In Brief:
- On 3 October 2022, the UAE Government issued the Family Companies Law, with the aim of developing a comprehensive and accessible legal framework to regulate the ownership and governance of family business in the UAE.
- One major challenge for family businesses is to ensure the sustainability from one generation to the next.
- This legislation should assist family businesses with succession planning under the existing legal framework of the UAE Companies Law.
Family owned businesses are vital to the economic performance and future growth of the UAE economy given their important contribution to the country’s gross domestic product (GDP). According to the Ministry of Economy, up to 90% of private companies in the UAE are family businesses involved in a wide array of sectors which contribute approximately 70% of the country’s GDP.
One major challenge for family businesses is to ensure the sustainability and prosperity of such businesses from one generation to the next. According to a number of studies, only 10 to 15% of family businesses make it to the third generation. Family members of the succeeding generation may not have the same level of commitment as the founder of the family business. It is therefore important that the legal framework provides sufficient tools and the necessary flexibility for families to ensure that succession is carried out in a smooth and efficient manner to satisfy their objectives including to minimise, to the extent possible, any disruption to the operation and management of the business.
For these key reasons, Federal Decree Law No. 37 of 2022 regarding Family Companies (“Family Companies Law”) was issued by the President of the UAE on 3 October 2022, and will come into effect on 3 January 2023. Prior to the enactment of the Family Companies Law, financial free zones such as the Dubai International Financial Centre (“DIFC”) and the Abu Dhabi Global Markets (“ADGM”) as well as the RAK ICC provided legal frameworks to enable families to devise a succession plan that would achieve their objectives.
However, for various reasons, a number of local and expatriate families are reluctant to devise and implement succession plans in the DIFC and the ADGM as they prefer to be subject to applicable mainland laws and regulations. But succession planning in mainland UAE was also subject to challenges, given the rigid legal framework applicable to family businesses under the UAE Federal Companies Law. For instance, the UAE Federal Companies Law:
- does not entitle a mainland company to create classes of shares;
- provides for statutory pre-emption rights whereby a transferring shareholder is free to dispose of his shares if none of the existing shareholders exercise their right to acquire such shares within a thirty (30) day notice period;
- does not provide a suitable mechanism for redemption rights in favour of a shareholder (who owns a substantial portion of the entire issued share capital) to buy out the minority shareholder(s);
- is not sufficiently flexible to enable family holding companies to buy back the shares of a family member who wishes to sell his shares in the family business;
- does not address corporate governance matters in a fashion tailored to family businesses;
- does not specifically address potential risks and issues that may arise as a result of the application of Sharia inheritance rules as codified under the UAE Personal Status Law; and
- does not provide appropriate mechanisms for dispute settlement for family businesses.
Given the above, the UAE Government has decided to issue the Family Companies Law which sets out a legal framework aiming at addressing such considerations. Furthermore, the Family Companies Law states the following objectives intended to be achieved by its provisions:
- developing a comprehensive and easily reached legal framework to regulate the ownership and governance of family business in the UAE, and facilitate the governance of such family business from one generation to another;
- supporting the continuity of family business, and enhancing the private sector role in economic growth and its contribution to UAE society;
- providing appropriate mechanisms for dispute resolution related to family business; and
- enhancing the contribution of family business to the UAE economy and its competitiveness.
It is important to note that UAE mainland family businesses which decide to “opt in” to the regime set out under the Family Companies Law (as further explained below) are still subject to the provisions of the UAE Companies Law to the extent that the Family Companies Law does not specifically address a relevant matter.
We set out below certain key principles that are introduced under, and key considerations that should be taken into account in relation to, the Family Companies Law.
Scope of Application
The provisions of the Family Companies Law are applicable to any family company in the UAE existing prior to, or formed after, the enactment of the law (being 3 January 2023) (“Family Company”) provided that it adopts one of the legal forms set out under either:
- the UAE Companies Law, except for public joint stock companies and partnerships; or
- applicable laws and regulations of a relevant free zone (to the extent that they do not conflict with such laws and regulations).
However, and as noted above, a family business would be required to “opt-in” in order to be entitled to benefit from the legal framework set out under the Family Companies Law. This would require a majority of the shareholders of the Family Company to pass a resolution approving the registration of the company as a Family Company in a special register (such register is to be subject to the provisions of the Family Companies Law).
The Family Companies Law provides that a Cabinet Decision shall be issued setting out the documents required and the procedure that will need to be followed in respect of such registration.
Definition of a Family Company
There are a number of definitions of family business used worldwide and, therefore, there is no consensus on what constitutes a family business.
The Family Companies Law defined the Family Company as a company (established in accordance with the provisions of the UAE Companies Law) in which the majority of its shares are owned by individuals belonging to a single family, such Family Company being registered in the special register described above. However, the Family Companies Law provides that a Cabinet Resolution shall be issued in due course defining what constitutes a “single family”.
We query whether the Cabinet Resolution will adopt the same view as the DIFC Authority when defining what constitutes a “Single Family”. Under the DIFC Family Office Regulations, a family constitutes a “Single Family” where it comprises one individual or a group of individuals all of whom are the bloodline descendants of a common ancestor or their spouses (including widows and widowers, whether or not remarried).
While the Family Companies Law provides that its provisions may apply to companies established in a relevant Free Zone, the definition of Family Company only refers to companies established in accordance with the UAE Companies Law. This appears to be an oversight as the body of the law specifically provides that it is intended to apply to free zone companies. However, as noted above, the mechanism for registering a free zone company in the special register will be clarified in due course.
Number of Family Members as Shareholders
Under the UAE Companies Law and a number of other laws and regulations applicable in various jurisdictions within the UAE, a maximum of fifty (50) shareholders is permitted for limited liability companies (LLCs).
This statutory limit is a source of concern for family businesses which have individual family members as direct shareholders of the family holding company given that such maximum number may be exceeded as a result of the application of forced heirship rules under the UAE Personal Status Law when ownership is passed from one generation to the next.
Under the Family Companies Law, there is no maximum number of individuals who may become shareholders in a Family Company.
Generally, it is recommended that family groups devise a structure whereby family members will own shares in the Family Company indirectly through investment vehicles such as trusts, foundations or corporate entities.
Family Company Charter
We note that the Family Companies Law provides that the Family Company may have, in addition to its memorandum and articles of association (AoA), a Charter which includes “special rules of the ownership, governance, objectives, and values of the family company, share assessment, distribution of profits, education of the family members and their work therein, the subsidiaries/affiliates thereof, and solution of family disputes and such other rules and provisions agreed upon by the shareholders and family members”.
Often, shareholders of an LLC (including family owned limited liability companies) incorporated in the UAE elect to enter into a shareholders’ agreement (in addition to the AoA) which is a private contract between the shareholders and is not filed with (or disclosed to) any government authority (subject to limited exceptions e.g. if there is a dispute in relation to the shareholders’ agreements which ends up before the courts (with the shareholders’ agreement being required to be disclosed to the court) or the shareholders are required as a matter of law (e.g. a tax authority) to file the shareholders’ agreement with a government authority).
The shareholders’ agreement often goes into much more detail in terms of (for example) how the relevant company is to be governed and the shareholders’ respective rights with respect to the company (and the shareholders’ agreement often addresses matters such as ownership structure, corporate governance, compulsory share transfer mechanisms, and settlement of disputes.
Additionally, the Family Companies Law provides that in the event of a discrepancy or conflict between the AoA and the Charter, the provisions of the AoA shall prevail. Furthermore, any provision which conflicts with the AoA or the Family Companies Law shall be repealed from the Charter.
We are of the view that the UAE Courts are likely to widely interpret the meaning of a Charter and include a shareholders agreement as part of such definition. In such case, the shareholders agreement will need to be carefully drafted as the usual provision included in a shareholders agreement whereby
“To the extent that there may be any conflict or discrepancy between the terms of this shareholders agreement and the memorandum and articles of association, the terms of this shareholders agreement shall prevail”,
may not be enforceable to the same extent as it was prior to the enactment of the Family Companies Law.
Classes of Shares
Under the UAE Companies Law, only ordinary non-divisible shares are permitted. Other types of equity or “quasi-equity” shares such as preference shares or other types of equity instruments (including different classes of ordinary shares with different rights attaching to them), are not permitted.
However, as part of a succession planning, families often require the ability to benefit from certain control mechanisms pursuant to which certain family members or groups will be able to influence the corporate decision making; such control mechanisms often include granting special voting rights to these family members.
Under the Family Companies Law, the Family Company may issue a dual class of shares whereby:
- “A Shares” would have a right to receive dividends and voting rights at the shareholders general assembly; and
- “B Shares” would have a right to receive dividends but have no voting rights.
As noted above, this dual share class mechanism which enables the separation of voting rights from ownership rights provides the family with a tool to exercise its control over the management and operation of the family business including mitigating potential risks and issues that arise as a result of an heir becoming a shareholder of the Family Company.
Furthermore, the Family Companies Law provides that the articles of association of the Family Company may include other categories of shares that differ in terms of value, voting power, priority rights and other rights and privileges.
While the default position is one vote per share, the flexibility of the Family Companies Law permits the creation of several classes of shares with or without voting rights, different voting rights in respect of certain matters including the appointment of the members of the board of directors.
Pre-emption Rights and Buy-Back of Shares
The UAE Companies Law provides statutory rights of pre-emption over the transfer of shares which cannot be waived under the law. Tiered pre-emption rights are also not acceptable under the UAE Companies Law, as it is generally accepted that the relevant shares must be offered to all of the shareholders pro rata to their shareholdings. These provisions cannot be incorporated into the AoA, and are only documented in private agreements between the parties.
Under the Family Companies Law, a shareholder in a Family Company may now transfer and assign his share, with or without consideration, to his spouse or first-degree relative, without offering the same to the remaining partners, unless otherwise provided by the AoA of the Family Company.
This new concept introduced in the Family Companies Law will enable certain groups within the family to restructure their shareholding in the Family Company without being required to first offer such shares to the extended family members.
Unlike the UAE Companies Law, the Family Companies Law provides for a buy back mechanism which enables the Family Company to buy back any outstanding sale shares (but not representing more than thirty 30% of all of the shares of the Family Company) following an offer made by a family member shareholder wishing to sell his shares in accordance with generally pre-emption provisions designed to support the relevant system of pre-emption preferences of the family.
Redemption Rights
Unlike the UAE Companies Law, the Family Companies Law provides that if a single shareholder owns not less than:
- 90% of the shares of the Family Company, he may notify the remaining non-family shareholders of his wish to purchase their shares; or
- 95% of the votable shares of the Family Company, he may notify the remaining family shareholders of his wish to purchase their shares,
who must sell to him (either at a price to be agreed between them or at the price determined by the Family Business Dispute Settlement Committee (Committee)) on request of any of them in case of lack of agreement.
It is interesting to note that redemption rights may only be exercised in respect of minority family shareholders if the proposed seller owns at least 95% of shares of the Family Company carrying voting rights while redemption rights in respect of minority non-family shareholders may be exercised at a 90% threshold with shares that are not required to carry any voting rights.
Family Company Management
The board of directors (BoD) is a central element of the governance structure of any company including a family business and whose role is mainly to monitor and oversee the management of the business and to provide its know-how in order to support the management function.
Similarly to the UAE Companies Law, the Family Companies Law provides that the Family Company may be managed by a BoD, however:
- the members of the BoD must be named in the articles of association;
- a Chairman must be nominated and appointed who has the necessary authority to represent the BoD (unless the articles of association provide otherwise);
- the members of the board may also act as managers, except for the Chairman;
- a director may be a legal person, however, at least one individual must also be a member of the BoD;
- a director must possess the knowledge and experience that could reasonably be expected from another person in the same position;
- the BoD or the sole director (as the case may be) must submit an annual report to the shareholders in relation to the management of the Family Company and its businesses; and
- the BoD or the sole director (as the case may be) shall not dispose of the Family Company’s assets unless otherwise permitted under the articles of association.
With respect to (v) above, a young family member appointed as a director of the Family Company will be required, from an objective standpoint, to have the necessary knowledge and experience in order to exercise his fiduciary duties including the reasonable care, skill and diligence that would be expected from a director carrying out such duties. However, from a subjective standpoint, he should be subject to a lesser duty than an experienced director.
Succession is a major challenge for families and the transition should be approached in a manner to ensure a proper corporate governance framework is put in place; such framework will include processes enabling sound decision making and implementation of policies relating to the management of the family business.
Inheritance
It is also worth noting that the Family Companies Law provides that the restructuring by family members of the ownership and transfer of their shares or assets in favour of the Family Company, whether this is effected through sale, donation or usufruct, shall not be considered in breach of the provisions of the UAE Personal Status Law, provided that such restructuring is carried out during the lifetime of the transferor transferring such assets and shares.
Under Article 361 of the UAE Personal Status Law, every fraud to the provisions governing inheritance by way of sale, donation, testament or other dispositions shall be considered void.
Therefore, this specific provision of the Family Companies Law is aimed at negating the potential risk that may arise in the event that a disgruntled heir challenges the validity of an asset transfer to the Family Company made during the lifetime of the transferor based on Article 361 of the UAE Personal Status Law.
Also, under the Family Companies Law, the AoA provide for the BoD or the director (as the case may be) to act as a trustee over the shares of a deceased shareholder for the purpose of supervising the procedure for transferring the relevant shares to the heirs and taking the necessary measures to reflect the same in the AoA (after settling any rights or debts over such shares).
Settlement of Disputes
One of the major issues for family businesses is conflicts that may arise between members of the family. Such conflicts may result from the business itself or from personal relationships and, as a result, can disrupt the operation and management business.
Family governance must be devised in a manner that addresses potential conflict between family and non-family members. This can be achieved through the combination of an effective ownership structure, compensation schemes, the manner by which the board is formed and the management of the business.
The Family Companies Law provides that the articles of association or the Charter may include a provision whereby a number of partners, family members or third parties may form a council for the purpose of considering disputes that may arise between shareholders and/or family members in relation to the Family Company in an attempt to reconcile their differences. The articles of association or the Charter will also set out the members of such council, its powers and mechanisms for managing its sessions and issuing its recommendations.
The Family Companies Law also provides that if the articles of association or the Charter does not include a provision regarding the formation of such council, or if the council has not succeeded in its conciliation endeavors within a maximum period of (3) three months from the date the dispute was presented to it, all disputes between shareholders and/or family members in relation to the Family Company, that may arise from the AoA or the management or ownership of the Family Company, or the application of the provisions of the Family Companies Law, shall be referred to a Committee, to be established by the Ministry of Justice for that purpose.
The Committee shall decide on the appeal within a maximum period of (3) three months, which may be extended for a similar period upon a reasonable request made by the relevant parties. This committee has the right to take the necessary preventive and urgent measures it deems appropriate to maintain the continuity of the Family Company, and to prevent the disruption of its business or affecting its reputation or financial position throughout the dispute period.
Decisions rendered by the Committee shall be subject to appeal before the Competent Court in the UAE.
As an exception to the jurisdiction of the Committee, the relevant parties to the dispute may agree to either refer such dispute to:
- arbitration (in accordance with the legislation in force in the UAE); or
- the existing courts of the DIFC or the ADGM.
Conclusion
The enactment of the Family Companies Law by the UAE government is a welcome piece of legislation which enables family businesses to overcome challenges when planning succession under the existing legal framework of the UAE Companies Law.
As a result of this important development, we strongly encourage family businesses to consider the extent to which they can benefit from the provisions of the Family Companies Law in order to mitigate potential risks and issues that may cause disruption to their business in the context of succession.
For more information, please contact Ahmad Sergieh, Partner, Head of Corporate, Dubai a.sergieh@hadefpartners.com or Marwan Abdel Hamid, Senior Associate m.abdelhamid@hadefpartners.com