31 Mar 2022

Prevention is better than personal liability

Authored by: Danielle Koen

In Brief:

  • The bankruptcy law in the UAE continues to evolve towards global standards of best practice.
  • Corporate debt incurred by companies prior to bankruptcy can be imputed to the manager or director in their personal capacity.
  • The legal position on personal liability for corporate debt emphasises the caution to companies that continue to trade in challenging and distressed circumstances.  

As a result of the global economic downward trend over the last two years, many countries and financial institutions have eased financing covenants, increased repayment terms, relaxed interest rates and, in some instances, mandated specific funds for distressed lending. While this was a welcome stimulus for companies around the world, the recent judgment of the Dubai Court of First Instance (the “Court”) in the Marka Case[1], sent a stark reminder that while companies can incur debt, their directors and managers are not free from the consequences of such debt.

No later than Federal Decree Law No. 35 of 2021 (the “Decree”) (amending certain provisions of the Federal Decree Law No. 9 concerning Bankruptcy (the “Bankruptcy Law”) was issued, the Court handed down a judgement regarding personal liability in reliance on the Bankruptcy Law.  

The Decree

The Decree, issued on 20 September 2021 clarifies Article 144 and Article 201 of the Bankruptcy Law and the potential personal liability of the board of directors and the managers of a company. Directors and managers may be held jointly or severally liable to pay all or a portion of a company’s debts, to the extent that they were responsible for such debt, if:  

  1. In accordance with article 144 of the Decree, a court has declared a company as bankrupt, and that company’s assets are insufficient to pay at least 20% of its debts, the members of the board directors or managers, may be ordered to pay the remainder or part of the company's debts, each according to their responsibility for these debts, where it is proven that any of them had committed the acts stipulated in paragraphs (a), (b) and (c) of Article 147 of the Bankruptcy Law; and
     
  2. Article 147 of the Bankruptcy Law then provides the specific acts by directors and managers which may result in personal liability, including:
    1. The use of commercial methods without considering the risks, such as disposing of goods at below the market value in order to receive monies to avoid or delay the initiation of bankruptcy proceedings.
    2. Entering into transactions with a third party to dispose of assets at no charge or for inadequate consideration without certain benefits or benefits not proportionate with the debtor's assets.
    3. Paying the debts of any creditors with intent to cause damage to other creditors, during the period of cessation of payment or during insolvency.

In addition to this, the Decree provides for penalties to be imposed on those directors and managers who are found liable for a company’s debts. Article 201 of the Decree stipulates that a director or manager who has been found liable for certain acts of mismanagement shall be punished by imprisonment for a period not exceeding two years and a fine not exceeding AED100, 000.     

Marka PJSC Bankruptcy Proceedings

On 10 October 2021, the Court found that the circumstances of Marka’s bankruptcy satisfied the test to hold its directors and managers personally liable to make good the debts of the company. In particular, the Court established that the directors and managers mismanaged the company in terms of the Bankruptcy Law and provisions of the Commercial Companies Law by: (i) failing to provide the trustee in bankruptcy with the necessary financial information of the company; (ii) hiding Marka’s assets; and (iii) failing to justify the lack of money despite the expansion of Marka’s business and the large volume and value of transactions it had undertaken.  

The Court also found that the conduct of the directors and managers caused serious harm to the company, its subsidiaries, its shareholders and creditors.

Interestingly, the Court did not make any findings as to the fraudulent or criminal nature of the directors’ mismanagement, nor did it rely on criminal findings against the directors to hold them personally liable for the company’s losses. The Court did however apply its judgement with regard to the current directors of Marka, to the previous directors as well, meaning that even though those directors no longer served on the board of Marka, they were held liable.

Conclusion

While it is the first time that a Dubai court has handed down a judgement in which it holds the directors and managers personally liable for a company’s losses in terms of the Bankruptcy Law, the Decree has clarified the circumstances in which a director and managers personal liability in bankruptcy proceedings can be established. There are also potential defences regarding such personal liability.  While the legal system in the UAE doesn’t follow binding precedent, the legal principles in the Marka case have yet to be decided on by another court in the UAE or, to be taken on appeal to a higher court. It is important to note that the Marka case applies to onshore UAE companies and that the DIFC and ADGM free-zones have their own insolvency regulations.

Insolvency and bankruptcy provisions are evolving globally, including in the UAE. In order not to meet the same fate that the directors and managers in the Marka judgment met, it is important for directors and shareholders of a company to be aware when there is trouble on the horizon and to exercise the necessary caution timeously. The global economy is on a slow turnaround post pandemic and it is unlikely that the allowances permitted by creditors and financiers will prevail for much longer. While it might seem the easiest and most accessible option in difficult trading circumstances to haphazardly borrow funds and continue self-imposed payment holidays, companies in distress may utilise preventative steps within the Bankruptcy Law for its protection and, for the benefit of its creditors and shareholders. At this stage, it is unclear whether the Bankruptcy Law will be applied as strictly in bankruptcies of private companies however directors and managers of both public and private companies must be mindful of their responsibilities and duties to the company and should always act in the best interests of its creditors and shareholders.

For a confidential discussion on your company’s outlook and the available preventative measures under UAE Law, please contact the Banking & Finance team.


[1] Dubai Court of First Instance, Case No. 14 of 2019 Bankruptcy Procedures

 
 

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.