It is not a secret that side, or otherwise called nominee,
arrangements represent an indispensible legal structure for many
foreign investors doing business in the UAE. Some unofficial
privately conducted studies suggest that around 80% of all limited
liability companies in the UAE have some form of nominee
arrangement in place.
The reason for adopting such arrangements is the simple fact that
foreign ownership is restricted to 49% of shares in UAE companies
operating onshore and not in one of the free zones.
1
Furthermore, certain business activities, such as registered
commercial agencies, restrict foreign shareholding altogether.
2 Accordingly, foreign investors (whether natural or
juristic persons) tend to enter into side arrangements to record
their economic interests in UAE companies.
Unlike other jurisdictions where public authorities tend to relax
foreign ownership restrictions by not requiring detailed
information regarding corporate structures to determine ultimate
shareholdings, the UAE regime has a solid and coherent practice in
enforcing the UAE 51% ownership requirement throughout any
corporate ownership structure.
Given the above, foreign investors have resorted to side structures
in order to vest controlling financial interests in UAE companies.
The components of such side structures are quite straightforward.
The foreign investor typically enters into one, or more, side
agreements with a UAE national by which the UAE national turns into
a silent registered owner of shares, while the foreign investor
secures all economic interests in such shares through the so called
side agreements. The legal debate arises regarding the validity and
enforceability of these arrangements/agreements. This article will
highlight the debate by addressing the following:
- Distinction between economic and registered ownership; and
- Fronting agreements
Distinction between Economic and Registered
Ownership
Certain jurisdictions permit the distinction between registered
ownership of shares and beneficial/economic ownership of shares.
The context of such distinction, however, is to permit custodian
services and allowing the management of shares for foreign
investors. Such practices are particularly important for GDR
investments. The UAE Civil Transactions Code does not explicitly
distinguish between registered and beneficial ownership. However,
Article 395 of the Civil Transactions Code provides that if parties
entered into an agreement to cover their actual contractual
agreement, the enforceable agreement would be the actual one.
The Dubai court of cassation in its ruling in the civil case No.
2009/211 awarded a principal the right to the financial interest in
nominee shares where the capital was paid in by the
principal.
This judgment supports the honoring of actual agreements entered
into between the parties (which reflects the true intent of the
parties), over the covering agreement (being the Articles of
Association of the Company). In no circumstances, however, would a
court permit breaching of local ownership requirements in respect
of the registered ownership of shares. In other words, a court will
never issue a judgment providing the foreign shareholder a right to
be registered as the owner of more than 49% of the shares of a UAE
company.
Having said that, we believe this judgment implicitly gave grounds
to distinguish between registered and economic/beneficial ownership
as well as grounds for honoring side agreements. Needless to say,
side agreements must be in writing to comply with laws of evidence
mandating same for admissibility in court given that the Articles
of Association are in writing.
Another recent ruling by the Dubai court of cassation in the Case
No 2008/212 of 27 January 2009 again implicitly recognised the
actual agreement in the context of stressing that only written
agreements can be admissible to negate provisions contained in the
Articles of Association of a company. This rule is also in line
with Article 10 of the CCL which prohibits verbal testimony in the
case of a dispute between the partners in a company in the context
of trying to prove an arrangement that is contrary to that
reflected in the Articles of Association.
Moreover, there is statutory support for the distinction between
registered ownership and financial or economic interests and/or
returns. This distinction can be found under Article 227 of the CCL
which does not restrict distribution of profits to the shareholders
in a ratio different from their equity stakes.
Fronting Restriction Regime (Articles 322 and 323 of the
CCL and Federal Law No. 17 of 2004 Regarding Commercial Concealment
("Concealment Law"))
The implications of the Fronting Restriction Regime are generally
perceived as restrictive in terms of entering into nominee or side
agreements. However, one of the golden rules of practicing law is
that nothing should be taken as a given and everything is subject
to debate.
The relevant parts of Articles 322 and 323 provide for sanctions on
those who intentionally state misleading information in the
Articles of Association of a company. In one of the court of
cassation judgments, though the court recognised the implications
of Article 323 of the CCL and ordered that a company be dissolved
as a result of the entry by the partners into a side arrangement,
it also held that the relationship between the partners shall be
governed by the side agreement as a de-facto company. The
implication of such judgment is again honoring the side/nominee
arrangement and awarding the financial interests to the beneficiary
under such side agreements. 3
It is also important to address the Concealment Law which contains
the following definitions (translated):
"Concealment: to enable the foreigner – whether
natural or juristic person – to practice any economic or
professional activity that is not permissible for him/it to be
practiced in accordance with the law and decrees of United Arab
Emirates, whether for his/its account or in participation with
others, or to enable him/it to evade all liabilities entailed on
him/it."
"Concealer: any natural or juristic person that enables the
foreigner – whether a natural or juristic person
– to practice any economic or professional activity which
is not permissible for him/it to practice within United Arab
Emirates."
"Concealed Person: any foreigner, whether a natural or a
juristic person, practicing with the assistance of the concealer
any economic or professional activity that is not permissible for
him/it to practice within United Arab Emirates."
Further, Article 2 of the Concealment Law states
(translated):
"It shall not be permissible to cover up any foreigner,
whether a natural or a juristic person, whether by using the name
of the concealer or his permit or his commercial register or
through any other method, in light of the definition of concealment
stipulated in Article 1."
When considering these definitions and Article 2, the question
arises as to whether entering into side agreements or nominee
agreements in the context of UAE limited liability companies
(undertaking activities that do allow for a 49% foreign ownership
element) would constitute the "practice of any economic or
professional activity which is not permissible for him/it to
practice within United Arab Emirates". It is arguable that the
scope of the restriction contained in Article 2 is limited to
activities that are restricted to 100% local ownership (such as
certain real estate activities). It is clearly permissible under
the CCL for foreigners to participate in UAE companies undertaking
activities where a 49% foreign ownership stake is permitted. The
relevant definitions in the Concealment Law do not, on the face of
it, apply to activities where foreigners can partially participate
in accordance with the CCL by way of a registered equity stake of
up to 49%.
Moreover, even if UAE companies undertaking activities, where a 49%
foreign ownership stake is permitted' were seen to come within
the ambit of the Concealment Law, conducting a thorough review of
the pertinent Articles of the Concealment Law it can be argued that
agreements reflecting legitimate commercial arrangements between a
foreign party and a local company would not constitute a prohibited
concealment arrangement. In other words, it is arguable that a
foreign shareholder who only owns 49% of the shares of a UAE
company would not be prohibited from entering into a management
agreement with such company nor would it be prohibited from
granting the local shareholder or the company a loan. If such
agreements are well drafted and reflect actual arrangements in
place, they should not fall under the category of fronting or
concealing agreements of the type prohibited by the Concealment
Law, when and if its enforcement is implemented.
Although the Concealment Law has been enacted and from a
theoretical point of view is enforceable, in practice, its
enforcement has yet to be implemented (and, indeed, was officially
postponed following the law's enactment in 2004, first until
late 2007 and then again until late 2009). Further, the committee
designated to enforce it has not been established or undertaken its
role as we understand. The enforcement of the Concealment Law would
require the supporting tools underlined in the law which have not
yet been adopted. Not to mention that enforcement of said law to
simply ban side agreements securing financial interests of a
foreign shareholder without relaxing foreign ownership
restrictions, could lead to a severe foreign investors' exit
and this approach would seem inconsistent with initiatives taken by
the UAE to continue to develop economically and attract foreign
investors.
Without wanting to comment on policy considerations, we are merely
making an analysis given the statistics revealing the number of
foreign investments made through side arrangements.
Conclusion
The existence of the Concealment Law and the provisions outlined
above are issues that need to be brought to the attention of
foreign investors. However the level of economic growth in the UAE
would not support an argument that the intention is to shut down
businesses relying on foreign investment and that foreign investors
should pack up and leave as a result of the Concealment Law
enforcement not being further officially postponed.
Further, in our opinion, the actual intended financial position of
a foreign investor to the extent it cannot, and should not, be
dealt with in the Articles of Association of a company, can be
reflected in enforceable and legitimate side agreements which are
not contrary to the UAE corporate or concealment regime. The key to
successfully doing so is to put in place the proper set of
agreements and create a structure that is in line with the above
through a legal technique that does not violate public order in the
UAE. This requires an in depth knowledge of local practice and
customs as well as a thorough analysis of court precedents for
guidance only, given that the UAE is a civil code regime and not a
common law jurisdiction driven by the notion of "stare
decisis", save for moral court customs followed in certain
circumstances.
In light of the above, although a strict academic approach to the
interpretation of the concealment regime may suggest that foreign
investors should not enter into side agreements, we believe that
the assessment requires a broader approach giving consideration to
the economic circumstances and the practical reality supported by
the available legal arguments.
Footnotes
1 Article 22 of the Commercial Companies Law, Law 8 of 1984
(the "CCL"), previously that UAE companies must, at
least, have 51% UAE national ownership.
2 Article 3 of the Commercial Agencies Law, Law 18 of 1981
restrict commercial agencies activities to UAE nationals or
companies 100% UAE owned.
3 Dubai Court of Cassation Ruling in case No. 2009/17
commercial.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
