Side Agreements Business Law Individual Assignment I. Introduction The Commercial Companies Law of the United Arab Emirates (Federal Law No. 8 of 1984, as amended) provides for seven types of entities through which business may be conducted outside of the free zones in the UAE. The type of entity most commonly adopted by foreign investors is the Limited Liability Company (LLC), in which Article 22 of the Companies Law requires that at least 51% of the shares be held by a UAE national or company. In other jurisdictions, this loss of control by a foreign investor to a UAE national could be resolved by issuing different classes of shares. However, the Companies Law does not permit the issuance of different classes of shares as Article 227 specifically states that the 1 share capital must consist of equal shares and Article 245 stipulates that each shareholder must have a number of votes equal to the number of shares it owns or represents. In order to overcome their lack of control over an LLC and attempt to protect their investment/financial interests, foreign investors have resorted to entering into side agreements or otherwise called nominee arrangements with the UAE national holding 51% of the LLC's shares; this effectively turns the UAE national into a silent registered owner of shares, while the foreign investor secures its economic interests. Though the company's MOA and trade license may reflect the de jure ownership, side agreements may assist the foreign shareholder in protecting their interests and ensuring that they have control over the company. Some unofficial privately conducted studies suggest that around 80% of all LLC's in the UAE have some form of side agreement/nominee arrangement in place. 1 The purpose of this essay is to assess the legal debate regarding side agreements/nominee arrangements and address the question of their validity and enforceability in the UAE. II. Types of Side Agreements/Arrangements Generally, the common characteristics and aims of side agreements are as follows: - - The UAE national is paid an agreed annual sponsorship fee for providing administrative assistance to the company (liaising with authorities, arranging visas, etc.) The foreign investor contributes the entire minimum statutory required share capital; and The UAE national is not involved in the LLC or its day-to-day management. One way to achieve these goals is to enter into an agreement which is a trust and sponsorship arrangement, pursuant to which the UAE national agrees to act as trustee and holds 51% of the shares of the LLC for and on behalf of the foreign investor as the beneficial owner thereof. Another way is to sign a side agreement which is a loan and pledge arrangement, pursuant to which the shareholders enter into a loan and pledge agreement which provides that the foreign investor will contribute the UAE national's 51% share of the minimum share capital of the LLC and pledge its shares and all rights attaching thereto to the foreign investor as security for the loan.2 III. Anti-Fronting (Anti-Concealment) Law 1Khodeir, Mohamed and Wallman, Marcus - Al Tamimi & Co. (22 October 2010). 'The Known Secret: Side Arrangements'. Available at: http://www.mondaq.com/x/113484/Directors+Officers/The+Known+Secret+Side+Arrangeme nts (Accessed: 17 October 2014). 2 With the signing of a side agreement, the local investor has no insight into the business dealings of his foreign partner and has no control over possible illegal practices of this limited liability company; therefore, he cannot prevent them from happening. Authorities in the UAE have been trying to undermine this common practice of so called \"Sleeping Partners\" since 2004 with the passing of the \"Anti-Fronting/Anti-Concealment Law\RUNNING HEAD: SHAREHOLDERS' AGREEMENT Shareholder s' Agreement 1 RUNNING HEAD: SHAREHOLDERS' AGREEMENT SHAREHOLDERS' AGREEMENT INTRODUCTION The essay briefly describes the following topics: Meaning of \"Shareholders' agreement\"; its constituent elements; provisions; strengths and weaknesses; types of \"shareholders' agreements\" and \"Side agreement\" in UAE. WHAT IS A \"SHAREHOLDERS' AGREEMENT\"? A \"shareholders' agreement\" is an \"agreement\" between the \"shareholders\" of an organization. It can be between all or, at times, just a portion of the shareholders. Its motivation is to secure the shareholders' interest in the organization, to set up a reasonable relationship between the shareholders and represent how the organization is run. The agreement will: Set out the shareholders' rights and commitments; Control the offer of \"shares\" in the organization; Portray how the organization will be run; Give a component of insurance to minority shareholders and the organization; and Characterize how essential choices are to be made. The \"shareholders' agreement\" will contain particular, essential and down to earth rules identifying with the organization and the relationship between the shareholders. This can be helpful both to minority and greater part shareholders. [ CITATION Pet1 \\l 1033 ] What is secured by a \"Shareholder's Agreement\"? Generally, such an agreement incorporates procurements managing the accompanying bury all matters: The Company Structure: Includes the piece of the offer capital of the Company. The appointment and evacuation of executives: Includes procurements of the presence of consistent assent of shareholders, for certain critical matters, or the presence of particular larger parts for the reception of specific choices, limitations on the forces of the \"Board of Directors\Side Agreements Business Law Individual Assignment I. Introduction The Commercial Companies Law of the United Arab Emirates (Federal Law No. 8 of 1984, as amended) provides for seven types of entities through which business may be conducted outside of the free zones in the UAE. The type of entity most commonly adopted by foreign investors is the Limited Liability Company (LLC), in which Article 22 of the Companies Law requires that at least 51% of the shares be held by a UAE national or company. In other jurisdictions, this loss of control by a foreign investor to a UAE national could be resolved by issuing different classes of shares. However, the Companies Law does not permit the issuance of different classes of shares as Article 227 specifically states that the 1 share capital must consist of equal shares and Article 245 stipulates that each shareholder must have a number of votes equal to the number of shares it owns or represents. In order to overcome their lack of control over an LLC and attempt to protect their investment/financial interests, foreign investors have resorted to entering into side agreements or otherwise called nominee arrangements with the UAE national holding 51% of the LLC's shares; this effectively turns the UAE national into a silent registered owner of shares, while the foreign investor secures its economic interests. Though the company's MOA and trade license may reflect the de jure ownership, side agreements may assist the foreign shareholder in protecting their interests and ensuring that they have control over the company. Some unofficial privately conducted studies suggest that around 80% of all LLC's in the UAE have some form of side agreement/nominee arrangement in place. 1 The purpose of this essay is to assess the legal debate regarding side agreements/nominee arrangements and address the question of their validity and enforceability in the UAE. II. Types of Side Agreements/Arrangements Generally, the common characteristics and aims of side agreements are as follows: - - The UAE national is paid an agreed annual sponsorship fee for providing administrative assistance to the company (liaising with authorities, arranging visas, etc.) The foreign investor contributes the entire minimum statutory required share capital; and The UAE national is not involved in the LLC or its day-to-day management. One way to achieve these goals is to enter into an agreement which is a trust and sponsorship arrangement, pursuant to which the UAE national agrees to act as trustee and holds 51% of the shares of the LLC for and on behalf of the foreign investor as the beneficial owner thereof. Another way is to sign a side agreement which is a loan and pledge arrangement, pursuant to which the shareholders enter into a loan and pledge agreement which provides that the foreign investor will contribute the UAE national's 51% share of the minimum share capital of the LLC and pledge its shares and all rights attaching thereto to the foreign investor as security for the loan.2 III. Anti-Fronting (Anti-Concealment) Law 1Khodeir, Mohamed and Wallman, Marcus - Al Tamimi & Co. (22 October 2010). 'The Known Secret: Side Arrangements'. Available at: http://www.mondaq.com/x/113484/Directors+Officers/The+Known+Secret+Side+Arrangeme nts (Accessed: 17 October 2014). 2 With the signing of a side agreement, the local investor has no insight into the business dealings of his foreign partner and has no control over possible illegal practices of this limited liability company; therefore, he cannot prevent them from happening. Authorities in the UAE have been trying to undermine this common practice of so called \"Sleeping Partners\" since 2004 with the passing of the \"Anti-Fronting/Anti-Concealment Law\ASSESSED COURSEWORK 2015/16 WRITING THE ASSESSED ESSAY Individual Assignment:Shareholders in UAE and US companies are motivated to enter into shareholders' agreements as a matter of best practice for the same business reasons as in other jurisdictions, namely to set out their respective rights and obligations and to protect their local commercial interests. That being said, what is a Shareholders'Agreement? What are the advantages and disadvantages of Shareholders' agreements? Are Side Agreements enforceable in the UAE? Yes or No Please explain. How will the essay be assessed? Introduction: This should provide an abstract/ summary of all the issues you wish to discuss in the body of the essay. This is your roadmap to the essay. It tells the examiner where you are going and how you plan to get there. Mark 2/ Body of essay: Discuss one after the other the issues you have already identified in the introduction. You should divide the body of the essay into sub-sections as you deem appropriate. Mark 2/ CONCLUSION: This should be a summary of the issues you have discussed in the body of the essay. An essay without a conclusion is like an unfinished painting. Mark 2/ Support you discussion with: Academic authorities - i.e. textbooks, articles, etc (Suggested 7-10 references). Mark 1/ Academic discipline: Writing a good essay involves knowing what to include and what to leave. All sources quote/cite must be acknowledged and appropriately referenced. Mark 3/ Analysis and evaluation: How you have analysed and evaluated the subject-matter of the essay. How much you know and understand the subject-matter. How you have applied legal, academic and judicial sources. How you structured and presented the essay. A judgment as to the overall value of the final outcome, and its relative welfare gains whencompared to alternative outcomes that might have been reached. Mark 5/ Each essay should be 1.5 lines, 12 font, 1 inch margins. Please have a cover page with your name, course name/professor's name, and date. The body of the paper should be approximately 10-12 pages (Excluding cover and bibliography). Plagiarism/copying other people's work will be detected and punished with a zero, and possibly expulsion. UD College of Law | LLM Course Syllabi 2 Company Law DIFFERENT TYPES OF BUSINESS ORGANISATIONS 1 There are different types of business organizations or business associations. These range from small, individually owned businesses to large multi-national corporations. There are at least three categories of business organization in the UAE excluding the free zones (e.g. D.I.F.C Zone) Company Private company Public company Limited liability company Partnership limited in/by/with shares Partnership General partnership Limited partnership Sole trader Sole trader business UAE Sole Trader Formation A sole trader is a structure in which a business is owned by one person, acting under their own name or using a 'trading name'. This person is fully liable for the company's debts and contracts and there is no distinction in law between the business and their own personal wealth i.e. unlimited liability. He is liable/responsible to the extent of his own personal assets for the business's debts. This means that their personal possessions are at risk. It is a \"sole\" proprietorship in the sense that the owner has no partners. This is the most straightforward structure for a business. Basically it means the business decisions are being made by one person. Of course, it doesn't necessarily mean that the business has only one worker. The sole trader can employ others to do any or all of the work in the business. Being a sole trader is the simplest way to get started in business. Once you have informed the government agencies of your intentions to go self-employed, you can start trading right 2 away (subject to any specific licenses you might require in your line of work). An Establishment, or Sole Proprietorship, is a simple structure whereby an individual is issued a trade license in their own name, permitting them to trade or conduct business activity on their own account. The sole proprietor is held personally liable to the full extent for all assets and liabilities incurred by the business. Mainly, it is only UAE nationals and nationals of GCC countries (subject to certain conditions) who are permitted to form establishments in UAE. However, in recent years, a practice has evolved whereby a UAE national obtains a license for an establishment and leases it to an expatriate(s) for an annual fee. These expatriates, then, take on all management functions of the business and retain all profits. This type of Arrangement, though common, is not recommended as it is fundamentally unlawful and problems may arise if the business relationship between the parties breaks down. Certain foreigners in selected fields may form sole proprietorships if they reside in the UAE. This is also referred to as \"Professional Firm\". professional consultants in: A) medical services, b) engineering fields, c) the legal profession, d) computer services, f) artisan activities and similar services. 3 These include A professional firm of foreign sole proprietor is required to appoint a local service agent. The local service agent must be a UAE national, but he has no direct involvement in the business and is paid a lump sum and/or percentage of profits or turnover. The role of the local service agent is to assist in obtaining licenses, visas, labor cards, etc. Partnership 1. General Partnership: General partnerships are between two or more partners who are jointly or severally liable to the extent of their personal assets for all of the liabilities of the partnership. The name of a general partnership should consist of the names of all of its partners or may be restricted to the name of one of its partners with words to indicate the existence of a partnership, or it may have a special trade name. There is no prescribed capital requirement for general partnerships and no negotiable shares are permitted to be issued due to the personal nature of the company. Similarly, assignment of a partner's share without the consent of all partners is not permissible and any contract to the contrary is deemed to be void. The names of the person(s) who will manage the company is required to be set out in the company's Memorandum of Association and decisions in a general partnership have to be unanimous unless the memorandum provides otherwise, in which management is carried out in accordance case, the with such provisions. All the partners of a general partnership have to be UAE nationals. Memorandum of Association: is a written constitution that governs or regulates both the company's (or firm's) relations with the outside world and its internal affairs. 4 Resolutions: this is the method by which companies or firms decide what they are going to do. When decision has to be reached at a meeting the manger or chairman will ask the members to vote on a resolution. In a general partnership have to be unanimous unless the memorandum provides otherwise. For example, memorandum of Association may allow resolutions to be passed by a simple majority i.e. 50% + 1. (Article 42) The Memorandum of Association of a general partnership shall contain the following: a. Name and purpose of the company. B. The company's registered office and the branches thereof. C. The capital and shares undertaken by each partner whether paid in cash or in kind, the estimated value of these shares, subscription method and due dates. D. Date of establishment, and expiry, if any. E. Management of the company and names of authorized signatories and the extent of their respective powers. F. Commencement, and expiry, dates of the company's financial year. G. Rate of distribution of the profit and loss. (Article 45/3) Unless the Memorandum of Association allows for a majority of votes, general partnerships shall adopt resolutions made by unanimous voted the partners' unanimous votes, and unless otherwise stipulated in the Memorandum of Association, "majority" shall mean numerical majority of votes. Resolutions pertaining to the amendment of the Memorandum of Association shall be valid only in taken by the partners' unanimous votes. 5 Features of Partnerships a. The ordinary rules of contract apply between partners, for example, the partnership is voidable if induced by misrepresentation, and it is void if formed for an illegal purpose. b. Partners are known collectively as a 'firm'. The name under which they carry on business is the 'firm name'. c. The actions of one partner can bind the whole firm. d. Partners are jointly liable for ALL the partnership's debts - They do NOT have limited liability. e. Death, insanity, retirement or bankruptcy of any partner automatically dissolves the entire partnership, (unless otherwise provided). For example, a partner has the power to withdraw and dissolve the partnership. The surviving, or remaining, partners have the right to continue a partnership after its dissolution. When a partnership is continued, the old partnership is continued, the old partnership is dissolved, and a new partnership is created. Advantages (1) Ease of formation - no written agreement or registration required. (2) Greater privacy - minimum of state regulation (3) All partners have a right to participate in management of the business Disadvantages 6 (1) No separate legal personality. This means that the business is the same as the owners. Debts owed by the firm are deemed to be owed by the members. Wrongs done by the firm are deemed to be done by the members. (2) No limited liability. Partners fully liable for firm's debts. This means there is no limit to the partners' liability. Any debt owed by the firm could be satisfied from the personal fortunes of the partners. (3) Difficulties of finance. More difficult to raise loans; floating charge not available to use as security. (4) No perpetual succession. A partnership is dissolved on departure/bankruptcy/death of a single partner and then wound up. 2. Limited Partnership: This type of entity is constituted by general or active partners and limited or sleeping partners. General or active partners take an active part in the management of the company and are jointly liable to third parties to the extent of their personal assets for all of the liabilities of the partnership, while sleeping partners do not interfere in the management of the company against third parties and their liability is limited to the extent of their share capital in the partnership. Limited or sleeping partners may however take part in the internal administration of the firm to the extent permitted by the Memorandum of Association. A limited partner's name cannot be mentioned as part of the name of the firm. 7 A limited partner may be held liable personally to third parties if he holds himself out as a general partner and third parties are induced to believe so. Internal decisions in a limited partnership are valid only by unanimous consent unless otherwise provided in the Memorandum of Association. Only UAE nationals may be active partners, however, limited partners may be non UAE nationals. Limited partnerships are prohibited to issue negotiable shares in the form of instruments. There is no minimum capital requirement. COMPANIES Companies are the most advanced form of business organisation. A company comes into existence by a process known as incorporation. Definition of 'Company.' An artificial legal person i.e. a personality created by incorporation rather than by birth. Upon incorporation, a company becomes a body corporate and assumes a separate identity in law distinct from those of its members. Even though the company is owned by its members, it is regarded as different from those members. The law in a sense throws a veil between the company and its members/shareholder. Formation of Companies The process of formation of companies is generally referred to as incorporation. 8 Companies formed in accordance with the registration procedure stipulated by the Companies Act are referred to as registered companies. Most companies now are registered companies and we shall concentrate on such companies. Registration of Companies The documents needed for registration of companies are: (a) A copy of Memorandum and Articles of Association. This is a formal document stating the subscribers of the company and number of shares they have taken in the company. (b) An application for registration. The application must contain the following particulars: - A statement containing particulars of the first directors and secretary of the company and their residential and service addresses. This statement must be signed by or on behalf of the subscribers to the memorandum. It must also contain consent by each of the persons named in it as director or secretary to act in the relevant capacity. A private company need not have a secretary. The shareholders have the power to appoint and remove directors but at this stage the company does not have shareholders and this explains why the founding members/ subscribers have the power to appoint subsequent the directors first will be directors. appointed However, by the shareholders. - The company's proposed name - Statement of intended location of the company's registered office 9 - The type of company - A statement of capital and initial shareholding - This is a statement as to the amount of share capital the company proposes to start business with. Only companies limited by shares are required to provide this statement. The statement should include the total amount of the share capital, its division into smaller units, the classes of shares and number of shares in each class and the rights attached to each class of shares, the number of shares taken by each subscriber, and the amount paid and owed on each share. All these documents would then be submitted to the Registrar of Companies. Once the necessary documents have been lodged and the registrar is satisfied with them, the registrar of issues a certificate of incorporation. The certificate will contain the name of the company, the date of registration, type of company, and the situation of the company's registered office. The certificate of incorporation is conclusive evidence that the requirements of the Companies Act have been complied with, and that the association is a company authorised to be registered and is duly registered under the law. Classes of shares: a. Ordinary shares: These are the most common. They carry no special rights. Dividends are payable to ordinary shareholders after the preference shareholders have been paid. b. Preference shares: They carry special rights in relation to dividends. A preference share confers the right to receive a specified amount/percentage of 10 dividends before any dividends are paid for other ordinary shares. The right to dividends is deemed to be \"cumulative\". This means that if dividends are not paid in any year, they are carried forward to the following year. c. Redeemable shares: these are shares issued on the understanding that they could be bought back by the company at a fixed date or when the company desires. They give temporary membership and are used to raise capital when needed. In other words, redeemable shares are used to raise short-term funds without intending to make the holders permanent member of the company. Classification of companies as Private companies or Public companies The main characteristics of a public company are as follows: 1. The capital is represented by negotiable shares publicly subscribed to with provision for rights issues; 2. The minimum capital requirement is UAE Dirham 30,000,000 and a minimum of 5 founding members are required to subscribe to a minimum of 30% and a maximum of 70% of the share capital of the company. 3. The management vests in a Board of Directors consisting of a minimum of three and a maximum of 11 persons, the chairman being a UAE national; 4. The liability of its members or shareholders is limited to the extent of their respective share value. 5. There is indefinite personality; 11 duration and separate legal 6. The shares are freely transferable provided always that 51% of the shares are held by GCC nationals. 7. They are allowed to offer their shares for sale to the general public. The main characteristics of a private company are as follows: 1. They are not allowed to offer their shares for sale to the general public. 2. The minimum capital requirement is UAE Dirham 5,000,000. 3. The management vests in a Board of Directors consisting of a minimum of three and a maximum of 11 persons, the chairman being a UAE national; 4. The liability of its members or shareholders is limited to the extent of their respective share value. 5. There is indefinite duration and separate legal personality; 6. This type of company is constituted by at least TWO founding members and maximum of 200 who fully subscribe to the company's capital between themselves. Advantages of incorporation The following features/characteristics of incorporation should be noted: (1) Incorporated companies enjoy separate legal personality different from that of the members. 12 (2) Members enjoy limited liability for the company's debts (for limited companies). This means the members are liable to pay only the amount outstanding on their shares, or in the case of a guarantee company, the amount they had undertaken to pay on liquidation. (3) Companies are easier to finance; they attract more loans and can use floating charges (4) Companies have unlimited capacity for growth. A small company can become a large conglomerate (5) A company has perpetual succession. This means the members may come and go but the company could theoretically live forever. Disadvantages of incorporation (1) Detailed state regulation means that incorporated companies do not have as much privacy as partnerships or sole proprietorships. Companies, especially public ones, have to file notices of its decisions and annual returns of its activities with the Registrar of Companies. The Companies Act provides a compulsory framework, which all companies must comply with. (2) Formation of companies involves some formalities and expense in comparison to sole proprietorship or partnership. (3) For a company to cease to exist it must be formally wound up and then dissolved. Partnerships and sole businesses do not have to follow such formalities before ceasing business. (4) Owners of companies may lose control of the business to outsiders who invest money in the company. Companies may 13 also be taken over by other companies against the wishes of some owners. Limited Liability Companies (LLC): Limited liability companies must have at one and not more than fifty partners. Each partner is liable to the extent of his share capital. LLC must be owned 51% by the UAE nationals or 100% by GCC nationals. In other words, should there be a foreign (Jordanian, US, British...etc) partner, then at least 51% of the LLC must be owned by UAE nationals. The company is prohibited from issuing negotiable share certificates; carrying on the business of insurance, banking and investment of funds; resorting to public subscription for raising its capital and accepting deposits or taking loans from the public. The shares of the company should be divided into equal shares. Partners enjoy a right of pre-emption in respect of shares to be transferred by any partner of the company to third parties. If any partner wishes to transfer his shares to a third party the existing partners have the right within thirty days of receiving notice, to purchase the shares offered for sale at a mutually agreed price. If no price can be agreed, the company's auditor must value the shares and existing partners may purchase the shares at that price. If the existing partners do not elect to purchase the shares offered for sale within the period of thirty days from receipt of notice, the partner offering to sell the shares is free to sell them to third parties. In August 2009, the UAE President, His Highness Sheikh Khalifa bin Zayed Al Nahyan, issued a decree amending certain provisions of the UAE Commercial Companies Law Federal Law 8 of 1984 (CCL) with respect to reducing the 14 capital required to form new businesses. Previously, a new limited liability company (LLC) was required to have share capital of at least AED300,000 in Dubai and a minimum of AED150,000 in the other Emirates. The amendment now enables partners in LLCs to determine what they consider to be sufficient capital requirements for establishing their company. The LLC must have at least one manager (no maximum is prescribed by the NEW UAE COMPANY LAW 2015) who may be appointed under the Memorandum of Association or by a separate agreement. The manager(s) may be an expatriate and maintain full authority to manage the affairs of the company. If there is more than one manager the Memorandum of Association may provide for the formation of a Board of Directors and may specify the method of operation of the board and the majority required for passing its resolutions. If the number of the partners in the company exceeds seven, supervision of the company must be entrusted to a Board of Supervisors from at least three of the partners. I explained earlier that company's constitution (memorandum and articles of association) is a contract between all the members (shareholders) of the company. One objective/aim of this constitution is to protect shareholders' rights (right to vote, right to attend meetings, right to receive dividends etc...). However, some shareholders still prefer to enter into another agreement between themselves "shareholders' called agreements" to "side protect agreements" their rights. or A question arises here: why would shareholder enter into another 15 agreement? Isn't the company's constitution adequate to protect shareholders' rights? One simple answer is that some shareholders are looking for more security and that is why they prefer to enter into side agreement (they want to get better protection). A detailed answer as to why shareholders prefer to enter into such agreements is shown below. Two main reasons why shareholders in the UAE enter into a shareholders' agreement: 1. To protect minority shareholders A properly drafted shareholders' agreement together with a compatible company Memorandum can be structured so as to protect the minority. The Companies Law does provide some rights to minority shareholders most notably the right to receive the annual audited accounts of the company and to inspect its books and records. The shareholders' agreement can expand upon these terms so that the minority will be able to monitor the business operations of the company. The law also provides that special majorities may be set for decisions of the board of managers of a company and that special majorities in excess of statutory requirements (being 50% for ordinary resolutions and 75% for amendment of the company's Memorandum) can be established for shareholder resolutions. These majorities can be set at a threshold sufficient to require minority input, effectively giving them "negative control" over the company. However in order to be effective these types of provisions - while they can be embellished agreement or - Memorandum. 16 expanded must be upon included in in a shareholders'' the company's So, minority shareholders can protect themselves by insisting upon a shareholder's agreement (sometimes called a "minority protection agreement")1 which restricts the capacity of majority shareholders to engage in designated "corporate actions" without the prior consent and agreement of the minority shareholder (or the supporting vote of the minority's Board representative). A well crafted shareholders' agreement will contain terms which make it clear that a variety of "reserved decisions" should be taken only where there is unanimous, 95%, or 75%, approval of the Board or the shareholders. The "usual" list of "reserved matters" will generally extend to the following, although this list is not exhaustive: Changing the company's scope of business; Selling major fixed assets; Changing the auditors; Altering or amending the company's constitution. Issuing new shares; Reducing or increasing share capital; Entering a joint venture Buying major fixed assets; 1 Reconciliation with Memorandum: Unlike many jurisdictions, entering into a unanimous shareholders' agreement in the UAE does not bind the parties to the exclusion of the company's constating documents. Under the Companies Law, where there is a discrepancy between these constating documents and the terms of a unanimous shareholders' agreement, with few exceptions, the provisions of the Memorandum will prevail. 17 Entering into any major financing or leasing commitments Hiring or changing senior executive management; Giving guarantees; Paying dividends; Entering into related party transactions. Although Article 154 of the CCL, in the absence of express provisions in the company's articles of association, requires prior shareholder approval to the Board entering into loan agreements for a period longer than the duration of three years; or to the Board agreeing to sell fixed real estate assets, it has limited utility for the protection of minority shareholders, for two reasons: The articles of association can and normally do authorise the Board to do these things; and The majority can usually gather 50% + 1 vote required to pass an ordinary shareholder resolution. Enforcement of Shareholder Agreement's Outside the Courts Although shareholder agreements are usually enforceable through the UAE Courts, because they are merely private contracts it can be difficult to rely on them in dealings with government authorities and third parties. In these situations it is better if minority shareholder rights are actually embedded and reflected in the company's memorandum of association and articles of association. If there is a serious shareholder dispute, unless the shareholder's rights are "mirrored" in the memorandum and articles of association 18 those rights will be "invisible" to, and will likely be disregarded by, important outside parties and authorities, e.g.: The company's bankers; The Department of Economic Development; Other government departments (e.g. Ministry of Labour); and Free zone registries. Many shareholders are understandably reluctant to repeat and embed detailed provisions of their shareholders' agreements in the memorandum of association and articles of association, because these documents are, to some extent, public documents. However, crucial terms needed to uphold minority rights (e.g. the composition of the Board and the taking of important corporate actions) should always be reflected in the company's constituent documents as a matter of best practice. Otherwise, the onus rests with minority shareholders to enforce them as private contracts through the Courts. Enforcement of Shareholder Agreements in the UAE Courts Shareholders' agreement will be enforced as binding contracts by the UAE Courts but the remedies for a breach of contract are limited. The general practice of the UAE Courts is to award financial damages after the loss making event. In general terms, the UAE courts do not make interim orders, e.g.: 19 Restraining orders (e.g. injunctions); or Mandatory orders compelling a party to take specified action; until the case before the court is tried in full. This process can take months or years. 2. To circumvent or avoid the ownership requirement (51/49) specified in the UAE COMPANY LAW Shareholders' agreements are extremely common in the UAE and have been for some time. This is due in part to a longstanding requirement under the Commercial Companies Law of the United Arab Emirates (Federal Law No. 8 of 1984, as amended) (the "Companies Law") stipulating that every limited incorporated within the UAE must have one or more national shareholders whose share in the company's share capital must not be less than 51%. In other words foreign parties are limited to 49% ownership in UAE companies, subject to some exceptions made for ownership by nationals of the Gulf Cooperation Council (GCC) states. Accordingly into entering shareholders' agreements between foreign investors and their UAE partners is one way protect the (minority) interests of those foreign investors in UAE companies. Where the company in question is owned entirely by UAE or qualified GCC nationals there may be a less of an impetus for a shareholders' agreement to be put in place. However these agreements are increasingly being accepted as necessary in any event as part of good commercial practice. 20 Formal Requirements There are no formal requirements for shareholders' agreements in the UAE. Contracts concluded in written or oral form and even by telephone are given equal recognition by the Civil Code (Federal Law No. 5 of 1985, as amended). Commercial practice however is to have a written shareholders' agreement signed by the parties. It is important to note that there are important formal requirements stipulated under the Companies Law for the Memorandum and Articles of Association ("Memorandum") of each LLC and for any subsequent Schedule of Amendments to the Memorandum, altering its terms. These documents - which are themselves contracts among the stakeholders - will often be drafted to conform their terms to substantive matters provided for under a shareholders' agreement or to include key aspects of such agreements. The Memorandum or any amendments must follow strict the form requirements of the Companies Law, must be executed by the parties before a notary Public and must be properly filed with the Department of Economic Development or similar authority in the Emirate in which the company is formed. Limits on Term There is no limit on the term of the shareholders' agreement itself; it is simply a matter of contract. However the Companies Law does require the Memorandum of a limited liability company to stipulate an expiry date for the company (Article 224). The Memorandum of such companies may state varying terms for the existence of the company - ranges of between 5 to 50 years are not unusual. The 21 Memorandum may also stipulate rights of renewal for the stipulated terms. Assignments of Shares and Preemption Rights The Companies Law stipulates that: a. No assignment of shares will be effective if: i. It results in the shareholdings of the national shareholders of the company being reduced to less than 51% of the total shares of the company; or ii. Results in the increase in the number of shareholders in the company in excess of the number prescribed for a private company (currently 50); and b. Where a shareholders does wish to sell his shares in the company he is entitled to do so subject to the preemptive rights of existing shareholders as set out in the Companies Law. These statutory preemptive rights deserve some special consideration given their importance in the general scheme of corporate law in the UAE. Under Article 79 of the Companies Law where a shareholder proposes to assign his shares to a third party non-shareholder (whether for value or not) he must first offer to sell his shares to the remaining shareholders. Each shareholder has the right (pro-rata to their holdings if more than one take up the offer) to purchase the shares of the departing shareholder at any agreed price or, in the absence of agreement, at a value determined by the auditors of the company. If at the expiry of 30 days from the date of the initial notice none of the shareholders 22 has exercised their right to acquire the departing shareholder's shares that shareholder shall be free to dispose of his shares. No shareholders' agreement can deprive a shareholder of this fundamental right although many such agreements augment or flesh out the terms of the preemptive rights - for example providing guidelines to the company's auditors for valuation methodology or setting out basic representations and warranties to be given by the departing shareholder on the sale of his interest. So long as such terms do not violate the terms of the Companies Law or other applicable law they will in all likelihood be permissible. The parties may also seek to include other contractual restrictions into their shareholders' agreement and potentially company Memorandum. Again to the extent that these do not contravene the law or in particular impinge upon a shareholder's legislated preemptive rights they will be acceptable restrictions. Such restrictions would include "lock-ins", drag along and similar rights and buy-sell provisions. "Side Agreements" Shareholders in UAE companies are motivated to enter into shareholders' agreements as a matter of best practice for the same business reasons as in other jurisdictions, namely to set out their respective rights and obligations and to protect their local commercial interests. This latter concern is of particular importance to foreign parties conducting business through limited companies where their UAE partner has no real involvement in the business itself. This is often the case in the UAE where the 23 local shareholder merely acts as a "sponsor" to the commercial activity carried on by the foreign party. This type of arrangement is often enshrined in a form of shareholders' agreement under which the local national is systematically management stripped rights and of his shareholders' proportionate share and of the company's profits while the de jure ownership is reflected in the company's Memorandum and trade licence. The same type of arrangement may be accomplished through other forms of agreements such as trust declarations in favour of the foreign party or though loan and pledge arrangements. While common these types of arrangements are not favoured in the UAE. On a strict reading of the Companies Law these types of "side agreements" as they are known are legally void. In fact in 2004 the UAE Federal National Counsel enacted Federal Law No. 17 of 2004 - the AntiConcealment (Fronting) Law for the purpose of fighting the quasi-established practice of implementing side agreements in commercial activities. The Anti Fronting Law provides that that any arrangement designed to circumvent the ownership requirements of the laws of the UAE would be considered unlawful, punishable by fines and possibly imprisonment. To date the Anti-Fronting Law has not been implemented. The UAE courts have - pending the law's implementation recognised the interests of foreign parties in considering the validity of such agreements however they have also required the companies subject to such arrangements to be dissolved subsequently. Foreign parties entering the UAE market need to be aware of these considerations when entering company. 24 into the agreements relating to their local So, in view of the Companies Law requirement to have a minimum 51% of the shares in UAE companies owned by UAE nationals, the foreign shareholder will often have entered into a \"side agreement\" with the UAE shareholder. The side agreement probably provides for the following: Only the foreign shareholder has contributed to the share capital of the company and accordingly owns all the share capital of the company. The foreign shareholder is the sole owner of all the assets and the trade name of the company and is the actual agreements agent and with respect commercial to distribution agencies of the company. The UAE shareholder is the custodian and trustee with regard to the 51% shares registered in his name. The UAE shareholder will waive/give up any shares held by him in the share capital of the company in case of liquidation of the company (whether in the form of in kind dividends or public auction proceedings or amicably). The entire profits and losses in the company will be earned/borne by the foreign shareholder except for an agreed percentage of the net profits of the company (agreed percentage). The UAE shareholder will not claim any right to the profits generated by the company except for the agreed percentage. 25 The UAE shareholder acts only as the local sponsor for the company to obtain and renew the licences, visas and work permits relating to the company and its employees. The UAE shareholder is entitled to an annual fixed fee (fixed fee) at the beginning of each financial year for acting as the local sponsor for the company in addition to the agreed percentage. The UAE shareholder is entitled to 10% interest on undistributed amounts of the agreed percentage at the end of the financial year, to the extent that the company did not distribute profits in the relevant financial year. The foreign shareholder, represented by an individual, is appointed as the manager of the company. I explained earlier that one aim of a shareholders' agreement is to circumvent the ownership requirement specified in the UAE Company law and that such agreement is null and void. But what if a dispute occurs between the UAE shareholder/partner partner/shareholder? On and one the foreign hand, the company's constitution shows the UAE partner owns 51% of the company's share capital. On the other hand, the side agreement either shows that the UAE partner has not actually contributed to the company's share capital (zero contribution) or that he has contributed to less than the limit specified by the UAE Company law (e.g. 15% of the company's share capital). In such cases, we have two contradicting documents namely the company's constitution 26 and the shareholder's agreement. So, which document/agreement will prevail over the other one? In Dubai courts, judges are willing to enforce and recognize side agreements but they will liquidate the company (bring the company's life to an end). However, Abu Dhabi judges, as shown below, have recently declined to enforce and recognize side agreement. Abu Dhabi Court's approach - Side Agreements and their enforceability In a dispute between a UAE investor and a foreign investor, the parties disputed over whether a side agreement or the official Memorandum of Association (MOA) governed their relationship. The UAE investor insisted that the official MOA is the valid document whereas the foreign investor argued that the side agreement states that the foreign investor has a greater percentage in shares and that the side agreement is the valid/ applicable agreement to govern the relationship between the two parties. As outlined in the previous article, the matter had been decided in favour of the UAE investor at the first instance and appeal levels, however the foreign investor appealed further to the Supreme Court. In its judgment, the Supreme Court held that the side agreement can be established by any means of evidence and allowed the parties to hear testimony of witnesses. When the Court of Appeal heard witnesses brought in by the foreign investor and rejected the claim, the parties appealed again to the Supreme Court. The Supreme Court considered the evidence and decided that there was enough evidence to prove the existence of the side agreement and subsequently 27 directed the Court of Appeal to look into this. Upon review of the evidence, the Court of Appeal issued its judgment confirming the existence of the side agreement. The UAE investor appealed for the third time to the Supreme Court contesting the validity of the side agreement and it is this appeal which is the subject matter of this update. This recent judgment handed down by the Federal Supreme Court demonstrates a unique position on the issue of side agreements and the removal of a partner in a company. The judgment sheds light on the validity and enforceability of side agreements in the context of a 49/51 UAE limited liability company. The judgment also addressed a very important issue on whether the majority shareholder can request the court to remove any of his partners/shareholders and the grounds for such request. The case is discussed in detail below. Background A dispute arose in relation to a limited liability company in Abu Dhabi between a UAE shareholder (owning 51 % of the shares), an Omani shareholder (owning 24 % of the shares) and a US company (owning 25 %). An action was filed by the UAE shareholder requesting confirmation of its entitlement to 51 % of the profits according to the shareholder's agreement. The UAE shareholder also requested the court to issue judgment for the withdrawal of the Omani shareholder on the basis that the Omani shareholder had not been cooperative and caused loss to the company as a result of his lack of cooperation. The Omani shareholder argued that the partners in the company signed a side agreement and entered into an arrangement whereby the UAE partner would own 37.5 % of the shares, the Omani 28 partner would also have 37.5 % and 25% was owned by the US Company. Court of First Instance The matter progressed before the Court of First Instance and the court issued judgment in favour of the UAE partner on the basis of the official documents (the Memorandum of Association) which confirmed that he was the owner of 51% of the shares of the company. The court however rejected the request of the UAE partner to expel the Omani partner. Federal Court of Appeal Both the UAE and Omani partners appealed further against the judgment and the Court of Appeal rejected both appeals and upheld the lower judgment. Federal Supreme Court Both parties appealed further to the Federal Supreme Court. The Federal Supreme Court ruling highlighted two important issues: Side agreements The general principle in UAE Evidence law is that a written contract can only be contradicted by written evidence, except where the opponent waives his right to documentary evidence or where there is an agreement to defraud the law. When the fraud exception to the general principle applies, the party against whom the fraud was made can use all means of evidence including testimony of witnesses to prove that the official agreement is not genuine vis--vis the side agreement. 29 Withdrawal of the Omani shareholder The UAE shareholder requested the court to dismiss the Omani shareholder as a result of the losses he caused the company to incur. The Court of First Instance refused to accept the UAE shareholder's request on the basis of articles 37, 47 and 63 of the Commercial Companies Code. These articles mandate that a numerical majority is required and in these circumstances, only one shareholder out of three requested the dismissal. This was followed by the Court of Appeal however this was reversed by the Federal Supreme Court (as discussed below). Federal Supreme Court The Federal Supreme Court decided that what is legally required is the majority of shares rather than a majority of the partners and accordingly a shareholder owning a majority of the shares could request the court to dismiss a partner based on sufficient reasons to justify the request. As the UAE shareholder owned 51% of the shares he could request the dismissal of the Omani entity on the basis of the following articles: Article 677 of the civil code provides: (1) It shall be permissible for a majority of the partners to apply for a judicial order dismissing any partner if they adduce serious reasons justifying the dismissal. (2) It shall likewise be permissible for any partner to apply for a judicial order that he cease to be a partner in the company if the company is of defined duration, and he provides 30 reasonable grounds for such application. (3) In both of the foregoing events the provisions of Article 675 (2) shall apply to the share of the dismissed or withdrawing partner, and such share shall be assessed in accordance with its value on the date the claim was brought. Article 675 (2) provides that 'it shall likewise be permissible for an agreement to be made to continue the company as between the remainder of the partners if one of them dies or is placed under a legal restriction or becomes bankrupt or withdraws, and in those events such partner or his heirs shall be entitled only to his share in the assets of the company...' In light of the above, the Federal Supreme Court overruled the Court of Appeal judgment and remanded the case again to the Court of Appeal to look into the appeal and consider the directions of the Supreme Court. The Court of Appeal Upon re-trial, the Court of Appeal gave the Omani shareholder the opportunity to call witnesses to prove his side agreement. However, the case was dismissed for lack of evidence confirming ownership of the UAE partner for 51% of the shares. The court also dismissed the appeal filed by the UAE partner to remove the Omani partner on the basis of lack of evidence to support such request. Both parties appealed again to the Supreme Court. The Omani shareholder argued that it has submitted sufficient evidence to establish the side agreement but argued that the Court of Appeal neglected this issue. The UAE shareholder filed its appeal insisting on its request to 31 remove the Omani shareholder. Federal Supreme Court The Federal Supreme Court confirmed that the Court of Appeal neglected to look at evidence confirming the Omani's shareholding. The Court of Appeal did not address the side agreement which contains a clause (Article 20 of the contract) Article 20 of the side agreement states that \"Each of the parties acknowledges that they hold shares equally in the company.\" The profits and losses of the firm were distributed equally under Clause 20. This is in addition to various other documents which prove that the profits and losses were distributed equally between the two companies and not based on the official 51/49% shareholding of the UAE Company. The Federal Supreme Court, however, rejected the appeal filed by the UAE shareholder on the basis that there was no evidence to support its request to remove the Omani shareholder. The Supreme Court therefore overruled the Court of Appeal judgment for the second time and returned the case back for retrial to look into the documents and arguments raised by the Omani shareholder in support of the side agreement. As a result of this judgment the request of the UAE partner to expel the Omani partner became final and the only issue that remained to be addressed by the Court of Appeal was the issue of the side agreement as argued by the Omani partner. 32 The Court of Appeal Judgment -upon retrial As a result, the Court of Appeal heard the case again (for the third time) in order to decide whether or not there are sufficient documents to establish the existence of the side agreement/arrangement as argued by the Omani partner. Upon reviewing all the documents submitted by the Omani partner, the court concluded that there is sufficient evidence to establish the existence of the side agreement between the parties (and that the shares have been distributed on the basis of 37.5% to the UAE and Omani partners and 25% to the US Company). Comment In this case, it was clear that the shareholders of the company could continue the company's business on the basis of the side agreement. In the event that one of the parties wanted to dissolve the company, a separate court judgment would be needed to dissolve the company on the basis that the company lacked the required legal corporate structure as the UAE partner's shares had been declared to be less than 51%, however the partners may need to decide whether or not their interest are better served by living with the side agreement and continue with the company or dissolve it. LATEST SUPREME COURT JUDGMENT The Supreme Court ruled on this matter for the third time and in this latest judgment, the Supreme Court decided very differently to the last decision and declared that the offical MOA as registered agreement that with governs the the authorities relationship parties and not the side agreement. 33 is the between valid the The Supreme Court relied on Articles 8, 10 and 11 of the Commercial Companies Law (CCL) and held that it is imperative for all agreements relating to commercial companies to be in writing, notarised and registered in the Companies Commercial Register so as to comply with the requirements of the CCL and that all amendments to the company documents (i.e. Memorandum of Association) must also be duly notarised and registered in the same manner as the MOA. In this case, the Supreme Court concluded that as the side agreement was not notarised or registered in the Companies Commmercial Register, it is therefore null and void. Reminder of the facts of the case: A dispute arose in relation to a limited liability company in Abu Dhabi between a UAE shareholder and an Omani shareholder over the ownership of the actual shareholding in a limited liability company. Legal action was commenced by the UAE shareholder requesting confirmation of its entitlement to 51% of the shares, assets and profits of the company according to the official memorandum of association (MOA) of the company as officially registered and declared with the competent authorities. The Omani shareholder, however, claimed that it owned more than it's registered shares (as reflected in the side agreement). COMMENTS ON THE JUDGMENT 1. It is apparent that this Union Supreme Court judgment contrasts with the previous two judgments by the same court (in the same dispute) which previously decided that side agreements are not null and void if they were not notarised or registered pursuant to Articles 8,10 and 11 of 34 the CCL. The court in the former two rulings held that the parties can even hear witnesses to prove this matter. The court also held that the side agreement can be concluded from various documents and not necessarily from a single written agreement and that such agreement is valid even without notarisation. 2. The new ruling is therefore a material change from the Supreme court's agreements. former As side rulings on agreements the are issue of not side official agreements, they cannot be notarised or registered in the Commercial Register. 3. The main purpose of the side agreement is that it is binding between the two parties only and concealed from the Commercial Register. This purpose would not be achieved if there was a requirement to notarise it or file it with the Commercial Register. This has been confirmed by the Supreme Court itself in former rulings. The side agreement also includes provisions that cannot be notarised or accepted by the official authorities such as the shareholding percentage which is usually different from the official documents. 4. It is to be noted that this latest judgment did not address the effect of Article 395 of the Civil Code. Article 395 provides that: \"If the contracting parties conceal a true contract with an apparent contract, the true contract will be the effective one as between the contracting parties and a special successor.\" If Article 395 had been addressed by the Supreme Court, it is possible that the court would have produced a different result. 35 5. It should also be highlighted here that although this judgment addressed the issue of the validity of the nominee agreement with regard to the official MOA, it has not however, adressed the issue of whether the rights of the parties under the MOA should be liquidated as a result of the invalid nominee agreement. 6. The judgment also did not address the issue of the date the invalidity occurs i.e. whether it is from the inception of the company or from the date of the judgment. 7. In view of the above judgment and the previous Supreme Court decisions on the same matter, it should be noted that the courts in future cases, will not necessarily decide that all side agreements are null and void. Each case will be decided on a case by case basis and the arguments raised above (in paragraphs 3, 4, 5 and 6) may also appear in separate matters in the future. Capitalisation of UAE companies As a general rule, companies in the UAE must have a minimum national shareholding of 51 per cent. Companies based in the free zones are not caught by such ownership restrictions - although their ability to do business in the UAE outside the free zone is restricted. The most common forms of corporate vehicle in the UAE are limited liability company (LLC) and joint stock company (public and private), with LLCs tending to be the more commonly used vehicle for international investors establishing joint venture operations. As well as differences relating to board representation and governance generally, the other clear distinction between 36 the company forms is the minimum share capital required. A Private JSC requires a minimum share capital of AED5 million (AED 30 million for a Public JSC) and an LLC has historically required a minimum of just AED150,000 in Abu Dhabi and AED300,000 in Dubai. However, the minimum amount for LLCs has now been removed, although the authorities will expect the LLC to be established with a sufficient level of capital to conduct its proposed activities (there are no guidelines as to how this will be assessed). Certain sectors also impose additional or higher levels of capital. Both LLCs and JSCs must allocate 10 per cent of their net profits each year to a statutory reserve, but this allocation can be suspended if the reserve reaches an amount equal to 50 per cent or more of the company's total equity share capital. There has accordingly been a preference for shareholders of highly capitalised UAE companies to put shareholder funds in by way of loan (as opposed to shares), thereby avoiding the need to reserve more than necessary - an approach assisted by the absence of any thin capitalisation rules in the UAE. Partnership Limited With Shares: A partnership limited with shares is a company formed by general partners who are jointly liable to the extent of their personal assets and participating partners who only participate in the capital and are jointly liable with the general partners only to the extent of their shares in the capital of the company. All general partners must be UAE nationals whereas participating partners may be non-UAE nationals. The capital of a partnership limited with shares must be divided into negotiable shares of equal value. 37 The names of the general partners must be part of the name of the partnership. If the name of a participating partner is mentioned, with his knowledge, as part of the partnership name, such a partner becomes liable towards third parties. The capital of the company must not be less than UAE Dirhams 500,000. The management of the partnership is entrusted to one or more general partners under the Memorandum of Association. A participating partner may not, even with consent of the general partners, deal with third parties. He may, however, be actively involved in the internal management of the company within the limits laid down in the Memorandum of Association. Every partnership limited with shares must have a Board of Supervisors consisting of at least three members from amongst the participating partners or others. The board of supervisors does not take part in the day to day management of the company but performs a supervisory function and may request managers to present reports of their management and examine the company's books and documents. Free Zones in the UAE In recent years, the UAE has become host to many free zones which offer foreign investors numerous benefits such as 100 per cent foreign ownership (in contrast to the 51 per cent minimum national shareholding mentioned above), guaranteed tax free status, a one-stop-shop of support services (including licensing and visa sponsorship procedures) and other advantages such as high technology facilities and services and real estate infrastructure. In most free zones it is possible to establish either a branch or representative office of a foreign company or to establish a limited liability company. 38 There are numerous free zones in the UAE - each has its own geographic bound