Contributed By Afridi & Angell
The United Arab Emirates’ (“UAE”) banking sector saw a modest growth in assets, improved profitability and asset quality in 2018 and is expected to deliver a similar performance in 2019. This was primarily due to a combination of the slowdown in population growth and economic activity (resulting in businesses being reluctant to commit to any long-term borrowing) and the volatile geopolitical environment (including the continuing severance of ties with Qatar and the possible escalation of disputes between Iran and the United States). There are also ongoing concerns regarding the (i) continuing volatility in oil price (the price of Brent crude oil reached USD86 per barrel in October 2018, only to fall to USD50 per barrel in the following month), (ii) the UAE Central Bank (“Central Bank”) FX reserves and (iii) loan to deposit ratios. The government continues to withdraw funds held with local banks in order to plug shortfalls in their domestic budgets and push ahead with investment in key infrastructure projects, especially those related to the Expo 2020. However, we note a greater shift towards financing infrastructure projects (particularly small-scale projects in the Northern Emirates) using public private partnership ("PPP") type structures.
Lenders have also reported a significant increase in debt restructurings, partly down to borrowers struggling in the tough economic environment (particularly in the construction and real estate sectors) and some borrowers wanting to renegotiate their long-term funding while interest rates are still favourable. It should be noted that the cost of funding increased in 2018, principally due to an increase in EIBOR and the Central Bank raising its benchmark rates by 25 basis points, in line with the US Federal Reserve.
While 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 vehicles for funding, conventional loans continue to retain the lion's share of the financing market in the UAE.
Alternative credit is not a prominent feature of the local financial landscape.
There is no applicable information in this jurisdiction.
UAE Federal Law No. 14 of 2018 regarding The Central Bank & Organization of Financial Institutions and Activities (the “Banking Law”) came into force on 30 September 2018. This replaced much of the existing banking regime in the UAE. The Banking Law is discussed in further detail in 2.1 Authorisation to Provide Financing to a Company.
The Netting Law (Federal Decree Law 10 of 2018 regarding Netting came into effect on 30 October 2018 (the “Effective Date”). The Netting Law is closely modelled on the 2018 ISDA Model Netting Act and Guide (the “ISDA Model Act”) and applies to all qualified financial contracts, netting agreements or collateral arrangements (each as defined in the Netting Law) entered into by a person or entity in the UAE (other than persons and entities located in financial free zones, ie the DIFC and the ADGM, which have separate netting regulations). The Netting Law provides that the provisions of a netting agreement shall be deemed final and enforceable, even following the insolvency of one of the parties thereto. Similarly, the provisions of a netting agreement shall not be affected by any limitations on setoff or netting imposed under any insolvency or bankruptcy laws.
Licensing requirements in the UAE
The principal governmental and regulatory policies that govern the UAE onshore banking sector are the Banking Law, UAE Federal Law No. 18 of 1993 as amended (the Commercial Code) and the various circulars, decisions, notices and resolutions issued by the board of governors of the 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 Central Bank. Under the Banking Law all existing Central Bank circulars, decisions, notices and resolutions will remain in full force for a period of three years, unless replaced by new circulars, decisions, notices and resolutions.
The Banking Law is the primary legislation giving the Central Bank the authority to regulate financial services (including Islamic financial services) in the UAE. According to the Banking Law, the Central Bank has the power to license and regulate a wide variety of financial institutions operating in the banking and financial sector in the UAE. In particular, the following institutions are regulated:
The Banking Law does not apply to statutory public credit institutions, governmental investment institutions, development funds, private savings and pension funds, or to the insurance sector. It also does not apply to the free zones or financial institutions established therein. 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 a business in the UAE and are not liable to pay tax in the UAE merely on account of such bilateral facilities or participation in such syndications. The confidentiality of customer information by banks is not specifically provided for under the Banking Law, but the principle is implicitly recognised as a customary banking practice under certain regulations issued by the Central Bank. However, the Central Bank has wide powers to obtain information.
More than 30 years ago, the large number of foreign and local banks caused the Central Bank 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. The number of UAE banks reduced by one to 21 as the result of a merger between the First Gulf Bank and the National Bank of Abu Dhabi. Discussions are also ongoing between Abu Dhabi Commercial Bank, the Union National Bank and the Al Hilal Bank in relation to a potential three-way merger. The number of foreign banks registered in the UAE remain unchanged at 26.
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 and the ADGM. In practice, foreign banks’ lending to UAE borrowers normally appoint a local bank as its security agent to hold such immovable UAE securities. 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 Israeli 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 an Islamic facility and/or the issuance of a sukuk (as applicable).
The concepts of facility and security agents 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 the 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.
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 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.
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. However, losses 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 is 1st January to 31st December. Taxes are due and payable to the Dubai Department of Finance no later than 31st 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 1st 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 (to register a security) are payable to the local emirate authority. 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, as 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 AED16,000.
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 case 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 a 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.
Interest in excess of 12% per annum, compound interest and interest in excess of principal are not enforced. However, 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 the JAFZ, the first free zone in the UAE, around which the laws and procedures of most other free zones are modelled.
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 include:
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 or a 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 the 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.
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. As with the Commercial Code, we expect that moveable assets under the Pledge Law would cover most types of immovable assets located onshore in the UAE (subject to the provisions of the Pledge Law).
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:
c) machinery; and
a) contract rights;
c) trade name;
d) intellectual property; and
e) licence rights.
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 ta 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 be:
A chattel mortgage is a pledge over movable property. A chattel mortgage can be created over:
In addition to the above, mortgages can be granted and registered over:
The UAE is a signatory to:
Security over movables under the Pledge Law
The Pledge Law in intended to provide a purely online registration process, where the lenders can establish an on-line account with the “Register” (as defined Cabinet Resolution No. 5 of 2018 on the executive regulations of the Moveables Security Framework Law) (the Security Register). In light of the significant benefits of registering a security interest under the Pledge Law, the registered pledge/mortgage has effectively replaced the use of business/commercial mortgages. The following assets can be registered in the Security Register:
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.
To be valid and effective, a business mortgage must be registered in the Commercial Register maintained at the relevant Emirate’s Department of Economic Development (only the Department of Economic Development in 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). A 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:
Security over movables under the Pledge Law
It is possible to register a mortgage in the Security Register in accordance with the following requirements under the Pledge Law as follows:
the process of registering the security interest created under a mortgage contract in the Security Register requires the submission of an application form, which must include, among other things, information about the parties (including the security provider and beneficiary of the security interest) along with payment of the relevant registration fees (currently ranging from UAD200-300).
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 shareholdings 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)
Under the laws and regulations of the JAFZ Authority (JAFZA) the shares of a JAFZ company can be pledged and perfected through registration with the JAFZA.
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.
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.
It is now possible to perfect the security created under an assignment of income and receivables under the Pledge Law. It is also possible to register the security interest created under an assignment of insurances provided that the insured asset(s) has been pledged as security for the same financing.
The most common form of security over cash deposits is a pledge. It is now possible to perfect the security created under an accounts pledge under the Pledge Law.
Formalities – Cash Deposits
The UAE does not recognise the concept of a floating charge; therefore, if an accounts pledge cannot be pledged under the Pledge Law, such a pledge will only cover the sums standing in the pledged account on the date of the pledge agreement. Consequently, banks usually require unregistered account pledges 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. In relation to assets that cannot be pledged under the Pledge Law, such assets must be in existence at the time of the creation of the pledge over the assets.
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.
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 company, 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 public joint stock company target or any of its subsidiaries (including any limited liability companies) to provide any financial aid (such as loans and guarantees) that will assist a purchaser in acquiring its shares. However, limited liability companies are exempt from such restrictions under Ministerial Resolution No. 272 of 2016 on the Implementation of Certain Provisions of the Public Joint Stock Companies to Limited Liability Companies (issued by the UAE Ministry of Economy).
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 Register. For this reason, lenders with unregistered security documents (which can be registered under the Pledge Law) should register the same in the Security Register.
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 and 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 (such provisions are not applicable in the other UAE emirates). The various free zones in the UAE, including the Dubai International Financial Centre (DIFC) and the Abu Dhabi Global Market (ADGM), 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 Central Bank. Dubai also has special laws allowing enforcement of land mortgages. 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 court must be satisfied that all relevant requirements contained in the security document and/or the relevant laws have been complied 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 adhere to the concept of binding precedent. Furthermore, all proceedings before UAE courts are conducted in Arabic and all evidence must be translated to Arabic. There is also no oral advocacy in civil matters and all submissions are made in writing.
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.
In practice, however, if an agreement with a foreign governing law provision is presented to a court in the UAE for interpretation or enforcement, the court may well apply UAE law regardless of any contrary choice of law by the parties. In circumstances where the court agrees to apply the foreign governing law, the applicable provisions of 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, with the exception of arbitration and the DIFC Courts as the choice of jurisdiction, 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. 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 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.
The following disputes are reserved exclusively for the jurisdiction of UAE courts: real estate action, labour disputes and any disputes between a principal and an agent regarding a commercial agency agreement.
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.
At federal level the ability of government departments to sue and be sued is recognised..
It should be noted, however, that recovery against UAE government-owned assets is prohibited under UAE law.
Enforcement of foreign judgments in the UAE is governed by the Cabinet Resolution No 57 of 2018 on the regulations of Federal Law 11 of 1992 (the Cabinet Resolution). The Cabinet Resolution provides that a foreign judgment or order will be enforced in the UAE only if the country issuing such a 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. The law 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 so 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 made 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 courts 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.
With regard to enforcement of foreign arbitral awards, the UAE is 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.
However, UAE law provides for certain subjects that are reserved exclusively for the UAE courts and, are therefore, non-arbitrable. For example, labour disputes must be referred to the UAE courts. 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.
With respect to the enforcement of foreign arbitral awards through the DIFC, 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.
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, 3.2 Restrictions 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 repealed 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 the protection and reorganisation of distressed businesses.
Rather than having to proceed directly to bankruptcy proceedings (if 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 can 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.
While 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”. 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 will 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 a 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.
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 the project company (a special purpose vehicle (SPV) created for the project), repayment is done through the project’s cash flows and debt is guaranteed principally by the project assets.
The parties involved in a standard project finance deal include: the project company, which acts as the borrower, holds equity interests and implements the project; the project developer or main sponsor, who lead the project development; the other sponsors who hold equity interest in the project; the lender(s) who finance the project; and the contractor(s) that execute the project.
Most infrastructure projects in the UAE are implemented wholly or partially by government-owned entities and to that extent are typically self-financed. This is the case with almost all public-works projects, oil and gas projects and power projects. Consequently, there is limited scope for pure “project finance” within the local market, with certain exceptions such as some power, water and infrastructure facilities structured through public-private partnerships (PPP) discussed later. Most real estate and tourism projects are funded on a corporate or full-recourse basis (not discussed in this section).
The UAE is highly regulated and 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 (IPPs) are becoming common structures in the UAE and, while there is no applicable federal legislation, 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 the ADWEA and various international power companies on a build-own-operate (BOO) basis.
Some major IWPPs include the Al Mirfa International Power & Water Company, the Arabian Power Company, the Emirates CMS Power Company and the Shuweihat Asia Power Company PJSC. The ownership structure of these IWPPs is split between the ADWEA and the foreign investor on a 60:40 basis.
Project companies are usually structured as joint-stock companies; however, of late we have been seeing limited liability company structures as well. In a recent reorganisation of the water and electricity sector in Abu Dhabi, a new Department of Energy (DOE) has been established to replace and act as the legal successor of the ADWEA. Before the DOE was set up, the most common ownership structure was where the ADWEA owned a 60% stake in a project company through an intermediate holding company which was held 10% by the ADWEA and 90% by the Abu Dhabi National Energy Company PJSC (also TAQA). However, the new structure that we are now seeing is one where DOE or TAQA directly own a 60% stake in the project company. This is, of course, not standard practice and some project companies have other structures.
A new law regulating public private partnerships in Abu Dhabi (Abu Dhabi Law no. 2 of 2019) was enacted earlier this year.
In Dubai, Dubai’s Law No. 6 of 2011 regulating Participation of Private Sector in Electricity and Water Production in Dubai (the Dubai Electricity Privatisation Law) was enacted in 2011 to allow 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 to regulate partnerships between government agencies and private entities to develop projects in Dubai. This law does not apply to water and electricity related projects, which come within the purview of the Dubai Electricity Privatization Law. The Dubai PPP Law permits various structures such as 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 IPPs have been launched in Dubai, the most recent one being the 900MW fifth phase of the Mohammed bin Rashid Al Maktoum Solar Park for which DEWA issued a request for qualification in March 2019.
In Dubai., there are also laws that empower the Dubai Roads and Transportation Authority (RTA) to enter into 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 to meet foreign ownership requirements.
Given that the UAE is a federal structure with powers divided between the federal government and the governments of each emirate, government approvals may be required at both federal and emirate levels. Relevant federal ministries include the Ministry of Energy and the Ministry of Climate Change and Environment. At an emirate level, there are different authorities involved such as DEWA and the Dubai Road and Transport Authority in Dubai.
Contractors also must take into account local licensing requirements. In addition to the basic corporate structuring requirements discussed later, contractors, whether local or international, must be licensed to carry out their activities in the relevant emirate. The procedure to obtain construction-related licences is more cumbersome and each emirate has different requirements. 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) and demonstration of minimum capital requirements and corporate documentation. Approvals will then be required from the relevant authorities regulating the particular activity. 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. In such circumstances arrangements can be made with existing local contractors to work together on a partnership basis.
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 emirates with division of power between the federal and emirate governments enumerated in the Constitution. To that end, federal authorities and emirate authorities both have 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, the DOE is the relevant emirate level authority that issue licences to conduct regulated activities in the energy sector.
Privately funded projects with foreign sponsors (other than PPPs whose structure will be as per the relevant government policy) require a structure compliant with local majority ownership requirements.
In accordance with the Companies Law, foreigners are permitted to own up to a maximum of 49 per cent of a UAE company (other than in the free zones) and the majority 51 per cent is required to be owned by UAE nationals. Although this restriction is a deterrent to foreign investment, it is not an insurmountable hurdle as informal arrangements exist to enable foreign investors to transfer 100 per cent beneficial interest in local companies to themselves. It is common for foreign investors to enter into side agreements with the local majority-owning partners by virtue of which the foreign shareholders assume management powers and at the same time transfer to themselves the economic interest in the shares held by the local partners. The local shareholder is usually paid a fixed fee as part of this arrangement for acting as a local sponsor. The authorities in the UAE have so far tolerated this practice, and as long as there is no dispute between the parties, the arrangement works to the benefit of all shareholders. The enforceability of these side agreements is questionable and untested in the local courts. Although the local partner could, in theory, take over the business by revoking the side agreements, the arrangement works well in the vast majority of cases and offer a practical way forward for foreign investors wishing to do business in the UAE.
While Federal Law No. 19 of 2018 on Foreign Direct Investment (the FDI Law) was recently promulgated to allow 100 per cent foreign ownership of companies in certain sectors in the UAE subject to approval of the UAE Cabinet, the FDI Law sets out a “negative list” of thirteen sectors where existing laws and restrictions will continue to apply and majority foreign ownership will not be permitted. This includes insurance, water and electricity, land and airport services and retail infrastructure.
Foreign sponsors have different options for structuring their investment in the project, such as becoming a direct shareholder in the project company or creating a holding company to serve as the shareholder in the project company. The latter is advantageous in that the holding company can be incorporated in a foreign jurisdiction such as the British Virgin Islands where certain shareholder rights (such as drag and tag) can be enforced as a matter of right unlike the UAE.
Foreign contractors can partner with local contractors, either by setting up an offshore holding company to hold their interests in a UAE company that will be licensed to carry out the construction work or entering into contractual arrangements outside of the UAE company. The former is advantageous in that it allows the foreign contractor to have a direct interest in the local company. Smaller projects can also be carried out by a single established local entity, where a foreign contractor is the sole shareholder.
Typically, project financings in the UAE are in the form of long-term loans granted by large international and domestic banks, with tenure of 20 to 25 years being 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.
The financing arrangements for privately funded projects are typically on a corporate or full recourse basis. This is in contrast to the large PPP-style projects where traditional limited recourse project 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.
The usual security package taken by lenders in the UAE is similar to other jurisdictions and includes: (i) an asset pledge over plant, machinery and other company assets, which will be registered under the Pledge Law and (ii) 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.
Export credit agency (ECA) financings, while not very common in the past, have of late been gaining popularity for funding infrastructure projects. Further, 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 Constitution, acquisition and export of natural resources in the UAE is governed at an emirate level, and not federal level. Therefore, individual emirates have the authority to determine how to exploit their natural resources.
Oil and gas affairs in Abu Dhabi are governed by the Supreme Petroleum Council 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, not by general laws and regulations. Some of these agreements date back to the 1930s.
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. Local authorities in the UAE, such as the Dubai Municipality, Trakhees (part of the Dubai Department of Planning and Development) and the Abu Dhabi Department of Urban Planning and Municipalities and Environment Agency - Abu Dhabi, also have their own rules and regulations.
Although the modern Islamic financial industry has only been in existence for over 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.
The UAE is one of the largest Islamic banking markets in the world, after Saudi Arabia and Malaysia. According to the Central Bank’s annual report for 2018 as at December 2018, 20.3% (AED583 billion or USD158.72 billion) of all banking assets in the UAE were shari’a-compliant.
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, regulations 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 Islamic banks (except in the DIFC and ADGM) are the same as for conventional banks in the UAE (including the Banking Law). Under the Banking Law, Islamic financial institutions means financial institutions licensed to undertake all the activities of a commercial bank, but in accordance with the principles of Islamic shariah.
The concept of a higher shari’a authority (the “Higher Authority”) was first contemplated under Article 5 of the repealed UAE Federal Law No 6 of 1985 concerning Islamic Banks, Financial Establishments and Investment Companies. The Banking Law formalised the establishment, and expanded the mandate, of the Higher Authority. The Higher Authority will, amongst other things, determine the rules, standards and general principles applicable to Islamic financial institutions, and shall undertake supervision and oversight of the Shariah Committee. The fatwas issued by the Higher Authority shall be binding on both Shariah Committees and all Islamic financial institutions undertaking part or all of their business in accordance with the principles of shariah.
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 aircraft). 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. 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. Under an ijara wa iqtina there is no stipulated transfer, rather a unilateral promise of transfer may be made by the lessor (ie the financial institution). 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, 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 among 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). 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) while 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.
Under the Musharaka Mutanaqisa (also called the "declining balance partnership" or "diminishing musharaka") contract it is agreed 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 Bankruptcy Law.
There are no recent cases relating to the application of Islamic finance in the UAE.