Share Unshare – The 51:49 rule in UAE on Share Distribution in LLCs
Profit is not the (only) legitimate purpose of (any) business. The legitimate purpose of business is to provide a product or service that people need and do it so well that it’s profitable.
Paula J in her article suggests that the corporate law fraternity continues to debate on the imposition of fiduciary duties on shareholders who control and manage business enterprises. It is her view that fiduciary duties obligate those who have the power to operate, manage and oversee affairs of business. Referring to corporate context, she classifies directors as individuals who have the authority. In contrast, shareholders in her view may have indirect influence or role, but they certainly have no legal power over corporate property, and nor over other shareholder's property. Speaking purely in the UAE limited liability companies' context, Paula's view may call for a refined debate on the role of the majority shareholder (local partner) and minority shareholders (the expatriate shareholder(s)).
We all know about the 51:49 ownership rule of limited liability companies in the United Arab Emirates. But, ever thought what could potentially happen if the 51% local owner sells his shares to the 49% foreign owner without registering it? Yes, that is against the law. But, still.. Imagine!
STA's team has covered at length the implications of UAE Anti-fronting Law and the new UAE Commercial Companies Law. Law firms in UAE counsel their clients on matters involving corporate governance, corporate structures, drafting key contracts, besides general corporate law advisory. Speaking of contracts, parties to a limited liability company may execute several agreements to protect their respective interests and to (or “intending to”) ensuring that these arrangements are consistent with the laws of specific Emirate and that of the UAE. The effect of UAE Anti-Fronting Law is to ensure that parties do not resort to side agreements and avoid cases where the UAE National acts merely as a frontier. This article does not intend to review the position under Anti-Fronting Law, but the opposite. A case where local partner sells his fifty-one percent (51%) shares to the expatriate forty-nine percent (49%) shareholder.
The UAE courts have lately issued a landmark judgment on the distribution of profits between the local and foreign partner. The decision gets categorized as a benchmark ruling given its far-reaching implications. Traditionally, the courts in UAE examined the position differently Where the local partner acting in the capacity of a sponsor of a limited liability company claimed fifty-one percent shares despite a set (but; an arrangement contrary to the UAE Anti Fronting Law). Subsequently in 2015 Article 10 of the Federal Law Number (2) of 2015 On UAE Commercial Companies) echoed the provisions contained in UAE Anti Fronting Law. Such arrangement surely was against the laws of UAE. Article 10 reads as under:-
(1) “With the exception of joint liability companies and simple commandite companies, where all the joint partners of any such companies shall be UAE Nationals, any company established in the State shall have one or more UAE partners holding at tleast 51% of the share capital of the company.
(2) Notwithstanding the provisions of Clause (1) of this Article, the Cabinet may, based on the proposal made by Minister in co-ordination with the competent authorities, issue a Decision setting the class of activities to be exclusively exercised by UAE Nationals.
(3) Any transfer of the title to any share of a partner that may affect the percentage as set out in Clause (1) and (2) of this Article shall be invalid.”
The courts in such matters ruled for the liquidation of the company on the premise that local partner not a contributing towards the share capital equated the company’s status as a sole shareholding company, which is against the basic tenets of the UAE Commercial Companies Law.
The decision is one of the welcomed rulings which also supports public policy and declared that the consent given by local partner for waving his full rights in the LLC contravenes public policy. However, it is imperative to highlight that this judgment does not validate nor favors side agreements between the local Emirati and foreign partner for waiving the rights in actual shares. In this article, I shall further discuss the court's viewpoint in detail to understand the gray area in the subject and the position established under the laws of the UAE.
FACTS OF THE CASE: In this case, the Company’s financial status was not stable, and their financial statements reflected a negative balance sheet. The claimant (the local partner) had an apprehension to be a part of financially hurt or loss making company and proceeded to sell his shares to the defendant. The parties made the arrangement and entered into an agreement where the claimant sold his shares to the defendant in consideration for an agreed amount. The claimant subsequently novated as an inactive partner in the company. However, the defendant accepted to pay a fixed sum every year to reflect the local partner’s name in the constitutive documents of the company as required under the UAE Commercial Companies’ Law. Understanding the legalities surrounding the Anti Fronting Law, the parties intentionally decided not to legalize or notarize the above arrangement. The local partner issued a power of attorney to the defendant and authorized the expatriate partner to control, operate and manage the entire affairs of business without his interference, and the parties continued their relationship. Surprisingly but true, the company’s revenue stream excelled in its business in two subsequent years and reflected on now more positive looking books of accounts and improved cash flows.
The local partner subsequently became aware of the handsome profits the company was drawing. Resulting from a difference, the claimant chose to bring an action against the expatriate partner. Amongst other contention(s), the local partner requested the courts to disregard the agreement executed towards the sale of shares.
The local partner moved the Courts of First Instance in Abu Dhabi claiming loss of profits from the defendant. The matter related to the term commencing signing off of the sale of shares agreement. The claim documents requested the court to invalidate the sale agreement as it is in prohibition to the provisions of laws of UAE and reinstate the respective position of each shareholder as that of 51:49 shareholding. The Courts of First Instance decided on appointing an expert in the matter, and the expert concluded that the claimant had consented to waive his rights. Consequently, the expert’s findings did not find the defendant of any breach. The findings further reported that the local partner failed to prove any malice or intentional wrongdoing on the part of the defendant in executing the sale of shares agreement. The claimant however proceeded before the court of appeal and contested the decision of the Courts of First Instance.
The Court of Appeals, however, formed a differed view on the matter and classified the sale of shares agreement as violative of the then UAE Commercial Companies Law (Federal Law Number 8 of 1984 (as amended)). The Court referred to Article 22 and 230 of the said law and declared the share sale contract as void.
The Court of Appeal inclined towards the claimant and ordered to restore the position of local partner as a shareholder in the company and also entitled him to share in profits of the entity besides awarding compensation. I now elaborate the position under the above mentioned Article 22 of the old Commercial Companies Law (now repealed), it provides that “every LLC established in the UAE mainland shall have 51% ownership in shares by an Emirati national.” Article 230 of the old law states that “the share of the partner or third parties may not be invoked unless the appointed auditor effectuates the transfer and register the sale in the company’s registrar or at the commercial registrar’s office. In all cases, the waiver shall not result in a reduction in the share of the Emirati partner in capital below fifty-one percent (51%).
To resolve the inconsistencies surrounding 51:49 shareholding distribution, the new UAE Commercial Companies Law (Federal Law Number 2 of 2015) provides for Article 10, discussed above.
In sum, the court of appeal relied its decision on the constitutive documents, namely, the memorandum and articles (of association) signed by the parties and favored the claimant.
The Defendant decided to challenge the decision passed by the Court of Appeals and filed an appeal before the Court of Cassation. The Cassation Court reviewed the decisions of both - the Court of First Instance as well as the Court of Appeals. The Court of Cassation rendered its decision in support of the Defendant.
The court of cassation inferred that the court of appeal has wrongly referred to the constitutive documents signed between the parties as it was merely a formality. The actual relationship between the parties reflected in the sale of shares agreement and power given by the claimant to the defendant through the legalized power of attorney.
The court of cassation further corroborated that the court of appeal erroneously relied on the assertions made by the claimant and ordered the defendant to pay to the local partner the profits due from 2004, that is from the time, transfer of shares became operative. In its reasoning, the Court of Cassation held that the claimant had participated in the sale of shares transaction on his free-will and account. Accordingly, the courts decided that there was no undue influence of any kind. The Court of Cassation demanded the claimant to return the monies received from defendant towards the sale of shares and fees received for serving as a local partner.
The judgment brings positive sentiments to the business community and allows foreign investors to retain their trust in the judicial system. The sale of shares between the parties finally declared as void, but the act of claimant in claiming his share of profits and entering into an arrangement willingly in lieu of any fees is a wrongful act, carried out against the public policy. The significant part of the ruling is that the Court ordered the claimant (from the date the share sale agreement was executed) to return the amount received from the sale of shares and local partner fee received.