IBA paper Sept 2010 SAH

8/7/2019 IBA paper Sept 2010 SAH

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How has the global economic downturn

had an impact on the construction industry?

- Project insolvency issues

- Getting paid when the money stops flowing1

By Stephen A Hibbert2

Introduction

For a consideration of these topics, at this time, you could choose no better region than the

Middle East and especially the 2 principal states of the UAE Dubai and Abu Dhabi.

The events of the GFC, and the ensuing few years, exposed in the UAE the difficulties,

complications, inadequacies and incapacity of every element that make up the equation of project

solvency/ involvency and getting paid.

Indeed, I would advance the proposition that the impact of the GFC, and its aftershocks have

been, by an order of magnitude, far more significant in the Middle East, than anywhere else in the

world.

To support that proposition, I need to set the context in which the GFC affected the Middle East,

and then identify what I submit are the key ingredients in any legal and commercial setting to

address project solvency issues, and to manage the getting paid objective.

Some Statistics (UAE)

May I concentrate on the UAE, on the basis that, within this region, all of the propositions I wish

to advance can be identified and illustrated.

Size

1 IBA 4th Biennial Conference on Construction Projects, 17-18 Septmeber, 2010; Brussels, Belgium2 Director, Abu Dhabi Office, Habib Al Mulla & Co.; www. habibalmulla.com;[email protected]; Adj. Professor, University of New South Wales; B.Eng. (Civil) (Syd);LLM (Syd).

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The geographical size of the UAE approximates to the State of Maine in the USA. The total

population of the UAE is about 5-6 million people.

A Federation

The UAE is a federation of the 7 states formed in 1971 and 72. Of those 7 states, the Emirate of

Abu Dhabi both a city and a state occupies of the UAEs area, and is also the Fedreal

Capital of the UAE.

Wealth

For 2010, the GDP of the UAE is expected to be about $350 billion; of which near 70% will be

spent on projects and construction. (To put that figure in context, for Australia, with a workforce

of about 12 million, its 2009 GDP is about $900 billion. The UAE is planning to pass that figure

by 2015).

Value of acitive projects in the region

The significance of the UAE market was highlighted in the just published Dubai Chamber of

Commerce & Indusrty report, where it identified that there are presently $714.9 billion of

construction and infrastructure projects still active in the UAE, out of a total of $1,368 billion in

the GCC.

Population vs Wealth

Of the 5 million, or so, people in the UAE, only about 20% are nationals, or Emirates.

Accordingly, the per capita/GDP, taken in relation to the national population, places the UAE, 1st

or 2nd on world rankings, to, in 2009, Belgium.

Growth oil and gas reserves

An investment report released by Isthmus Partners, 31 March 2010 said that, based on current

utilization levels, the UAEs oil reserves (95% of which are in Abu Dhabi), will last for at least

150 years.

1998-2008 in the UAE

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There was, and continues to be, a contrast in the strategies for economic development and growth

in each of Dubai and Abu Dhabi.

Dubai has pursued the business sectors of being a finance hub (witness the Dubai International

Financial Centre DIFC); the worlds largest port operator (Dubai Ports); tourism and real estate.

Abu Dhabi, to a certain extent, avoided the frantic pace of development Dubai sought to achieve.

You will see in the Abu Dhabi 2030 plan ( www.abudhabi.ae and search for 2030 plan)

that the government plans to build a substantial city, centered around international universities

and museums. The University of New York has a campus in Abu Dhabi. Both the Guggenheim

and Louvre are building new museums and art galleries. The Cleveland Clinic has just

commenced construction of the worlds largest hospital in Abu Dhabi.

Abu Dhabis new Formula 1 GP track reputably the best in the work (Yas Marina Circuit) - will

host its second GP in November 2010.

On the eve of the GFC just how busy was it in the UAE?

The most quoted measure of the fenetic pace in Dubai (and, to some extent, Abu Dhabi) was that,

in 2007-2008, 27% of the worlds cranes were at work in Dubai.

I prefer, however, this statistic, in July 2008 - the total value of developments underway in Dubai

exceeded the equivalent total value in all North America.

How did the GFC affect the UAE?

It is a debate for others as how to classify the GFC the USA real estate bubble bursting; a

seemingly overnight evaporation in bank liquidity; a loss of confidence in the market (or all

markets); the coming home to roost of massive country debt, or, even further, financial mis-

management by governments, corporates and, of course, individuals.

In the UAE, the immediate, short term, impact of the GFC was to cause almost all projects to

halt. At the heart of things, money stopped flowing, real estate buyers delayed payment

installments, or stopped them altogether. The secondary market for residential and commercial

real estate dried-up overnight. Banks stopped lending. Real estate valuations meant little.

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Caught in the middle, were a massive number of contractors, consultants and suppliers waiting to

be paid for work already done, and unable to assess with any confidence the likelihood of being

paid, or their projects continuing.

In the legal-contractual setting of the UAE , what issues then presented

themselves in the context of project solvency and getting paid?

The capacity of the underlying legal system to cope, in terms of:

- the scope and nature of the laws generally

- specific aspects of the laws, such as the insolvency provision in

Federal law No18, 1993 (Commercial Transactions Law); the Real Estate

laws; the true or enforceable security of lenders to projects

- laws that were suddenly needed, but not yet in place, eg the new

laws introduced in December 2009 to address the insolvency of Dubai

World

- the application, in practice, of what were thought to have been

effective laws to protect real estate buyers and investors, the Escrow

account laws and regulations, which were exposed as deficient in many

respects

Freedom of Contract:

- how pre GFC enthusiasm had encouraged major international

contractors to sign up to the most Draconian contract terms imaginable.

The role and true effectiveness of key, 3

rd

parties in the constructionprocess:

- the Engineer

- project financiers

- design and certifying consultants

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The value (or otherwise) of the ADR procedures in project contracts:

- interim DAB processes in the FIDIC forms

- the process of arbitrating in the region

- the ability to enforce an arbitration award in the UAE,

and hence the effectiveness of non-court based dispute determinations in

the UAE

Islamic financing issues, especially the rights of investors in instruments

like sukuks - when things go wrong.

The capacity of the court systems to cope, and their response to disputes

which involved complex and highly technical and commercial issues.

May I make some more detailed observations on certain of these issues.

Freedom of Contract and Contract Interpretation

A western-trained, common law, lawyer might find it either refreshing, or somewhat

disconcerting, to be in a jurisdiction where there is the degree of freedom in contracting last

experienced in the Bristish common law system over 50 years ago.

Certainly, as a general proposition, civil law countries, not being burdened with the common

laws history of precedents, and the deveolopment of text book thick laws of contract, can

contract more freely, or with greater flexibility. In the pre-GFC period in the Middle East, many

project contracts were not only written in the harshest, and most one-sided, manner, but then

accepted, and entered into, by many of the worlds majors.

Below I identify some of these types of provisions relating to getting paid and the flow of project

monies. Additionally, many contractors are, today in the UAE, paying a very heavy price for

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agreeing to take over design responsibility and complete what are, in many cases, leading edge

architectural or engineering designs.

Let me illustrate freedom to contractin action in the UAE with a few examples.

Paidwhen-paid although a concept almost universally legislated-out in the

UK, Australia, Singapore and in many States in the USA, back-to-back payment

schemes are found in almost every construction contract in the Middle East.

Termination for conveniece also universally common, but rarely if ever

matched by a fair, post-termination, quantification of the entitlement of the

contractor, or the contractor actually getting paid in a timely way.

Non payment in any period of non-excusable delay- capable of being

classified as one of the most deadly provisions in any building contract, this

type of clause is only now surfacing for serious attention.

Example: Consider a project with an intial contract sum of $ USD 700million; 60 plus floors of combined residential and commercial premises;overlooking the sea, with world class finishes and its share of unique(read difficult to build) architectural features.

Construction commenced 2007, and by July 2010 the project is at the

65% completion point.Variations claimed but unpaid say $100m.EOT claims number now #6 and, together, seek a 16 month extension.FIDIC 87 and special conditions, with one clause stating (to the effect):

If at any time the Contractor has not reachedTaking Over by the due date, the Employer shallhave no obligation to make any further

payments to the Contractor until a Certificate ofTaking Over has been achieved.

The Contractor is presently in a period of non-excusable delay, as none

of the six eot claims have been addressed.

He seeks your advice:Q: Does the clause mean what is says?Q: If it is triggered now, and then some, or all, eots are granted,

does it cease to apply?Q: Is this type of provision legal in the UAE?Q: If we took it to court, what would the courts say?

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Rewriting the role of the Engineer (and Employer)

In 2007, in the Emirate of Abu Dhabi, the government determined to produce its own, bespoked,

version of the FIDIC99 for construct only, and for design and contruct, and published by

decree an amended version to be used on all government projects.

One stream of changes seeks to do two things:

a) replace the Engineer with the Employer in certain key functions or processes; and

b) to control (and thereby limit) any descretion the Engineer might otherwise have had,

particularly relating to money matters.

Two examples:

Cl 8.4 Extension of time notice of claim is to be given to the Employerand the Employer determines the amount, if any, of time to be extended.

The authority of the Engineer under Cl. 3.1 has now been conditioned by

the following:

The Engineer is required to obtain the writtenapproval of the Employer before exercising the

following authority:

(a) Instructing the Contractor to suspend progress ofpart or all of the Works in accordance with clause

8.8 of these conditions;

(b) Issuing a Taking-Over Certificate in accordancewith clause 10.1 and/or 10.2 of these conditions;

(c) Issuing a Performance Certificate in accordancewith clause 11.9 of these conditions;

(d) Initiating and evaluating Variations in accrodancewith clauses 13.1 and 13.3 of these conditionsrespectively;

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(e) Certifying the payment of Retention Money inaccordance with clause 14.9 of these conditions;

(f) Issuing a Final Payment Certificate in accordancewith clause 14.13 of these conditions; and

(g) Authorising any changes in Materials or supplierspreviously proposed or agreed.

On the face of it, you might believe that these amendments are somewhat benign, However, in

practice, they can create very significant issues for a contractor seeking to finish and get paid.

It is a commonly accepted axiom regarding the role of the Engineer under FIDIC-styled contracts

that, at critical times, his obligation to act fairly, and as a certifier and valuer, is relied upon by the

contractor in his day to day running of the project.

Commonly, the Engineer is ever-present on a project, and is progressively involved in design

development and the choice of materials and supplies.

Imagine, then, the case of the detached Employer, who rarely participates in progress meetings

and generally has little direct contact with the contractor, but is presented from time to time with,say, variation valuations that, to him, seem expensive. You can predict his reaction.

Additionally, the laws of the UAE are nowhere near clear enough as to whether the Employer can

withhold approval at will. The jurisprudence does not know of the doctrine of implied co-

operative duty, and the courts interpret provisions like the above literally.

Force Majeure in the wake of the GFC, clause 19 of FIDICs 99 version, and its equivalent in

most project contracts, has been, naturally, the got to provision for Employers and developers

seeking to avoid paying contractors.

For those seeking a detailed analysis of the (quite complex) jurispurdence involving the

interperation and application of force majeure under the national laws of Arabic countries, a

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good starting point is the work of Dr. Sue Rayner in her book, The Theory of Contract in Islamic

Law (1991) (Graham and Trotman, London)

For a project based on a contract like FIDIC 99, with an express term such as Cl 19 in which

Force Majeure is defined, and a code sets out what the claiming party needs to do, you can have

comfort that the court systems in the UAE (and Middle East generally) will enforce those terms.

Where complexities arise is, in particular, where the head contract, or the development

contract, is written with its proper law being, say, England a not uncommon situation for major

projects, especially if lenders are involved but in the building contract, and then the Sale and

Purchase Agreements, or Agreements to Lease, or the hotel operating contract, the proper law is

the law of the UAE, or the relevant Middle East country.

Consider then the same event (here the GFC) being claimed as a Force Majeure Event by each of

the parties in that contractual chain, but accompanied by legal assessments grounded, in one case,

in the UKs common law system, and, for the other(s), derived from applying the received

principles of the UAEs laws (in that area), supplemented by the occasional reference to the

Napoleonic Code, together with how Force Majeure has been judicially commented upon in

Europe, notably the French Courts.

It is a sufficient form of victory for Employers if this debate at least creates an impass, and

payment obligations are suspended, pending the decision of courts or arbitrators.

The role and true effectiveness of the Engineer and other project 3 rd

parties.

It is necessary to make this initial observation to set the scene. It does not, at all, sit comfortably

with either government or private sector principals in the Middle East to have the concept of a 3rd

party, like the Engineer under a FIDIC styled contract, creating time or money entitlements with

the contractor, without the prior consent of the Employer.

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The concept of the Engineers independent duty and autonomy has evolved in both the common

law, and civil law systems (in Europe), over many years.

Historically, the Engineer almost always was the project designer, and his role was mainly to see

that his designs were properly constructed, value monthly progress claims and to administer the

contract. As times changed, and project values, complexity and speed of construction all

increased, the Engineers single role, as we all know, was taken over by architects, project

managers, quantity surveyors and professional client representatives.

Indeed, there is an argument that the power and contractual presence of the Engineer most

probably peaked in the 1960s and 1970s, as described in the forms of contract that then existed

(e.g the early editions of the FIDIC Red Book the ICE Conditions).

But the UAE does not have that history. Nor does the Middle East generally. It has become

painfully clear to many contractors that to do construction business successfully in the Middle

East they must recognise and understand that you cannot simply sign up to a FIDIC-form of

contract, and expect the Employer, or the Engineer, to behave as they do in, say, the UK or

USA.

In the Abu Dhabi government FIDIC 99 contract there are, as noted above, some clear signposts

that confirm that, in most cases, the Engineer is the Employers man. Even if the contract is not

so clear, the same is true in practice.

The value and effectiveness of ADR processes in major projects in the

Middle East

In the Middle East, almost every building or construction contract contains an arbitration clause,

or agreement.

Via Article 203(5) of the UAEs Civil Procedures Law (1992), if the parties have agreed to refer a

dispute to arbitration, an action on that dispute cannot be brought before the courts.

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If you then consider that by mid-2010, the courts of Abu Dhabi had pending before them

approximately 320,000 cases, making arbitration work in the UAE is a necessity. (Note: the vast

majority of court cases relate to employment and labour issues and real estate disputes.).

The UAE does notpresently have an arbitration law. It does have, in the UAEs Civil Procedures

Law (1992), Articles 203 to 218 which specifically address arbitration; aspects of its process and

the enforcing of awards. But, with respect, those provisions were not designed in anticipation of

the current dimensions of project disputes and major, complex, arbitrations in the UAE in 2010.

It has been predicted that the UAE will receive a new arbitration law in 2010, as part of a broader

package of new laws for the commercial & business sectors. A draft is circulating for comment.

Presently, the only real alternative to litigation in the UAE is via commercial arbitration, whether

preagreed, or via an adhoc reference.

So how efficient or effective is the arbitration process?

Let us assume for present purposes that the project in question, or the relevant commercial

transaction, does have an arbitration agreement in it, which is recognized by the courts and

enforced.

In many ways, arbitrating major disputes in the UAE can be a far more complex process than in,

say, the USA, UK or Europe.

First, what needs to be understood is that the list of criticisms and adverse features of modern

comercial arbitration, enumerated by Thomas Stipanowich recently in his paperArbitration:

The New Litigation (Univ. Illinois Law Review 2010) are all present and accounted for in the

UAE. But, in the UAE, their mix and relative weightings differ to their equivalants in westerncountries.

300 plus years of common law litigation in both the USA and UK has produced such a detailed

set of procedures for litigation, that their almost complete adoption into major arbitrations, has

done arbitration a great dis-service.

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In these Western countries, the Medieval processes of the merchants ( the sniff & smell

arbitrations) have now been replaced by processes quoted by Thomas Stipanwich as being similar

to civil litigation judicialized; formal; costly and time consuming.

We all know what the elements are, in the arbitration process, that lend themselves to this

criticism. They include discovery (especially nowadays e discovery); accessing 3 rd party

documents; prehearing procedures; factual and expert reports (for both claimant and respondent);

a hearing process of some form, including possibly oral testimony and cross- examination.

Next, and quite critically, once an award is delivered, while there should be a clear pathway to

enforcement, in some jurisdictions the relevant arbitation law will permit appeals allowing time

to run on, and further costs to be incurred.

It is unfair to generalise too much as there are, of course, many examples of successful

arbitations. But let us accept for present purposes that in the Gulf most arbitrations over

significant sums of money, or complex technical issues, do involve these traditionally litigious

styled steps and processes.

Now consider a scenario under which the concept of judicialized does not, in effect, exist.

Judicialized can of course mean many things, but to western lawyers it is, perhaps, the briefest

way of starting with due process; moving though natural justice and fairness; touching upon

the independence of experts and the arbitrator(s); having the abitlity to verify facts, and ending

with a comprehensive, detailed, judgment, with reasons.

Accordingly, a fair deal of the debate on arbitration reform, especially in the USA and UK, has

been framed on the basis of a comparative analysis with the processes in the respective courtsystems of these countries. But what if, in the country of your arbitration, there were not so

similar court processes?

What would then be the dimensions of the arbitration debate? Less clear, and more open to

argument on the fundamentals.

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The court system in the UAE copes with technical or complex construction matters by essentially

referring the issues out to court appointed experts . In construction matters, those experts are

generally engineers, fluent in Arabic. The expert will submit his report (in Arabic) to the court,

and the court will decide whether to adopt it or, if the findings are contested, the court might be

persuaded to refer the matter to another expert. This whole process can take 3-6 months and be

entirely based on the materials submitted by both parties. Rarely, if at all, is there a hearing with

oral testimony in civil cases.

Accordingly, there has not been, and, indeed, there cannot really ever be, a judicialisation of

arbitration in the UAE if by that term we refer to the processes of civil litigation in western

common law and mature civil law systems.

Accordinly, in the UAE, the responsibilities that then devolve to the relevant arbitration bodies

and arbitrator(s) are far more significant than in Western countries.

Put another way, for disputes arising from major projects, or complex commercial transactions,

the pressure on the arbitration process (and institution) to get it right, and to deliver an outcome

that is just, fair and within an acceptable time frame, is probably no greater anywhere than in the

UAE at present given the sheer size of the UAEs build and investment programme.

And that is not at all to say that the arbitration institutions in the region have not risen to the

challenge. They have, and continue to do so. But the sheer size and volume and complexity of

many of the disputes in the region have never really had to be addressed by such a small

artibration community.

Further, what the Global Financial Crisis has thrown up in the Gulf, in the context of dispute

resolution, is the role and legitimate interests of the finance/banking sector and investors.Unfortunately, the system in the UAE, has had difficulty coping with the combination of

insolvent developers; defaulting purchasers and defacto mortgagees in possession.

Add to that the fact that most of the building contracts and real estate sale and purchase

agreements included arbitration clauses, then for some developments there are literally hundreds

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of disgruntled purchasers, who have to initiate individual arbitrations to try to either get back

their deposits and partial payments, or to seek some form of remedy.

The challenge therefore, particulary in the UAE, for the legal profession, and for the government

seeking to secure international investment, is to design and implement dispute resolution

processes that recognize the realities and limitations of the underlying court system(s) and

respond to the demands for investor certainty, and enforceable outcomes.

What about the use of Dispute Adjudication Boards?

Turning more specifically to engineering and construction projects, the most commonly used

form of construction contract in the Gulf is the FIDIC form.

Although the development of the FIDIC forms, for project procurement and consultantcy

services, progressed slowly over the years, culminating in the burst of colours in the suite of

contracts issued in 1999, some parts of the Middle East still use the 1987 (Red Book) version.

Indeed, most government contracts in Oman are based on the 1981 version of the Red Book,

updated marginally in clause 67.

As noted above, in Abu Dhabi, some years ago, a decision was made by the government to

prepare, under license from FIDIC, two bespoked forms of the contract build only, and design

and build. Those forms were issued in 2007, accompanied by the requirement that they be used as

the form of contract by all government departments in the Emirate of Abu Dhabi.

The centrepiece of the ADR process in that new form of contract is the mandated use of a Dispute

Adjudication Board (DAB) as a pre-cursor to arbitration. It is not the purpose of this note to

review the quite lengthy and detailed DAB and related dispute resolution procedures set out in

that form of contract.

What is perhaps more relevant, in terms of focusing on ADR in the Abu Dhabi major projects

market , is the fact that, via this mandated form of FIDIC, the dispute resolution process proceeds

first to the DAB (cl20.4), i.e the use of a DAB is now the default rather than, in earlier versions,

an option.

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The Abu Dhabi governments version of the FIDIC contract does maintain cl20.5 which

expressly encourages amicable settlement at any time.

Finally, if those two processes do not resolve the matter, the dispute is referred to final and

binding arbitration. The default body and rules are those of the Abu Dhabi Commercial

Conciliation and Arbitration Centre (ADCCAC).

In theory, of course, it is possible for some of these provisions to be amended by a government

authority for a specific project. But what is more relevant for this note, is that after a detailed

review and consultation process, the decision was made to mandate the use of a DAB.

Many in the region see the introduction of DABs as a very valuable, and important, step to

facilitate the resolution of major project disputes in Abu Dhabi.

In theory, a project-specific DAB, properly appointed and constantly in touch with a projects

progress and the development of a dispute, seems like not just a good solution, but an almost

must have for the demands created by projects in the Middle East in 2010 and onwards.

But as good as they appear to be in theory, DABs seem to have a chequered history, and more of

a B rating, than an A+, in some countries.

In many jurisdictions DABs compete with an array of offerrings from commercial ADR

institutions advancing solutions that are quite varied and not limited to just arbitration (see for

example AAAs and the ICCs extensive menus of ADR solutions).

So what are, or should be, the drivers in the UAE market for making thisDAB process work?

First, speed to an initial decision. Around the world, and particularly with in-house counsel, the

constant and resounding criticism of arbitration is that it takes too long, and is too appealable (ie

even longer). In almost all surveys of arbitration users, time and delay ranks far more

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significantly than cost as a source of criticism. The case for arbitration, for major project and

construction disputes, is not helped these days by being almost always a very expensive process.

But, speed of decision consistently comes first in surveys of in-house counsel, and the users of

the ADR systems, as the key factor in choosing an ADR solution, or in measuring its success or

value to them.

Consistently with the views of Tom Stipanowich (Arbitration: the New Litigation (Univ. Illinois

Law Review 2010) a speedy process must, by its very nature, require the setting of tight

boundaries on evidence, submissions and expert reports. And the surveys tend to indicate that a

controlled, and ostensibly fair, but speedy system, is what most large organisations are looking

for these days.

Witness the outstanding success of the statutory adjudication system in England. In England, and

in Australia where it has been almost uniformly adopted in all States, it has had the effect of

greatly reducing the number of disputes that go to arbitration or court.

Adjudication has, however, had some adverse side effets. It has produced a large number of court

cases, at the stage when the court is asked to adopt the adjudicators report. In the first 6 years of

its introduction in Australia, there were over 100 cases which addressed issues ranging fromstatutory interpretation of the legislation, through to whether the adjudicator had exceeded his

jusrisdiction, as well as a full suite of administrative law issues. The outcome being that now, a

relatively short statute needs to be read and interperted in the light of a number of important

judicial pronouncements. Another side-effect is that the lawyers running these matters regularly

have only 14 or 28 days to prepare claims and evidence that otherwise would take many months

in an arbtiration or even in court.

So, will the use of DABs produce a better result than say arbitration? Or is there a better

alternative in this region, and at this time in the cycle of major projects?

On any view the introduction of a mandated DAB is a very good first step. The essence of an

effective DAB is a decision making process, in real time, by people who can see and view the

project and fully understand the issues.

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It is the complete converse of a project-specific DAB, that, years after construction is completed,

three learned arbitrators have a sitting lasting mouths, to hear and consider expert debate on what

did happen and more theoretically, what should have happened or been done, as they look at as-

built programmes and the true audited accounts of the builder (did he really suffer a loss?).

If you therefore set the scene as being the UAE in 2010 and onwards, looking to attract and

secure investment; seeking to give transparency to the dispute resolution process; and both

physically and commercially just purely managing the massive volume of work (and hence

disputes) - there can be no argument against doing everything that is sensibly possible to make

the DAB system work.

One real concern I have is that this initiative is not backed by my professional collegues, or their

clients, in Abu Dhabi. If that were to happen, I do not believe that the system, absent a DAB

process, will cope at all.

Islamic Financing you need to understand how it affects your project, or

investment.

The comments here are more by way of a footnote to the principal issues canvassed above.

In Middle East projects Post-GFC, there will be present a far greater role for Islamic financings.

Further, with the world-wide contraction in sovereign funds, and the project finance market

generally, the availability of funds via the Islamic finance market cannot be ignored.

The Dubai-World /Nakheel events of December 2009 involved two quite complex issues, leading

to a solution that failed to provide clarity for either.

First, within the terms of the Nakheel sukuk, were the interpretation of the default provisions and

the assessment that the investors had to make regarding the true value of their, ostensibly, asset-

backed security.

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Secondly, in parallel, and for this particular transaction, was the perhaps more significant issue of

whether or not the Dubai World entity would be backed by the government of Dubai, even if

ultimately some form of work-out was needed.

The resolution of these issues is still on going. One part of the solution was for Dubai to rush

through special Dubai World insolvency legislation on the eve of the sukuk default in mid

December 2009.

As of September 2010, creditors are still in negotiations and some payments have been made to

small creditors.

Relevantly for this note, is the fact that across the Middle East, it is likely that Islamic financing

for major projects will become more common. (For more on the intricacies of Islamic Financing

a good reference is www.financeinislam.com, and see there the paper on the Equate

Petrochemical project by Benjamin C. Esty.)

Knowing how to work with the various forms of Islamic financing, and especially, how investor

rights can be enforced, will be critical to getting paid and projects remaining solvent.

Stephen Hibbert

Habib Al Mulla & Company

Abu Dhabi

September, 2010

[email protected]

www.habibalmulla.com

Appendix: Attached is a 2010 paper prepared by Mazen Boustany, Head of Banking andFinance, Habib Al Mulla and Company, which summarizes the insolvency provisions in the UAE

law and canvasses the scope for reform. It is extracted here in full as the paper has been

recognized as one of the best, and most comprehensive statements on the topic and, importantly,

a synopsis prepared post Dubai World.

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mailto:[email protected]:[email protected]


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Mazen can be contacted on:[email protected]

UAE INSOLVENCY LAW EXISTS!

Mazen Boustany Head of Banking and Finance

Habib Al Mulla & Co

DURING THE BOOM TIMES, DUBAI AND THE UAE seldom experienced insolvencycases, so it became a widespread rumour that the UAE does not have an insolvency law.

In addition, it had also been widely speculated that the UAE has a very archaic regime inwhich debts can lead a debtor to jail.

By opposition to such rumour, an insolvency law does indeed exist and it is shockinglymodern in more than one aspect. Looking more deeply at this law might be very useful inthe near future, due to the credit and financial crisis that is affecting Dubai and itsbusiness sector.

By looking at Federal Law No 18 1993 (Commercial Transactions Law) it is clear thatout of 900 articles of which this law is composed, 255 articles are dedicated to insolvencyand bankruptcy procedures, which means that almost a third of the CommercialTransactions Law is dedicated to such procedures.1 This is not bad in a countryconsidered to be without insolvency law.

The provisions apply solely to both individual traders and commercial companies whenthey have stopped paying their due commercial debts (Articles 645 and 650). The articlesare subdivided as follows:

Articles 645 to 763 are related to insolvency;

Articles 764 to 799 are related the arrangement by the court;

Article 800 relates to small insolvencies;

Articles 801 to 816 are related to companies insolvency (although Article 801 specificallyprovides that all above articles are applicable to companies in addition to the articles in

this section);

Article 817 to 830 are related to the rehabilitation of the insolvent individual (such astraders and partners in partnerships);

Articles 831 to 877 are related to voluntary arrangement; and

Articles 878 to 900 are related to bankruptcy.

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It is clear that this a very comprehensive law with specific procedures. Unfortunately, itremains largely untested and only two judgments are published on the Dubai Courtswebsite:

1) a Dubai Supreme Court judgment dated 9 September 2008, which provides that a singleunpaid commercial debt is enough to provoke the insolvency of a company; and

2) an older, more interesting, judgment by the Dubai Court of Appeal dated 25 May 1998,where the court considered that the insolvency provisions and procedures are of publicorder since they were meant to promote confidence, and have been put in place to protectthe creditors and to safeguard the debtor of good faith).

The above judgment has clearly defined what the UAE insolvency law is all about:protecting the creditors and safeguarding the debtor of good faith. The different

procedures that are outlined in the Commercial Transactions Law are described in theremainder of this article.

BANKRUPTCY

In the event of bankruptcy (whether fraudulent, negligent or gross negligent bankruptcy),the Criminal Court shall be competent and shall sentence the bankrupt trader or managerof a company, or the member of its board or its liquidator, to a prison term that may notexceed five years in the event of fraudulent bankruptcy (Articles 878 and 879).Alternatively, a fine of 20,000 dirhams in the event of a gross negligent bankruptcy

(Article 880) and no more than two years of prison or a fine of 10,000 dirhams in theevent of negligent bankruptcy (article 881) may be issued.

In addition to the above, Federal Law No 3 1987 (the Criminal Code) contains provisionsrelated to bankruptcy in Articles 417 to 422. Articles 417 to 419 of the Criminal Code arevery similar to Articles 878 to 881 of the Commercial Transactions Law, while Article420 provides:

If a commercial company is bankrupt, its board of directors and managers shall beconvicted with the sentencing related to fraudulent bankruptcy if it was proven that theyhave committed any of the acts provided in Article 417 of this Code or assisted in thecompany ceasing its payment, whether by declaring wrongful facts about its subscribedcapital or its paid-up capital, or by publishing wrongful balance sheets or by distributingfictious dividends, or by taking to themselves more than they are entitled to in thecompany articles of association.

The discussion in this article does not apply to the member of the board of directors orthe manager who proves that they were not involved in the crime or their objection to theresolution that was taken in its respect. It can be deducted from the above provisions that

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a shareholder of an insolvent company who was not involved in its management maynever be considered as bankrupt. The board of directors or managers of a company thatnever committed any of the actions mentioned above shall never be considered as

bankrupt themselves.

INSOLVENCY

Insolvency is covered by Articles 645 to 763, 800 and 801 to 816.

Companies insolvency

Focus shall be made here on the articles more specifically related to companies.

Article 802 provides for the declaration of insolvency of a commercial company when it

ceases payment of its commercial debts, due to the disruption of its financial activities.

Article 806 is very interesting, since it entitles the court, de facto, or on the request of thecompany to postpone the declaration of insolvency for a period not exceeding a year, ifits financial position is likely to be supported or if the interest of the national economy sorequires. The court can order that appropriate measures should be taken for maintainingthe assets of the company.

This article is in addition to the provisions related to the arrangement that are discussedlater, which gives the company a breath of fresh air, allowing it to arrange itself beforebeing declared insolvent.

Article 809 provides that if the assets of the company are insufficient to satisfy at least20% of its debts, the court who has declared the insolvency may order the members ofthe boards of directors, or some or all of the managers, jointly or individually, to pay thedebts of the company, in whole or in part, in the cases where they are held responsible, inaccordance with the provisions of the Commercial CompaniesLaw (CCL).

The articles in the CCL provide for the liability of the chairman and members of theboard of directors towards the company and its shareholders for all acts of fraud andabuse of power, and for any violation to the CCL or the articles of association, or the

management violations, and any provisions to the contrary shall be annulled (Article 111of the CCL).

The liability mentioned in the previous article shall be borne by all the board members ifthe violation has arisen as a result of a unanimous decision. Otherwise, if the resolutionwas approved by the majority, the opponents shall be absolved if they prove that they hadopposed the resolution in the minutes of a meeting. An absentee may still be liable unless

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they prove that they were unaware of the resolution or were aware of it without beingable to object to it (Article 112 of the CCL).

It is important to remember that Article 237 of the CCL provides that the liability of themanager of a limited liability company is similar to that of the board members and anystipulation to the contrary shall be annulled.

Procedure

The insolvency is declared on the request of the commercial company or on the requestof one of its creditors. The court may declare the insolvency on the request of the publicprosecution oripso facto (Article 647).

The commercial company may request to be declared insolvent if its financial activities

are disrupted and it has ceased paying its debts. Such a request becomes mandatory if 30days have elapsed since the cessation of payments, otherwise this would be considered acase of negligent bankruptcy (Article 648).

The request shall be submitted within a report explaining the reasons for the cessation ofpayment and to which shall be attached several documents, such as the accounting books,the last audited financial statements, the profit and loss account, a detailed statement ofmovable and immovable assets, a statement of the names of the creditors and the debtors,their address, their rights and obligations, and security (Article 648).

In its insolvency judgment the court shall determine a provisional date for the cessation

of payment, shall seal the debtors premises and shall appoint a trustee (Article 655).

In all events, the date of cessation of payment may not be deferred back to more than twoyears prior to the insolvency judgment date (Article 659).

In the insolvency or in a subsequent judgment, the court shall appoint a remuneratedattorney to manage the insolvency: the insolvency trustee (Article 668).

The judgment shall be published in the Trade Register and in the Courts Board for 30days. The trustee shall take care of the publication of the judgment in a daily newspaper,as determined by the court, with all the details pertaining to the insolvent company and

the summon to the creditors to come forward with their debts.

The judgment shall also be published in the name of the Assembly of Creditors at theLand Register within 30 days of the issuance of the judgment (Article 661).

The insolvent shall be prohibited from managing its assets or disposing of them (Article685).

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Article 691 provides that any lawsuit emanating from the insolvent or against them shallbe prohibited.Any activities undertaken by the insolvent that are detrimental to the Assembly of

Creditors may be cancelled if the counterparty was aware of the cessation of payment ofthe insolvent (Article 697).

An Assembly of Creditors shall be created by law on the issuance of the insolvencyjudgment composed of the insolvents ascertained creditors. Any holder of mortgage orspecial privilege shall not be a member of the Assembly of Creditors (Article 703). Thisis because these secured creditors are at liberty to sue the insolvent individually (incontradiction to Article 691 and 704) and they have preferential rights over the attachedassets.

Competent court

As mentioned above, the competent court to oversee the insolvency is the Court of FirstInstance in whichever jurisdiction the headquarters of the insolvent company is located(Article 653).

In the Dubai Court of Appeal judgment, the insolvency is related to the public order ofthe state and is therefore closely linked to its judicial system. Any arbitral proceedingshould therefore be excluded.

However, Article 747 entitles the insolvency judge, after hearing the supervisor (beingthe creditors representative) and the insolvent, to allow the trustee to settle or approvethe arbitration in any dispute related to the insolvency, even if related to rights in

rem(Article 678).

This could mean that the arbitration agreements executed before the launch of theinsolvency procedure may still be valid after such a launch. The arbitral tribunal will onlybe in a position to declare a debt and determine its amount without being able to sentencethe debtor to pay.

Nevertheless, providing such a clause in the insolvency law is very innovative of theUAE legislator, considering the public order nature of the UAE insolvency law.

ARRANGEMENT BY THE COURT

AND VOLUNTARY ARRANGEMENT

Arrangement by the court

This procedure involves the invitation of the creditors by the insolvency judge todeliberate on the arrangement (Article 764). The creditors may attend personally orthrough an attorney. However, the insolvent must attend personally (Article 765). It isassumed that in the case of a company, it should be its authorized signatory (ie themanager in an LLC and the chairman of the board or the CEO in a joint-stock company).

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The trustee must submit a report to the meeting, related to the insolvency procedure andtheir opinion about the arrangement. The insolvent shall also be heard (Article 766).

The arrangement shall not be approved unless a majority of creditors, holding two thirdsof the debts, agrees. Any creditor not attending the meeting shall be considered asdissenting to the arrangement (Article 767).

The secured creditors are not part of the Assembly of Creditors and shall not be entitledto vote on the arrangement, unless they waive their privileges (Article 769).

However, no arrangement is possible in the event of fraudulent bankruptcy (Article 771),but it is possible in the event of negligent bankruptcy (Article 772).The arrangement might involve delays for the insolvent to pay its debts or a waiver by the

creditors of some parts of the debts (Article 773).

The arrangement shall not be applicable on the secured creditors for the reasonsmentioned earlier. Nor on the ordinary creditors where debts have arisen during theinsolvency procedure (Article 775).

The arrangement shall remove all effects on the insolvency, without prejudice to anycriminal pursuit. The debtor shall be reinstated with all their belongings and effects(Article 777).

This is, when going through the voluntary arrangement, a deficiency in the UAE

insolvency law, which has failed to give enough power to the judicial authority, allowingit to take the necessary steps to allow a good company to survive without its failed ordishonest management. Since at the exception of the criminal pursuits that shall de factolead to the insolvency of the company again, no provisions entitled the judicial authorityto replace the former management of the company to protect its staff . Indeed, thearrangement shall be dissolved if, after its ratification, the insolvent is condemned withthe crime of fraudulent bankruptcy (Article 778).

Voluntary arrangement

46 articles (from Article 831 to Article 877) are related to a voluntary arrangement by thecompany, with the assistance of a trustee appointed by the court (Articles 843 and 844 of

the law). The trustees role in this procedure is only as formal as evidenced in Articles844 and 852, and the trustee will not intervene at all in the management of the company.

The voluntary arrangement may be initiated before or after the launch of the insolvencyprocedure.

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These articles are progressive and protective of the company, provided that the lattersubmits a comprehensive plan evidencing means to continue operations and secure atleast a payment of 50% of its debt within a period not exceeding three years.

Such a voluntary arrangement applies to both secured and unsecured creditors, and thusthe secured creditors are bound by the voluntary arrangement and are not at liberty topursue with their individual lawsuits.

However, as pointed out above, in relation to the arrangement by the court, very little isprovided in relation to the management and operation of the company during thevoluntary arrangement period. Nothing is provided in relation to the fate of themanagement of the company, since Article 846 of the law provides that the debtor shallcontinue to manage its assets and shall perform all regular acts necessary for themanagement of the business.

In that sense it may be argued that UAE insolvency law is not in tune with moderninsolvency laws which have made a distinction between the failed management of acompany and its survival, mainly to protect its staff. In other words, in modernlegislation, if a company is able to survive, it should do so. However, it should notnecessarily survive with the same management that could be subject to civil and criminalsanctions. In this sense the UAE insolvency law does need improvement and evolution.

CONCLUSION

The UAE has a very modern and comprehensive insolvency law, which has unfortunately

been unnoticed by the most prominent legal experts, since they ask for its amendmentwithout even having read it.The main impediment for the application of insolvency law is the security asked by thecreditors and mainly post-dated cheques, which if not honored would constitute a crimeleading its drawer to jail.

So the creditors, instead of having recourse to the normal insolvency procedure, preferresorting to a speedier process consisting of filing a criminal complaint for a dishonoredcheque, thus avoiding any chance for the company to survive.

Therefore, it is best practice to decriminalise the cheque, and this security may be

replaced by other security and further information on the debtors. A credit bureau wasenvisaged last year by the UAE, which could be the first step towards decriminalising thecheque and towards applying the insolvency law.

By: Mazen Boustany

Head of Banking and FinanceHabib Al Mulla & Co. Dubai officeE-mail: [email protected]

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Mid - 2010

IBA paper Sept 2010 SAH

Documents