Side Agreements Business Law Individual Assignment I. Introduction The Commercial Companies Law of the United Arab Emirates (Federal Law No. 8 of...

Side Agreements

Business Law

Individual Assignment

1. 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 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.

1. 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

1. Anti-Fronting (Anti-Concealment) Law

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”, official name: National Law 17/2004 of November 01, 2004. This law also made the “Side Agreement” and “Side Letter” illegal, although there was a 3-year transitional period which ended November 01, 2007.

This would indirectly force the local partner who has the majority of interest in the company to take an active part in the business or at least keep track and stay informed of activities. The Law imposes fines and imprisonment for violations. The company involved will be deregistered from the commercial registry with respect to the activity involved and its licence will be revoked. The local as well as the foreign partners will have to pay huge fines of up to AED 100,000, face deregistration from the commercial register, and the foreign investor and his employees will be deported.

The Law was originally intended to come into force on 15 November 2007. However, the UAE Cabinet’s Resolution No. 229/12, issued in 2007, deferred the enforcement of the Law until 31 December 2009. The non-implementation of the Anti-Fronting Law to date or the delay so far in this law actually going into practice, could well be due to the argument being made repeatedly that if side agreements were invalidated, there would be an adverse effect in foreign investment in the UAE and that would be contrary to declarations being made by governments at the emirate and federal levels for encouragement of foreign investment.3

1. An Example of the UAE Courts’ Approach to Side Agreements

1. 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 partner would also have 37.5 % and  25% was owned by the US Company. Hence, 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. 

In 2012, a judgment handed down by the Federal Supreme Court demonstrated a unique position on the issue of side (nominee) agreements and the removal of a partner in a company. The judgment shed light on the validity and enforceability of side agreements in the context of a 49/51 UAE limited liability company and also addressed a very important issue on whether the majority shareholder can request the court to remove any of his shareholders and the grounds for such request.

The matter was 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 based on Article 37/5 of UAE Law of Evidence which states 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 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-à-vis the side agreement.

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 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. 

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.4

1. Latest Supreme Court Judgement

In 2013, The UAE investor appealed for the third time to the Supreme Court contesting the validity of the side agreement. 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 official MOA as registered with the authorities is the valid agreement that governs the relationship between the parties and not the side agreement.

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’ Commercial Register, it is therefore null and void.

1. 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 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 former rulings on the issue of side agreements. As side agreements are not 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.

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, addressed 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. 5

1. Effects of Side Agreements

Any side agreement between the partners of an LLC providing that only the foreign partner will be considered as the real owner of the entire share capital and excluding the local partner from any profit and loss distribution is a circumvention of the law. Any company, founding shareholder, manager or member of the board of directors violating the provisions of the Companies Law is subject to punishment.

The enforceability of such side agreement is not certain and the prudent view is that a UAE court will view these side agreement as an attempt to circumvent Article 22 of the Companies Law. However, Article 18 of the Companies Law states that any such agreement does not have any legal effect as against others: All responsibilities and liabilities of the LLC or the partners against third parties are dealt with only according to UAE laws and the memorandum and articles of association.

On the other hand, such side agreements might bind its parties. Where the local partner claims his "rights'' according to the provisions of the memorandum and articles of association, the UAE courts have referred to the side agreements to reveal the real intention of the partners. (Dubai Court of Cassation, Judgment Number 331/95 of 21 April 1996, and Judgment Number 76/99 of 1 May 1999). Combined with the principle that nobody will act contrary to what was really agreed between the parties, such side agreements create rights and obligations between the contractual parties.6

1. Conclusion

A literal interpretation of the provisions of the Companies Law renders most side agreements illegal and void. However, lawyers in the UAE often point to the fact that there is actually evidence that the highest courts in the Emirates of Dubai and Abu Dhabi have historically upheld side agreements and focused on the economic rather than statutory relationship of the parties, although there are no comprehensive judgments on their legality or enforceability. 7

There have been instances when courts have decided that Side Agreements are not valid and any agreement to vary the economic or other rights of the shareholders in an LLC should be in the registered articles and/or be recognised by a local Notary Public and undergo the normal recognition of the licensing authorities in the relevant Emirates. While such cases do not have precedential value in creating binding precedent as in a common law jurisdiction, foreign parties need to be mindful that there are examples of the judiciary invalidating such agreements. Furthermore, these side agreements could become a thing of the past if and when the Anti-Fronting Law is implemented.8

Finally, in view of previous inconsistent decisions on this matter, it would be realistic to assume that the courts in future cases will not necessarily decide that all side agreements are null and void and that each incident will be decided on a case by case basis.

Bibliography

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