating to Islamic financial products. In practice, Islamic financial institutions will still seek guidance from their internal shari’a supervisory board; this can be problematic when arranging syndicate financing amongst Islamic banks/financial institutions, as there may be differences of opinion between the shari’a boards on the application of shari’a principles to the financing structure.
In the short term, cash-rich Islamic banks and financial institutions have been successful in expanding their market share in the GCC. However, the medium to long-term prospects of the Islamic finance industry, both in the GCC and internationally, will hinge on, among other things, its ability to: (i) implement cross-border recognition of Islamic finance products (including legal/tax status and actions on liquidation); (ii) reach a consensus on market standards applicable to Islamic finance products/documentation; and (iii) secure sufficiently qualified professionals. While Dubai has taken steps to address these issues at a local level, it still needs to take the lead and work across borders to secure regional and eventually global agreement on the above issues.
A variety of shari’a-compliant project finance structures have been developed in recent years. Four of the most commonly used structures are detailed below.
Similar to lease financing and hire-purchase arrangements, an ijara structure is suitable when funding is sought for an asset that is commercially leasable (for example, real estate, ships or aircrafts). The ijara structure involves a financial institution purchasing an asset (usually at the request of a party), and then leasing it (usually to the party that requested the financial institution to purchase the asset). In addition to the shari’a principles, an ijarah contract must meet additional requirements not commonly required for a conventional lease, for example: (i) the duration and specifications of the ijara (such as the rental payments) must be specified in advance; (ii) the lessor must have legal ownership and possession of the asset (either directly or via an agent) before it can enter into an ijara; and (iii) in the event of total loss of the asset the ijara is automatically terminated and the lessor has no rental claim from the lessee. Shari’a permits the structuring of an ijara contract with additional security such as guarantees, mortgages, liens on receivables, assignment of insurances and/or hypothecation of cash accounts. There are two variations on the ijara contract. The first is an "ijara wa iqtina" (lease with acquisition) whereby the lessee will take possession of the object at the end of the lease. In the ijara wa iqtina there is no stipulated transfer, rather a unilateral promise of transfer may be made by the lessor (ie, the financial institution). Additionally, there may be a unilateral promise from the lessee to purchase the asset at a pre-negotiated price. A sale and purchase agreement must be signed to formally transfer the property ownership form lessor to lessee. The second variation is an "ijara mawsoofa bil thimma" (forward lease) which has proven very popular in the project finance arena, as it allows banks to receive advance rental payments (equivalent to the return expected by banks during the construction phase under conventional financing) for an asset, during its construction phase (this is particularly important in projects with long construction phases, as otherwise the banks would need to wait for the assets to be completed before they could lease or sell the same and recoup their investment). The "ijara mawsoofa bil thimma" is an exception to the shari’a requirement that rent can only be charged once the lessee has use of the asset.
Istisna’a (Procurement Agreement)
Istisna’a is a deferred delivery and payment arrangement and is used to provide advance funding for construction and development projects. It is based on a procurement contract (istisna’a) whereby a bank funds the manufacture, development, assembly, packaging or construction of an asset, which typically a bank is unable to do, to an agreed specification and at a fixed price – this avoids the element of gharar (uncertainty) in the istisna’a contract. Payment may be made in a lump sum in advance, or progressively in accordance with the progress of the project. On completion of the asset, the bank acquires the asset and will typically sell the asset to the customer or lease it back to the developer under an ijara. The bank’s return usually takes the form of a premium on resale or the rental payments, typically calculated by reference to a benchmark, such as LIBOR plus a margin. Istisna’a is commonly used as a tool for project finance or pre-export finance, where the bank acts as intermediary between the producer (construction firm or manufacturer) and the ultimate customer. It is common for financiers to combine two or more financing structures to meet their specific project financing needs. One combination which is particularly popular amongst banks and scholars, particularly for large, long-term financing (for example, infrastructure, power projects, transport equipment, etc) is the combination of an istisna’a and ijara mawsoofa bil thimma, followed by the ijara wa iqtina, which provides for rental payments and the eventual sale of the asset. This combination ensures that the banks receive a return during the construction of the project (ie, by forward lease rental payments during the construction phase under the ijara mawsoofa bil thimma) and following completion of the project (by lease payments or sale proceeds).
The mudaraba contract is a partnership contract where one partner provides the capital (rab al mal) and another partner provides the expertise to manage the project (mudarib). This is perhaps the most established and respected Islamic financing structure, which was well known at the time of the Prophet Mohammed (PBUH).
A good example of the mudaraba is the Prophet Mohammed’s (PBUH) partnership with his first wife Khadijah prior to their marriage. In this partnership she provided the capital with the Prophet Mohammed (PBUH) acting as the manager. The mudarib generally does not provide capital but manages it.
The two forms of mudaraba are mudaraba al muqayyada (generally used for a specific business or place and is contractually limited by time and place, partners and the deal) and mudaraba al mutlaqa (the manager is free to invest the funds, as long as the investments and the investment process are shari’a-compliant).
In a mudaraba, profits are shared according to pre-agreed ratios and losses are distributed in proportion to the capital provided. As a result, investors may share the profits according to the ratio pre-agreed in the mudaraba contract but bear all the losses as they are the sole providers of capital. In contrast, the mudarib is entitled to a pre-agreed share of the profits, but does not share in the losses (unless the mudarib has been negligent).
Musharaka (Joint Venture)
The musharaka contracts (or profit and loss sharing contracts) involve a partnership between parties (called musharik), with the musharik contributing to the equity and management of a shari’a-compliant project. There are two types of musharaka contracts, the permanent or continuous musharaka and the musharaka mutanaqisa (also called the "diminishing musharaka").
In the permanent musharaka contract, each partner (musharik) retains its share in the capital until the end of the project. This contract is particularly favoured by Islamic banks when investing in a specific project. It is also endorsed by shari’a scholars.
Like the mudaraba, the profit ratio is pre-agreed in the contract (although it cannot be structured to provide a guaranteed rate or yield to one party), losses are distributed in proportion to the capital provided. Although capital contributions may be in kind or services provided, they are typically in cash and valued at an agreed par value. An interesting application of musharaka is a partnership in goodwill (or wujuh, literally "face") in which one partner contributes his name, credit or track record with a particular value, thereby allowing his partner to engage in business.
In theory, every partner may participate in the management of the enterprise, but in practice the partners will generally appoint a person to operate the partnership, or perform specific functions of the business. As with the modern corporation, the members of the musharaka may elect one or more of themselves or a third party, to manage the musharaka.
The key limitation of the permanent musharaka is that the object of the partnership, the underlying property, is not divided or unitised. This creates restrictions for the use or specific division of the property.
The Musharaka Mutanaqisa (also called the "declining balance partnership" or "diminishing musharaka") has been a popular tool for banks, with particular success in the property sector. This method is also useful for pre-export finance and working capital. Under this contract it is agreed at the outset that one of the partners will, over time, purchase units in the musharaka venture from one of the other partners at a pre-agreed unit price. At the start of the partnership, the project is divided into a number of equal units. The repurchase can take place over time at a fixed or increasing number of units per period. Alternatively, the repurchase of the units can be as and when it suits the purchasing party. As the purchasing partner to the project accumulates more units in the project, its proportionate share in the capital and profits increases, its liability for losses will also increase. At the end of the project, the selling partner (the bank) will have recouped all the capital that it originally invested and, in addition, will benefit from the profits distributed from the project’s performance. The diminishing musharaka will also contain a promise, by the bank’s customer, to purchase the units from the bank.
There is no separate insolvency regime for Islamic finance products. Sukuk holders would be considered as unsecured creditors (not equity stakeholders) of the issuer, for the purposes of the insolvency regime under UAE Federal law No 9 of 2016 (the Bankruptcy Law).
The Bankruptcy Law recognises three insolvency regimes – bankruptcy, preventative composition and restructuring. In the case of the bankruptcy of the sukuk issuer, the assets of the issuer would be liquidated and the liquidation proceeds would be applied firstly towards payment to statutory preferential creditors and secured creditors. Any residual proceeds would be distributed to unsecured creditors and then the issuer’s shareholders. In the case of preventative composition or restructuring (both of these schemes aim to rescue the business of the company) the court-appointed trustee may request the court to terminate any agreements to which the relevant issuer is a party, including the sukuk certificates. It is not clear how the UAE courts would calculate any compensation for the sukuk holders – this is left at the discretion of the court.
The recent English High Court decision in Dana Gas PJSC v Dana Gas Sukuk Ltd & Ors  EWHC 2928 was a landmark decision in connection to shari’a compliance and its impact on the enforceability a sukuk structure and the enforceability of English law documents, which constitute the bulk of sukuk documentation, particularly in the case of listed sukuk.
In this case Dana Gas (a UAE-based energy company) issued a sukuk (due for redemption at the end of October 2017). However, shortly before the sukuk redemption Dana Gas issued an announcement to sukuk holders stating that due to developments of Islamic financial instruments, they had received legal advice that the sukuk was no longer shari’a-compliant and therefore unlawful under UAE law (UAE law governed some of the sukuk documentation). Dana Gas argued that the sukuk holders could not exercise the English law governed Undertaking Agreement (which would require Dana Gas to purchase their lease assets under the sukuk structure) and redeem the sukuk), for various reasons including mistake (because the parties entered into it on the mistaken assumption that other linked documents within the structure were enforceable under UAE law) and contractual construction (Dana Gas argued that its obligation to pay the exercise price under the Purchase Undertaking was conditional upon the parties being able to lawfully transfer certain assets under a separate UAE law governed document – which were no longer enforceable due to the sukuk structure no longer being shari’a-compliant).
On the first argument the English courts held that as the Purchase Undertaking included events of default for both “repudiation” and “illegality” (triggering the requirement to exercise the Purchase Undertaking) the unenforceability of the UAE law governed documents (including an asset purchase agreement) was within the structure, and any defect in title to the underlying assets were not grounds for mistake under English law. On the second argument the English courts held that the payment of the exercise price under the Purchase Undertaking was not conditional upon the transfer of assets under the UAE law governed documents and from a reading of the Undertaking Agreement the transfer was intended to be consecutive, rather than concurrent actions.
The English court ruling had a significant impact on investor confidence in the Islamic finance industry as a whole, given that many of the associated documents are governed by English law and subject to the jurisdiction of the English courts.