Small and medium-sized enterprises and insolvency law in the UAE: the missing link

October 2020  |  SPECIAL REPORT: BANKRUPTCY & RESTRUCTURING

Financier Worldwide Magazine

October 2020 Issue

Many countries, including the United Arab Emirates (UAE), have revised their insolvency laws to accommodate recent developments in jurisprudence. The UAE conducted a major overhaul of its bankruptcy law culminating in UAE Federal Law of 2016 on Bankruptcy. The purpose of the amendments is on restructuring businesses rather than dismantling them and selling their assets, which would be detrimental for the economy. Amid all these changes and amendments, UAE law seems to have adopted a one-size-fits-all approach whereby the insolvency law applies to all businesses, regardless of their size, and is even more focused on large businesses.

Small and medium-sized enterprises (SMEs) play a significant role in the economy of both developing and developed countries. For example, SMEs in Organisation for Economic Co-operation and Development (OECD) countries provide over half of all business sector employment, employing on average five workers, and generating over half of all business sector gross domestic product (GDP), creating on average around $270,000 of value-added per firm, according to the OECD. In the UAE, SMEs represent more than 94 percent of the total number of companies operating in the country and provide jobs for more than 86 percent of the private sector’s workforce. Despite these numbers, the UAE insolvency law fails SMEs as it is reactive, not proactive, in the sense that changes are not adopted or advanced unless there is a crisis.

Any modern insolvency regime should include provisions on commencement standards, treatment of assets of the debtor, creditors’ committees, debtor-in-possession (DIP) financing, and reorganisation plans, according to UNCITRAL’s Legislative Guide on Insolvency Law, 2005. However, the UAE insolvency law fails to accommodate the interests of SMEs; instead, it seems to focus on big corporations.

SMEs in the UAE may not have sufficient knowledge or experience when faced with the prospect of being insolvent. Therefore, documentation should be developed which highlights the different options available to SMEs and legal ramifications of each choice. These pamphlets should provide specific and detailed descriptions of the steps to be taken.

From a legal perspective, the UAE should incorporate provisions in its law which, in the event that SMEs face financial difficulties, provide grace periods whereby creditors are prohibited from filing for bankruptcy. During this grace period, both the debtor SMEs and creditors would have to engage in good faith negotiations to, among other things, defer payments and financial fines. This grace period would provide debtor SMEs the breathing space required to recover.

A cap should be placed on the monetary amount that would trigger insolvency proceedings, according to The National Law Review, 2020. For SMEs, the cap should be high and revised frequently, depending on the economic conditions of the country in question. For instance, it is unfair that an SME could go bankrupt simply because of a $5000 debt. The demand cap should be reasonably set.

SMEs do not have the luxury of hiring corporate lawyers to provide sound legal and financial advice in case of financial distress. SME owners lack the sophisticated financial and legal knowledge when faced with such circumstances. Indeed, some SMEs do not have projected financial statements or financial projections. Therefore, the UAE should establish a programme whereby SMEs can access a database of lawyers whose advice can be sought free of charge or for a reduced fee.

Once SMEs cannot operate due to financial distress, an effective insolvency process should be put in place. The insolvency process should be short and straightforward. SME owners often cannot afford to establish creditors’ committees or propose a reorganisation plan that must be approved by majority creditors and courts. Therefore, a bankruptcy officer appointed by the court, in a session or two, will either approve the reorganisation plan submitted by the SME owner or recommend winding up the business. During this process, secured creditors, which are often aggressive in pursuing their rights, should be obliged not to commence any enforcement action against SMEs. SME owners would have to defend their interests and convince the bankruptcy officer of the viability of their plan to turn their businesses around. Any decision taken by the bankruptcy officer should consider the history of business, cash return, what a good outcome looks like for both debtors and creditors, and the economic impact on the community.

Under the current UAE insolvency regime, SMEs fare poorly and there is a genuine need for reform. Central to the success of the reform should be simplicity and speed. There is a need to provide a clear-cut definition of a ‘small business debtor’ in the law. There should be separate provisions in the UAE bankruptcy law that address SMEs. These provisions would provide fast-track procedures for SMEs. Bankruptcy officers appointed by the court should be able to identify those SMEs which are likely to succeed under the reorganisation plan and those that are unlikely to do so. Any reform of the insolvency regime to accommodate the interests of SMEs does not mean that a lenient approach should be adopted, but rather an approach where SMEs are able to survive their financial distress and emerge stronger for their benefit and for the economy in general.

Bashar Malkawi is visiting global professor of practice in law at the University of Arizona. He can be contacted on +1 (480) 205 2713 or by email: bmalkawi@arizona.edu.

© Financier Worldwide

BY

Bashar Malkawi

University of Arizona

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