Part 1: Preventive compounding as a restructuring tool
As business enterprises in the UAE grapple with rising inflation and interest rates, supply chain constraints and labor market challenges, it seems inevitable that the number of struggling people financial increases.
With filing for bankruptcy in the UAE courts being a daunting proposition, the financial distress of UAE companies has historically been largely resolved through lengthy negotiations with creditors. However, when negotiations with creditors are not successful, the relatively new preventive arrangement procedure established under bankruptcy law1 can provide much-needed relief. In this article, we look at preventative compounding as a way to implement a successful restructuring strategy and the key concepts associated with it.
First – the terminology
What does bankruptcy mean?
“Bankruptcy” means the following proceedings established under the bankruptcy law:
• formal restructuring whereby an insolvent company is managed by a court-appointed expert with the aim of saving the business; and
• judicial liquidation which focuses on the dissolution of the commercial company and the distribution of assets (if applicable).
The bankruptcy law regime for insolvent companies applies to commercial companies incorporated in the United Arab Emirates (but not to financial free zones which have their own bankruptcy regimes, such as the Dubai International Financial Center (DIFC) and the Abu Dhabi Global Market (ADGM)).
Bankruptcy law sets out clear requirements for businesses to file for bankruptcy in court when they have has ceased to pay its debts as they fall due for more than thirty (30) consecutive business days due to financial difficulties or insolvency. In addition, attorneys, creditors with unpaid and overdue debts over AED 100,000 or the courts can seek bankruptcy under certain conditions.
What does insolvency mean?
“Bankruptcy” is a term that is often used interchangeably with “insolvency”. Bankruptcy law does not define insolvency. However, he uses the term to generally refer to companies whose assets are insufficient to cover their liabilities. When accepted by the courts of the United Arab Emirates, these companies can then be declared bankrupt. A company declared bankrupt can only be liquidated in accordance with bankruptcy law.
The concept of bankruptcy and insolvency under the bankruptcy law regime should not be confused with that of insolvency law or the provisions relating to the winding up of a company under various regulations or company laws when that company is solvent. Insolvency law applies to individuals (as opposed to businesses) and defines insolvency as “facing actual or anticipated financial difficulty which renders the debtor unable to pay his debts”.
What is the preventive composition?
The preventive arrangement is a relatively new and court-supervised protective device established under the bankruptcy law regime. It aims to facilitate the settlement between a company and its creditors through the implementation of a restructuring plan, with the assistance of a trustee appointed by the court and under judicial supervision. The purpose of preventive compounding is to save the troubled company.
Throughout the process, the corporation generally continues to manage the business, subject to certain preservation powers granted to the trustee.
A company in financial difficulty may apply for a preventive composition provided that it has not ceased to pay its debts when due for more than thirty (30) consecutive working days due to financial difficulties or insolvency. Therefore, time is running out for any company looking to initiate a preventative compounding. Otherwise, there is a risk of having no choice but to declare bankruptcy.
What is the preventive compounding process?
The preventive dialing process generally includes the following steps.
Step 1 – Application
Preventive composition can only be requested by the company itself. Bankruptcy law prescribes the documentation that must be submitted to the court, which includes the following:
• incorporation documents and corporate approvals;
• a note describing the financial and economic situation of the commercial company, including assets and its employees;
• a report containing cash forecasts, the status of creditors and debtors (including their contact details and the security granted to them) and a statement of movable and immovable property (including the approximate value and any rights of third parties );
• the company’s proposal in terms of preventive composition and implementation guarantees; and
• appointment of a trustee
A bank deposit or guarantee must also be lodged with the court treasury on a date set by the court. It is a question of taking into account the expenses and costs of preventive composition procedures, including the trustee’s fees.
Provided the application is complete, the court will decide whether or not to accept it within five (5) business dates following either (i) the date the complete application was submitted; or (ii) the date on which the deposit or bank guarantee was posted.
Step 2 – Appointment of the trustee
Upon acceptance of the claim, the court appoints the trustee to oversee the implementation of the business plan. This can be one of the experts on the expert list or, alternatively, another expert if no suitable expert is found on the list.
It is important to note that notwithstanding the appointment of the trustee, the existing executive management of the company continues to manage the business under the supervision of the trustee. However, the trustee also has broad powers and can require that actions be taken to preserve the interests of the company’s creditors.
In addition, the company is required to provide the trustee with any details required by the latter with regard to preventive composition procedures, within the time limits that the trustee may set. Therefore, it is advisable to carefully review the situation of the company and address any shortcomings (if possible) before filing the application for preventive composition.
Step 3 – Restructuring plan
Upon appointment, the syndic prepares:
• an inventory of the company’s assets; and
• the company’s registers of creditors (including amounts claimed, due dates and preferential rights).
Within 45 days of the acceptance of the request, the company and the trustee also draw up and submit to the court a draft restructuring plan (known as a preventive composition plan).
Within 10 working days, the court should then examine the draft restructuring plan. If approved, the trustee then invites the entitled creditors to a meeting to submit the restructuring plan to a vote.
As a general rule, only unsecured creditors (those ordinary and those with preferential rights such as employees or certain governmental authorities) whose debt is admitted according to bankruptcy law have the right to vote. Secured creditors are not affected by the restructuring plan. Thus, secured creditors only have the right to vote if they surrender their security or if they are not authorized by the court. A secured creditor participating in the vote on the restructuring plan without judicial authorization will be deemed to have waived the security.
The restructuring plan must be approved by the majority of qualified creditors who hold at least two-thirds of the total amount of its debt. If approved, the restructuring plan is submitted to the court for ratification. As one of the conditions for ratification, all creditors affected by the restructuring plan must be in the same (or better) position than they would otherwise have been if the company’s assets had been liquidated on the date of the vote on the plan.
Once ratified, the restructuring plan becomes binding on all unsecured creditors. The preventive plan does not affect the priority rights of secured creditors. The implementation of the restructuring plan then continues to be supervised by the trustee. On the other hand, if the plan is rejected, the court can request modifications or decide to open bankruptcy proceedings directly.
Why consider a preventive composition?
The main advantages of the preventive composition are as follows.
Suspension of enforcement proceedings
Enforcement proceedings are automatically suspended upon acceptance by the court of a request for preventive composition (subject to certain exceptions which require the approval of the court) until the earliest of the following dates:
• ratification of the restructuring plan in accordance with the relevant provisions of the bankruptcy law; and
• the falling date ten months from the date on which the court accepted the application for preventive composition.
From the date of acceptance of the application for preventive arrangement until the date on which one of the events described above in paragraphs (a) and (b) above occurs, the earliest of the following dates, the stay of proceedings also applies to secured creditors. Secured creditors can only enforce with court permission. Ultimately, this has the effect of imposing a moratorium on payments to creditors.
The company’s existing management continues to manage the business (subject to certain restrictions and preservation powers granted to the court-appointed trustee(s) and preservation of the position of creditors).
Subject to court approval, the company may raise additional funds (secured or unsecured).
As a result, the composition can provide companies on the brink of insolvency much-needed respite with the agreement of the prescribed majority of creditors and, importantly, not unanimous agreement. In our experience, creditors may also be more willing to accept a transparent restructuring plan overseen by a court-appointed trustee to avoid lengthy and costly bankruptcy proceedings.
On the other hand, it goes without saying that any application to the court of the United Arab Emirates in connection with the financial difficulties of a company should not be filed in haste. This is especially true, given the exposure of the company’s business in the process and the potential for civil and criminal liability of those in management positions of a company in the event of bankruptcy.