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A sea change in UAE corporate law: Doing away with minimum capital

Will the proposed changes in company law have the significant impact anticipated, asks Professor Bashar Malkawi?

The UAE is introducing new company legislation Steven Bostock

Limited liability companies under UAE company law appear to be a good alternative for those investors who wish to set up and be in direct control of a relatively small corporate entity. Limited liability is a fundamental principle of corporate law, under which investors in a company are not liable for more than the amount they invest. In other words, investors do not risk their personal assets beyond their initial investments in the company and some of the risks of a company's failure are shifted to creditors.

The most important requirement linked to limited liability company is the one governing capital. Under the present version of UAE company law, limited liability companies must have a minimum level of three hundred thousand dirham as paid-up capital before they can commence business. The minimum capital is the price that companies must pay to obtain the benefits of limited liability. To obtain this benefit, shareholders must make contributions of a minimum capital to the company, and the company may not return these contributions to the shareholders during the company's life.

The fundamental purpose of corporate law in UAE is to protect creditors. Minimum capital serves as the genuine guarantor for creditors who can rest assured when they supply loans that there will be backup in case of inability of the company to pay its debts. A creditor who enquires into the company's resources before allowing it to become indebted to him relies, in part, on the amount of the company's capital in assessing its creditworthiness. By requiring companies to establish and maintain a minimum capital, the Company Law reduces the likelihood of private companies failing due to undercapitalization.

However, in a bid to reduce the cost of setting up businesses and make the corporate form available to more investors, the UAE legislator is contemplating repealing the minimum capital altogether for limited liability companies. The lapsing of minimum capital requirement sets a dangerous precedent. In this scenario, creditors and other parties may be hesitant to deal with limited liability companies as there will be no guarantees to secure their rights in case of default. Moreover, if the amendment is carried out, there could be a shift by investors from establishing partnerships with unlimited liability to establishing limited liability companies and hence affecting the total percentage and normal distribution of the different forms of companies in the UAE.

So, rather than increasing the initial capital requirement for limited liability company, the UAE legislator opted for a new flexible formula. The level of capital, which is to be made up of contributions from shareholders, varies depending on the company's scope of business operations. The value or amount of capital is left to the discretion of founders. For example, the minimum level of capital for wholesale companies can be different from that for commercial retail companies. The language of the proposed amendment, if adopted, will make it impossible to permanently determine, with legal accuracy, a company's adequate capitalization, as it is measured by the individual corporate undertaking and its magnitude.

Because the concept of undetermined capital is an abstract one that does not guarantee capital sufficient to the individual pursuit of business, there must be some kind of safeguards. If adopted as it is, the proposed amendment should hold owners and managers personally liable when they are knowingly involved in a scheme leaving the company exposed to business risk without sufficient capital to pay its debts. Further, the proposed amendment should provide clear method for shareholders to protect their rights when directors and managers behave improperly. The amendment should expressly prohibits directors and senior management from engaging in, among other things, misappropriating company funds, depositing company funds into an individual account, seeking business opportunities for oneself or for any other person by taking advantage of one's authority, and taking commissions on a company transaction.

The newly proposed company law intends to make a revolutionary change in the practice of formation of limited liability companies in UAE. However, a mere change in the law is not sufficient to bring about such change. Dismantling the minimum capital can reduce the cushion upon which creditors depend when they extend credit to a company. The change will come only if sound principles and procedures embodied in the law are adopted and used. A balance must be struck between safeguarding creditors' interests by requiring a minimum capital and the goal of attracting investment and speed up the establishment of business. It remains to be seen if the proposed amendment in the company law is likely to have the significant impact the drafters hoped for.

Posted by:

Professor Bashar
Malkawi

22 January 2015

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