The UAE federal supreme court rules on the liabilities of shareholders in bankruptcy proceedings

Background

The Federal Decree Law No. 35 of 2021 (the “Decree”) came into effect on November 1, 2021, revising some Articles of the Federal Decree Law No. 9 of 2016 regulating Bankruptcy (the “UAE Bankruptcy Law”). The Decree comes after the Dubai Court of First Instance issued a major judgement on directors’ duty in the Marka Holdings PJSC (“Marka”) bankruptcy case (the “Marka Case”).

Facts of the Case

• The financial condition of a corporation that operated from 2001 to 2012 was excellent.
• The firm ran into financial troubles and lawsuits after 2012, and by 2020, it had accumulated debts of about AED 20 million.
• The corporation was declared bankrupt due to its nonpayment of commercial obligations, interruption of its operations, and loss of trust in the business market, which signals its poor financial status. Its credit position is shaken by federal trial courts (primary and appellate).
• The two shareholders were also declared bankrupt by the creditors.

• According to the wording of Article 142 of Federal Decree-Law No. 9/2016 on Bankruptcy, the Federal trial courts rejected the two shareholders’ bankruptcy on the grounds that the bankruptcy criteria did not apply to them.
• The creditors filed an appeal against the decision of Federal trial courts to the Federal Supreme Court, arguing that Article 142 specifies that if a corporation is declared bankrupt and its assets are liquidated, then all of the firm’s joint partners are declared bankrupt.

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The Supreme Court’s opinion

The Supreme Court dismissed the petition because the declared bankrupt company is a free zone company with a separate legal personality. Its financial responsibility is distinct from the shareholders, and each shareholder’s liability is determined by their share in the company, both to each other and third parties.

The Supreme Court emphasized that stockholders may be held personally accountable for debts up to the number of personal guarantees given. They have not deemed traders if the partners are not affiliated or do not answer for the company’s obligations with their personal property. Their involvement in the company’s formation and rights to partake in its earnings are not considered commercial acts.

According to the Supreme Court, section 142 applies to “traders” and partners in unlimited liability businesses (or civil firms), but not to limited liability company shareholders.

The Court said that Article 142 should be interpreted in light of Article 2, paragraph 4, which states that bankruptcy law requirements apply to recognized civil corporations of a professional nature.

A “merchant” as defined in Article 11 of the law on commercial transactions as “any person carrying on acts of commerce in his or her name and on his or her account, and any company exercising a commercial activity or adopting one of the forms prescribed by the law on commercial companies, even if the activity is civil”.

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Court of Cassation Verdict

Whereas, the texts relating to Articles 2(4) and 142 of Federal Decree-Law No. 9 of 2016 on bankruptcy state that its provisions apply only to the person:

1. who, in the legal sense, is approved by the merchant’s description,
2. who is doing business in his name and in a professional and exploitative way.

The merchant’s description applies to a general partner in a corporation that conducts trade as a profession.  It was ruled and based on what the judiciary of this Court did that declaring bankruptcy is a punishment confined to merchants who cease paying their commercial obligations due to their financial situation insolvency.

The Court further stated that the term “merchant” only applies to someone:

1. who engages in professional trade, that the capacity of a merchant in a commercial business cannot be presumed,
2. that the burden of proof is on the person claiming it, and

iii. that the company’s bankruptcy includes the bankruptcy of each joint partner in it, with the result that a collaborative partner in a commercial company is considered a trader, allowing him to file for bankruptcy.

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Conclusory Remarks

The Supreme Court’s clarification on the interpretation of Article 142 of the Bankruptcy Law comes at a critical moment, after the Dubai Courts’ recent Marka case on the bankruptcy of Marka Holdings Public Joint Stock Company. The Dubai Primary Court ruled that Marka’s management and directors were personally accountable for the company’s debts, which totaled over AED 450 million.

In the Marka case, the Primary Court based its decision on Article 144 of the Bankruptcy Law, which allows the Court to force any or all board members or management to pay all or part of the company’s obligations if the company’s assets are insufficient to cover at least 20% of its debts. Article 144 follows Article 142, with Article 142 dealing with partners’ obligations.

It’s worth noting that the Supreme Court currently emphasizes that the interpretation of Article 142 must be read in conjunction with Article 2(4), which applies the Bankruptcy Law only to licensed civil enterprises and excludes shareholders in corporations protected by limited liability restrictions.

This text is for informational purposes only and is not intended to be construed as legal advice. Before taking or abstaining from any action based on the contents of this publication, you should get professional legal counsel. Don’t hesitate to contact our best bankruptcy lawyers for more information on bankruptcy law and its related amendments.