01 Nov 2011

SHARE PLEDGES IN LIMITED LIABILITY COMPANIES

Authored by: Bilal Snaineh

SHARE PLEDGES IN LIMITED LIABILITY COMPANIES

Our clients frequently ask whether it is possible to pledge the shares of a limited liability company incorporated under the Federal Law No. 8 of 1984 concerning Commercial Companies (Companies Law), (UAE LLC) following a relatively recent announcement by the Dubai Department of Economic Development (DED) in which the DED indicated a willingness to record such pledges. We highlight that while a share pledge over the shares in a UAE LLC is contemplated under applicable UAE law, in practice, there are certain procedural challenges and issues that need to be addressed to be able to implement and register a share pledge.
 
In brief:

  • While a share pledge over the shares in a UAE LLC is contemplated under applicable UAE law, in practice, there are certain procedural challenges and issues that need to be addressed to be able to implement and register a share pledge.
  • The practical problem faced with the concept of “possession of a pledged item” is that there is no requirement under the Companies Law for a UAE LLC to issue share certificates.
  • The majority of the free zone authorities in the UAE issue share certificates for companies incorporated in such free zones and certain free zone authorities also permit creating a security interest or a pledge over shares of companies registered in the relevant free zone.

Moreover, while share pledges are expressly permitted in respect of private and public joint stock companies under the Companies Law, there is no such provision with respect to a UAE LLC, although the Civil Code and the Commercial Code do contemplate the concept of a share pledge as outlined below.
 
Federal Law No. 18 of 1983 concerning Commercial Transactions (Commercial Code) clearly contemplates the existence of a pledge and sets out the definition of a commercial pledge as being “a pledge relating to movable property as security for a commercial debt.” The concept of “moveable property” is further set out in Federal Law No. 5 of 1985 concerning Civil Transactions (Civil Code), which together with the above provisions of the Commercial Code, would indicate that the shares of a UAE LLC are considered to be “moveable property”. Therefore, in principle, such shares should be able to be the subject of a pledge. However, in practice, the registration and perfection of share pledges over shares in a UAE LLC and the mechanism to achieve this have not been developed.
 
The Commercial Code essentially provides that a pledged item should either pass from a pledgor to a pledgee, be held by a third party or remain in their joint possession. The practical problem faced with the concept of “possession of a pledged item” is that there is no requirement under the Companies Law for a UAE LLC to issue share certificates. Therefore, it is not clear how the requirement of “possession” under the Commercial Code can be achieved in the absence of share certificates, or alternatively, a deed or similar document that represents title to the pledged shares.
 
Although the DED has indicated that it is possible to register a pledge over shares in a UAE LLC in Dubai as described above, the mechanism for registering and perfecting such pledges remains unclear. In seeking clarification on this, the DED has verbally advised that any pledge over shares in a UAE LLC will be subject to the approval of the legal department at the DED.
 
It is also important to note that under the Commercial Code, a pledgee may not automatically “step in” and sell the pledged item when it seeks to enforce the pledge. The Commercial Code states that where the pledgor fails to pay the debt secured by the pledge on the maturity date the pledgee must petition a competent court to authorise the pledge to sell the pledged item.
 
The position with respect to share pledges in free zones is slightly different. The majority of the free zone authorities in the UAE issue share certificates for companies incorporated in such free zones and certain free zone authorities also permit creating a security interest or a pledge over shares of companies registered in the relevant free zone. We have been involved in registering pledges in a number of different cases for companies incorporated in free zones.
 
In summary, there does appear to be a willingness on the part of the relevant authorities to permit share pledges to be registered but the legal infrastructure to enable this still needs to be properly developed. It is though hoped that we will eventually have a system for registering pledges over the shares of a UAE LLC as this will considerably change the dynamics for all forms of corporate finance activity.