Parting ways – shareholders’ dispute post-loosening foreign ownership restrictions

The United Arab Emirates (UAE) has recently undergone significant changes in its laws regarding foreign ownership of onshore registered companies. Prior to 2020, one of the key requirements for foreign investors seeking to establish a company onshore in the UAE was to have a local partner. This local partner is often referred to as a “national sponsor” who holds at least 51% of the shares in the company. Hence, it was a settled practice to enter into nominee arrangements between foreign investors and national sponsors whereby both parties would agree that the latter (i.e. the national sponsor) shall hold his/her shares (51% or more) on trust for the benefit of the foreign investor in return for receiving sponsorship fees.

However, the recent changes introduced by the Commercial Companies Law No 32 of 2021, the Cabinet Resolution No 16 of 2020, and the Commercial Transactions Law No 50 of 2022, allow foreign investors to conduct commercial activities, and hold 100% of their investments in the onshore companies in the UAE. Nevertheless, the UAE legislator has identified a list of strategic activities, which still require the participation of a UAE national shareholder. While this monumental change has unlocked new opportunities for foreign investors in the UAE, it has equally unraveled legal challenges for both foreign investors and national sponsors.

The recent amendment prompted many foreign investors to request their national sponsors to give up the 51% shares in the relevant companies, in cases where foreign investors are ultimate beneficial owners. Breaking a long-term relationship is not pain-free and disturbs the stability of certain situations. It creates tension between the parties who have been partners for several years. Some of these relationships are carried through second and third generations on one or both sides. The parties have built long term relationships based on trust are now forced to confront each other to protect their own interests.

The complexity of this type of shareholders dispute is affected by many factors. The parties may find that, in certain aspects, especially the psychological aspect, these disputes will often be no less complicated than a divorce.

From the national sponsor’s perspective

Most national sponsors would typically contribute to the success of the company in many ways, particularly at the time of its inception. This is done through the facilitation of certain processes with government authorities and making necessary introductions to promote the business. Considering the long-term engagement, national sponsors start associating themselves with the brand and the business. A relationship of trust and goodwill develops between the foreign investor and the national sponsor, which makes parting ways not always a straightforward process.

In response to a request from the foreign investor to exit the company, some national sponsors choose to honour the contractual or verbal nominee arrangement and thus amicably transfer the shares, with or without settlement compensation. While others choose to litigate the foreign investor claiming they are genuine shareholders.

The basis of a claim from the national sponsor is the provisions of the Commercial Companies Law (CCL) which requires that at least 51% of the shares in the company are owned by a national sponsor, and the constitutional documents of the company, which show the local individual or entity owned by the national sponsor as an actual shareholder, to the contrary of any other agreements entered into between the parties.

From the foreign investor perspective

A foreign investor who wanted to do business in the UAE via an onshore company, had no choice but to make an arrangement with a national sponsor to hold 51% of the shares on its behalf.

To protect the rights of the foreign investors, as well as the national sponsor, who is ultimately not responsible for the liabilities and risks of the company, parties used to enter into what we call a nominee or sponsorship agreement. This was done to regulate their relationship and to declare the beneficial ownership of the foreign investor in the company.

Most foreign investors would take a leap of faith and enter into a nominee arrangement despite the uncertainty around its enforceability, and under the impression that it is similar to the concept of trust arrangement under the common law. This means that he/she would be considered as a beneficial owner and the national sponsor would be considered as the legal owner.

In fact, under UAE law, things might be a little more complex than that.

What is the position under UAE law?

The fierce legal debate starts when both the national sponsor and the foreign investor present inconsistent documents before the Court (i.e. the constitutional documents of the company and the nominee agreement, if any).

Nominee arrangements in the UAE are primarily governed by the Civil Transactions Law (CTL) and the CCL, which applies to companies established in the UAE. Accordingly, nominee arrangements should be interpreted from the perspectives of both laws as well as examining the practice of UAE Courts in applying these laws.

The UAE has also promulgated the federal Anti-fronting Law, but to our knowledge, there has been no active enforcement of this law and there are no guidelines as to when and how it may be applied.

To make such debate more interesting, significant changes have been introduced to the CCL regime since the enactment of the CCL No 8 of 1984. Two new CCLs entered into force; namely CCL No 2 of 2015, and CCL No 32 of 2021, which may create an issue due to the conflict of laws. In this case, the leading question is which law applies to the subject matter? Is it the law in force at the time of entering into the agreement, or the law in force at the time of the dispute?

To add another layer of complexity, in cases of discrepancies regarding the competent jurisdiction between the constitutional documents (i.e. the memorandum of association) and the nominee agreement, what is the competent court for hearing the dispute?

Furthermore, it must be considered, if the dispute were to be resolved in favour of the foreign investor through arbitration proceedings, will the UAE Court recognise and ratify such an arbitral award?

What is the position of UAE Courts?

In the UAE, there is no definitive jurisprudence or binding precedents on the enforcement of such nominee arrangements. It is unclear whether such nominee arrangements will be upheld by UAE courts. Under the revoked companies’ laws, there have been decisions made by the UAE Courts that have recognized and upheld the nominee arrangements. There have also been decisions that have declared the subject company is void and accordingly, ordered its liquidation. In such cases, the proceeds of the liquidation would usually go to the foreign investor pursuant to the terms of the nominee arrangement, but this is an area of uncertainty, which should not be ignored.

Interestingly, in a similar dispute, the Dubai Court of Appeal has recently upheld the nominee arrangement and applied the new CCL to the dispute in question even though the nominee arrangement has been executed under the purview of the revoked CCL. Needless to mention that such precedent is not binding to other courts and the legal outcome might differ on a case by case basis.

What is the ultimate solution?

To conclude, the assessment of this type of shareholders’ dispute is critical and quite sensitive. There is no one-size-fits-all advice or approach, whether from a legal or commercial perspective. Both disputing parties have their own legal and commercial weapons to fight with. The weaknesses or strengths of such claims will depend on several factors, including the terms of the nominee instruments, the level of involvement of the national sponsor in the business, proof of contribution to the share capital or the business, level of control of the foreign investor over the brand, assets, bank accounts and labour file of the company, impact of the dispute on the continuity of the business, Court precedents in each Emirate and many more. These need to be assessed collectively and on a case-by-case basis.

In light of the uncertainty around the legal position, the instability around the Court precedents and the legacies which are at stake; the parties to the dispute, on the advice of their counsels, should make a strategic decision on whether to litigate or use alternative dispute resolutions mechanisms such as conciliation or mediation. In any case, the parties should keep in mind that a breakup between a foreign investor and a national sponsor involves inevitable compromise on both sides to reach a favourable conclusion; otherwise, both parties will be forced to play a zero-sum game.

We have also seen using a third party who is well respected by both disputing parties, unbiased, and is able to understand the peculiarity of these types of disputes. For example, having the appropriate background, in-depth knowledge of the local culture, extensive experience in UAE laws and the current practice, would significantly increase the possibility of reaching an amicable settlement between the parties.

Our lawyers have proudly assisted many clients with the assessment of their legal position in this area, and have facilitated dialogues between foreign investors and national sponsors, thereby successfully helping both parties conclude a satisfactory settlement.