In March 2012, Bahrain-headquartered Arcapita Bank became the first company in the Gulf to file for Chapter 11 bankruptcy proceedings under US legislation. It was grappling with a $1.1bn debt obligation in the wake of the financial crisis and underwent 18 months of court-supervised restructuring in New York, where part of the company was based.
The rescue has been broadly hailed as a success. Just one year after emerging from the restructuring, Arcapita completed a $100m fundraising from Gulf shareholders, to make new investments in the region and beyond. It has since closed several deals, including the $200m acquisition of the first phase of Abu Dhabi’s Saadiyat Beach Residences last July, and the $85m purchase of senior living communities in Colorado last month.
Arcapita’s story is often used by lawyers and other parties lobbying Arab governments to introduce insolvency legislation similar to Chapter 11.
Arcapita chief executive and executive chairman Atif Abdulmalik, told Arabian Business in an interview last year: “The beauty about [Chapter 11] is it gives you enough time to restructure internally and is 100 percent controlled so there is no pressure to sell off your assets at a lower market price.”
However, the practice of formal restructuring is still rare in the Middle East, largely due to the stigma associated with public admission of corporate failings, and the anti-sharia implications of borrowing large sums of money.
It is for these reasons, and more, that the UAE government has yet to ratify a new bankruptcy law that would enable companies to adopt and implement a recovery strategy under the supervision of the courts.
This week, Arabian Business can reveal the contents of the draft law, but also the barriers to its implementation as it passes through the corridors of power.
The UAE government has been mulling reforms to its existing — though, experts say, flimsy — insolvency regulations since 2010 when the country was awash with businesses that had unravelled in the aftermath of the credit crunch.
A proposed new insolvency law was approved by the UAE’s cabinet in July, but six months later it is still awaiting ratification by the Federal National Council and the Supreme Council, and well-placed sources warn it could be years before it sees the light.
A top legal executive who wishes to remain anonymous says: “The truth is, Gulf states are hostile to banks, in particular the stench of usury [unethical loans that unfairly enrich the lender], plus they do not accept that banks should be able to foreclose and take assets from respected local families. Hence why there is no mortgage system in Saudi Arabia.
“The UAE objects to banks selling people up and the legal system is designed to hinder this. Combine this with the procedural complexity of introducing insolvency laws and [the new law] is unlikely to happen for a very long time.”
However, pressure is mounting. The World Bank’s Doing Business 2016: Measuring Regulatory Quality and Efficiency report, published in October, claims that the lack of a modern restructuring law is one of the biggest barriers to effective business in the UAE. The report found it is relatively easy for people to set up a company in the UAE compared to other GCC states, yet they face difficulties when confronted with debtors in financial trouble, and further challenges if they run into a sticky financial situation themselves.
The report claims that in the UAE it takes on average 3.2 years to complete an insolvency process with costs amounting to 20 percent of the debtor’s estate and an average recovery rate for creditors of 29 cents on the dollar.
By comparison, it takes on average 2.8 years to complete an insolvency process in Qatar, costs amount to 22 percent of the debtor’s estate and the average debt recovery rate is 56.2 cents on the dollar — almost 50 percent higher than in the UAE. Compare that with average figures for OECD countries: 1.7 years, 9 percent and 72.3 cents on the dollar.
For small businesses, the difference between being able to restructure in difficult times is the difference between make or break. Last autumn, UAE Banks Federation chairman Abdul Aziz Al Ghurair warned that an increasing number of small business owners are fleeing the UAE leaving behind an estimated $1.4bn of unpaid debt. This is bound to be alarming for a country that is working hard to encourage entrepreneurship and economic diversification in an era of persistently low oil prices.
Gary Watts, partner and regional head of corporate commercial at law firm Tamimi & Co, points out that the UAE already has insolvency laws — “though it is fair to say that nobody makes use of them”. When questioned by Arabian Business, several lawyers said they were aware of just one significant corporate insolvency administered in the UAE under the existing law — the White Bay case concerning property developer Al Murjan Real Estate in Umm Al Quwain in 2011.
The current bankruptcy rules have some value, says Watts, because they recognise a pari passu, or an equal starting point in negotiations between creditors and debtors, and contain provision for the court to make personal liability orders against company directors where a return to creditors is less than 50 percent. This incentivises directors to negotiate with creditors.
However, in practice, creditors are not treated equally either because the controllers “wish to look after their friends”, he says, or because some creditors have more leverage than others because they supply essential goods, services or relationships.
Informal arrangements are more common or, in the case of larger, more conspicuous companies for whom reputation is especially important, sizeable restructurings are often camouflaged as refinancing negotiations. Another factor that abruptly cuts short insolvency cases is the practice of jailing debtors. Bouncing cheques is a criminal offence under UAE law, which gives banks extra leverage to recoup unpaid debts.
In short, the current laws overwhelmingly favour creditors over debtors and give ailing companies only limited recourse to restructure debts and start again on a stronger footing.
“A formal insolvency law is much needed in the UAE as it provides transparency and drives growth by encouraging a healthy level of risk taking,” says Bharat Gupta, senior director at Alvarez & Marsal Middle East, whose parent company helped draft Chapter 11 in the US.
“Bringing restructuring out of the shadows and embracing it as a necessary and important part of business cycles would be a significant step in the development of the UAE economy and business environment.”
“Entrepreneurs often fail before they ultimately succeed,” he adds. “Alternative, ad hoc solutions are sometimes found but they are inefficient and lack transparency, hindering the chance of a swift business recovery.”
Arguably the most powerful restructuring facility in the UAE to date was the Dubai World Tribunal, a special judicial body set up in Dubai International Financial Centre (DIFC) to restructure and administer the repayment of government-owned Dubai World’s $24.9bn of debt incurred during the financial crisis.
Increasingly, Dubai World subsidiaries, including real estate developer Nakheel, have brought cases at the tribunal but it is not open to everyone. UK-based barrister Tom Montagu-Smith explains: “The tribunal was set up at the request of global banks who had lent vast sums of money to Dubai World and its subsidiaries but because Dubai World was created by ruler’s decree the cases did not fall under the remit of Dubai Courts.
“A key attribute of the tribunal was that it could bring injunctions against creditors and third parties to prevent ‘vulture funds’ from buying up debt and selling it across the world – fuelling a global financial crash of the sort we saw in 2008.”
He says the proposed new legislation being considered by UAE decision makers is likely to contain similar provisions, based on Chapter 11 proceedings.
Didier Bruère-Dawson is a partner at Brown Rudnick law firm who worked in the Middle East and North Africa (MENA) for 10 years and was one of several lawyers consulted during the drafting of the new law. He told a lawyers’ insolvency seminar at the DIFC last month that the proposed legislation contains four key provisions: a broad moratorium on litigation actions by creditors once a bankruptcy case has been filed; ability to implement restructuring based on a two-thirds creditor majority so minority interests cannot derail the process; debtor’s privilege of interim funding and management so long as secured creditors are adequately protected, and decriminalisation of bounced cheques, “because this is an obstacle to restructuring”.
Speaking to Arabian Business, Sir John Chadwick, deputy chief justice at DIFC Courts and a member of the Dubai World Tribunal, adds: “The legislation must provide for the company to seek the assistance of the court without the stigma of liquidation proceedings, and it absolutely must give the court the power to bind dissenting minority creditors to arrangements that are in the best interests of the company.”
Gupta says the new law should also include provisions enabling parties to call in international experts where necessary, which is not permitted under current legislation.
The proposed law was approved by the UAE’s cabinet in July but is awaiting ratification by the Federal National Council and the Supreme Council. According to Bruère-Dawson, it would replace the old and mostly unused insolvency and bankruptcy regulations squattered across different federal laws and concepts.
“However, many people doubt that the process is matured, despite announcements, because of clear barriers,” Bruère-Dawson says. In particular, he points to an inherent discord between the concept of restructuring and sharia law. “The Quran essentially says that to voluntarily forgive a debtor is not just a breach of the law, but a sin.”
Abdulhakim Bin Herz, founder of Dubai’s Binherz Advocates and a former legal counsel at Emirates NBD, insists this analysis is not conclusive and that sharia law does permit refinancing schemes. Under Jordanian law, he says, a formal restructuring arrangement is presented to the court. Creditors and debtors enter into a binding contract under which they agree that no less than 50 percent of the total debts will be repaid over a maximum of three years. All of this is administered in compliance with sharia law, he says.
Still, many experts say that ensuring the new law complies with sharia will be one of the main reasons for delays in its enactment. Another tricky issue is the difficulty of obtaining information about a debtor’s finances in the absence of centralised, publicly accessible registries that record a company’s interests. Mahmood Hussain Ali Ahmad, founding partner of Mahmood Hussain law firm in the UAE, says this sparks fears among debtors of a ‘fire sale’ of their assets at a much lower value than they are worth.
Perhaps more worrying is his observation that many UAE businesses do not even keep detailed financial accounts, making it impossible to find a record of all of the assets and draw up a viable restructuring plan.
Gupta warns that a shortage of competent specialist judges could cause the system to fail even if the law is enacted. “The key will be for [the UAE] to find ways of attracting good judges from private practice.”
In the meantime, the process of drafting and redrafting the law is highly complex, says Tamimi & Co’s Watts. “Comprehensive bankruptcy law reform is one of the most challenging legal reforms that can be attempted, as it cuts across contractual rights, property rights, banking practices, debt recoveries and even family law,” he says. “The design of sensible interfaces with other elements of the local legal system is extremely intricate. I think it will take some time to resolve these issues.”
One only needs to look at the experience of Kuwait, which also has a draft law under consideration that seeks to bring the insolvency regime closer to Chapter 11. The country appointed the World Bank in 2013 to help it draw up fresh restructuring laws. The proposed legislation has been debated in the Council of Ministers for almost two years and has yet to be passed to the National Assembly, even though the government identified its enactment of as one of its priorities in 2014.
A World Bank spokesperson tells Arabian Business: “By all accounts the assembly seems eager to receive and consider the proposed legislation. [But] it is only if the Council of Ministers approves it that it will go to parliament.”
In the meantime, Kuwait relies on a ‘financial stabilisation’ law it introduced in 2009. “There is a mixed view on its level of success in rescuing companies,” Gupta says. “Essentially, if there is no consensus, there is no provision for mandatory liquidation.”
Any GCC state wishing to introduce formal restructuring laws will also have to break down deep-rooted negative attitudes towards corporate distress, and this could prove to be one of the hardest hurdles to cross. As the anonymous source says: “Seems like GCC countries are tinkering around the edges for various reasons, one of which is cultural.
“No one wants to lose face and say we are restructuring or have failed. In the US, learning from failure is a big part of the success of their economy.”
As companies face tougher financial conditions as a result of the oil price and regional insecurity, calls for a more flexible insolvency regime may grow. But it is likely to be some time before any new law is introduced.
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