In Brief:
- The UAE Bankruptcy Law specifies circumstances in which managers and shareholders may bear personal liability for a bankrupt company’s debts.
- A recent Dubai Court of Cassation judgment found shareholders and former managers personally liable for all the debts of a bankrupt company, establishing a groundbreaking precedent.
- Hadef & Partners represented a major trade creditor, through this insolvency process, tracing actions and transactions of managers and shareholders culminating in the Court of Cassation affirming their personal liability.
- This article examines the implications of this precedent, exploring the risks for managers and shareholders in bankruptcy/insolvency cases and how liability may be avoided.
Background
Hadef & Partners represented a leading trade creditor (the “Creditor") in creditor commenced bankruptcy proceedings before the Dubai Courts. The Creditor’s claim stems from two ratified arbitration awards. These awards, totaling approx. AED 100 million, arose from a dispute with a development company in Dubai over a significant construction project. In the absence of assets to satisfy the debt, Hadef & Partners demanded accountability from the managers and shareholders of the Debtor Company through numerous mechanisms before resorting to insolvency proceedings.
The Creditor joined bankruptcy proceedings initiated by an unrelated trade creditor, ultimately prompting the Court to assess the personal liability of the managers and shareholders. The Dubai Court of Cassation upheld a judgment that holds the former managers and shareholders responsible for the Debtor Company’s debts of about AED 850 million, even though such shareholders removed themselves as managers of the Debtor Company over ten years ago.
Grounds for Personal Liability
The Court’s decision relied heavily on the Trustee’s report, which revealed insufficient assets to settle at least 20% of creditors’ claims (as set out under Article 144 of Federal Decree-Law No. (9) of 2016 on Bankruptcy (“Old Bankruptcy Law”). The Trustee’s report was supplemented by evidence of wrongdoing procured by Hadef over the course of several years. The Court attributed the deficiency of assets to actions of the managers (currently shareholders), which harmed the Debtor Company’s financial standing and deprived creditors of assets in the Estate. These actions included concealing assets, transferring them to affiliated companies and halting construction projects without valid reasons.
Significant grounds included:
- Transferring assets of the Debtor Company to affiliated entities owned by the same shareholders without evidence of an arm’s length transaction.
- Mortgaging company-owned plots to secure loans for other shareholder-owned companies.
- Failing to provide evidence of efforts to achieve profits or protect creditors’ interests, instead initiating transactions that damaged the company’s financial health; and
- Representing assets as beneficially owned by the Debtor Company and then, over the course of the bankruptcy proceedings, misrepresenting that such assets were always personally held.
The Court also found that the shareholders failed to submit justifications or financial returns for the transactions, failing to meet the Bankruptcy Law’s disclosure requirements. Additionally, the Trustee pointed out inaccuracies in the Debtor Company’s financial statements (which were not properly kept for over six years prior to the commencement of proceedings), which the Court found did not comply with proper accounting standards and practices.
The Bankruptcy Court of First Instance found that the conduct of these shareholders amounted to criminal misconduct and referred its findings to the Public Prosecutor. In the First Instance judgment, the Court referred to wrongdoers as shareholders and as board members interchangeably.
Old Law and New Law
The initial liability determined by the Court of First Instance stemmed from Article 147 of the Old Bankruptcy Law, which provides (in translation):
If the Court issues its decision to declare bankruptcy, the Court may order the members of the board of directors, managers or those in charge of liquidation in liquidation proceedings taken beyond the scope of this Decree-Law, to pay an amount to recover the debts owed by the debtor, in the event any of them evidently commits any of the following acts, within the two years following the date of commencement of the proceedings, as follows:
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- adopts commercial methods without considering its risk such as the disposition of commodities for amounts less than market value and receive funds to avoid or delay initiating the bankruptcy procedures;
- engages in transactions with a third party to dispose of assets without consideration or against and insufficient amount and without certain benefit or not proportional to the assets of the debtor.
Notwithstanding, the issuance of the new Bankruptcy Law (Federal Decree-Law No. 51 of 2023) (the “New Bankruptcy Law”) the Court of Cassation continued to rely on the Old Bankruptcy Law to affirm the prior court judgment.
Nonetheless, the New Bankruptcy Law expands on Article 147 of the Old Bankruptcy Law and states in (translation): “any person responsible for the actual management of the company" may be held liable if it is proven that they conducted high-risk or damaging transactions. Article 246 of the New Bankruptcy Law retains the previous 20% threshold but conditions such threshold on the mismanagement of a debtor company and also expands the provision separately in the event management is found to have exercised risky commercial methods, disposed of goods at below-market prices, or preferred certain creditors at the expense of others, among other factors, which ultimately causes to the financial distress of a debtor company.
Limitation Period
Notably, the Old Bankruptcy Law set out a specific look back period for the personal liability of managers/board members of two (years), however in this instance the Court found that the 20% threshold is not subject to this specific limitation period and the shareholders/managers/board may be held liable for such shortfall. The Court of Cassation noted that that certain bankruptcy actions could be subject to a further look back period if such actions are found to be criminal in nature, under Article 167 of UAE Companies Law.
Article 246 of the New Bankruptcy Law sets a limitation period of two (2) years from the commencement of proceedings to bring a claim against such managers/board directors/de facto managers.
Bankruptcy Risks
The UAE Bankruptcy Law provides a structured process for companies in financial distress, but managers and shareholders should carefully consider potential personal liability associated with bankruptcy proceedings. Seeking experienced legal counsel can help both debtors and creditors navigate such complexities.
Conclusion
As evidenced by the role of Hadef & Partners in securing this precedent, the UAE’s Bankruptcy Law can be “merciless” when managers, board members and shareholders fail to protect the company’s financial integrity or creditors' interests. The Court also found, in this precedent, that active involvement (or the lack thereof) of shareholders can be considered to amount to actions of “de facto managers” thus holding them liable.
Our Restructuring and Insolvency team is available to assist companies and their boards in understanding and meeting their legal obligations in such high-stakes scenarios, ensuring they make informed decisions with long-term implications or conversely can support creditors in utilizing the provisions of the Bankruptcy Law to trace assets and expand the estate in bankruptcy.
For any query relating to this article, please contact Ghalib Mahmoud at g.mahmoud@hadefpartners.com.