08 Jul 2019

Side Agreements in light of the FDI Law

Authored by: Bilal Snaineh

In brief:

  • A commercial company in the UAE is required to have at least 51% of its shares registered in the name of UAE national or a company wholly owned by a UAE national(s).
  • Therefore, side agreements are often entered into between foreign investors and UAE national shareholders.
  • The Foreign Direct Investment Law (Federal Law No.19 of 2018) came into force on 23 September 2018 and in this article, we discuss the future of side agreements in light of this law.

Background

As per Article 10 of the UAE Commercial Companies Law No. 2 of 2015 (as amended) (CCL), a commercial company in the UAE is mandatorily required to have at least 51% of its shares registered in the name of UAE national or a company wholly owned by a UAE national(s). However, there are certain arrangements which have been developed over the years between foreign investors and UAE national shareholders which are known as ‘side agreements’ (or ‘sponsorship’ or ‘nominee arrangements’) (Side Agreements). The main provisions of Side Agreements are:

  1. the beneficial interest and/or economic benefit in the shares of the company, which is legally held by the UAE national shareholder, are held on behalf and for the account of the foreign investor;
  1. the UAE national shareholder relinquishes their rights to any profits generated by the company; and
  1. the UAE national shareholder’s interests would be limited to an agreed annual fee for acting as a ‘custodian’ of the shares held by them.

Legal developments

Over the last couple of years, there have been certain developments in the legal scenery in the UAE. These developments include:

  1. the issuance of Federal Decree-Law No. 18 of 2017, which amends Article 10 of the CCL and authorises the UAE Cabinet to increase foreign investors’ ownership in companies in certain sectors of the economy; 
  1. the introduction of the Foreign Direct Investment Law (Federal Law No.19 of 2018) (the FDI Law) under which foreign investors are be permitted to hold 100% of the share capital of companies operating in certain sectors of the UAE economy, which are yet to be identified by the UAE Cabinet; and
  1. the issuance a Cabinet Resolution (Resolution) (which has not been published in the Official Gazette as of the date of this article) setting out a total of 122 economic activities across 13 sectors which will be eligible for up to 100% foreign ownership (Positive List) following recommendations by the FDI Committee.  

Future of Side Agreements

In light of the introduction of the FDI Law, questions have arisen around the impact it will have on existing Side Agreements in the following scenarios:

  1. companies that became available for 100% foreign ownership; and
  1. companies where foreign ownership has been increased beyond the current 49%.

Scenario 1

In this scenario, it is envisaged that foreign investors would be more inclined to request their UAE national shareholder(s) to:

  1. terminate any existing Side Agreement entered between the parties; and
  1. transfer the shares registered in the name of the UAE national(s) to the foreign investor.

This may lead also to change of shareholding structure of the company in the event that a single foreign shareholder would remain as a single shareholder in the company post the transfer of the UAE national shares. 

Scenario 2

In contrast to the first scenario, in Scenario 2, instead of terminating the Side Agreement and transferring the entire shares of the UAE national(s) to the foreign investor, we expect to witness changes to existing Side Agreements and the transfer of shares to reflect maximum ownership percentages permitted to foreign investors according to the Positive List.

Conclusion

Despite the fact that the enforceability of Side Agreements, and their legality (as seen by some professionals, based on the Federal Law No. 17 of 2004 on Anti Commercial Concealment Law), is still in question, these types of arrangements are and will continue to be very commonly used in the UAE. Given the business-friendly attitude of the UAE Government and that the objective of the FDI Law is to attract foreign investors, it would be inconsistent with this approach for any measures to be taken to limit or prohibit Side Agreements.

In any event, as described in the scenarios above, the FDI Law will impact Side Agreements in a number of ways. It is therefore important for those who are party to a Side Agreement to revisit its terms and their own objectives once the Resolution has been published in the Official Gazette.

Our corporate team is able to advise on Side Agreements as well as company restructures, including devising corporate structures that provide more protection to foreign investors.

 
 

This article, including any advice, commentary or recommendation herein, is provided on a complimentary basis without consideration of any specific objectives, circumstances or facts. It reflects the views of the writer which may, in some cases, differ from those of the firm, especially in the developing jurisdiction of the UAE.