Directors and managers duties - in good times and in bad

In this note, we focus on you, as directors (which includes managers) of “onshore” limited liability companies (“LLCs”), noting of course that the rules may also apply to certain free zone entities as well. We want you as directors to be certain of your duties and responsibilities in the good times but also sure of the actions you should or could take if things go wrong for your company, and financial difficulties arise.

Where can a director’s duties and liabilities be found?

There is no single code, which sets out all liabilities and duties of a director. Instead, you need to turn to a number of sources, which will set out the various civil and criminal layers of duty and liability as a director. There are various requirements, including financial reporting requirements imposed upon you. However, here, we focus on the key aspects of the main legislative frameworks, which will apply to your role:

1. Federal Law No. 2 of 2015 on commercial companies (the “UAE Companies Law”).
   
   
2. Federal Law No. 9 of 2016 relating to bankruptcy (the “UAE Bankruptcy Law”).
   
   
3. Federal Law No. 3 of 1987 promulgating the penal code (the “UAE Penal Code”).

In addition to this legislative framework, you should also be mindful of the duties and obligations imposed on you through:

1. the company’s Memorandum and Articles of Association and any shareholder or joint venture arrangement underpinning the company’s operations.
   
   
2. any employment contract or equivalent document, under which you are appointed.
   
   
3. any power of attorney, authorised signatory rules or delegation matrix, to which you are subject.

What are the general duties of directors?

When you assume the role as director, it is important to understand the scope of your responsibilities, which include that you:

1. act with the standard of care that one would expect of a “diligent person” to preserve the company’s rights and act for its benefit.
   
   
2. procure the accurate preparation and audit of the annual accounts.
   
   
3. call an annual general meeting (AGM) at least once a year within four months of the financial year end.
   
   
4. do not undertake any activities that compete with your company’s line of business (without shareholder approval) and do not vote on any resolution, in which you have a direct or indirect interest.
   
   
5. do not use or disclose company secrets or in any way damage the company’s business.
   
   
6. act at all times in accordance with applicable laws, the company’s Memorandum and Articles of Association and any company document, which you are required to be bound by.
   
   
7. take immediate steps to notify the shareholders where the company’s losses exceed fifty per cent of the company’s share capital and procure the convening of a general assembly.

What could the consequences be of certain actions or inaction when things go wrong?

The UAE Companies Law started the trend which was bolstered by the UAE Bankruptcy Law: corporate governance is high on the agenda and directors bear the burden of mitigating themselves and the company from some of the following risks, all the more so when things go wrong for a company. We recommend that you:

• do not commit fraud, embezzlement, forgery, acts of concealment and do not hold back information, deceive or provide false information. We add that it is not just about an express action; it is also about perception. It is key that as directors, you carefully document your actions, exercise strong corporate governance and ensure that honest, commercially beneficial steps are taken and documented by you and your company to mitigate the risk that you fall foul of such claims being made.
  
  
• exercise caution when underwriting cheques in times of imminent financial difficulty and carefully record, account for and track any post-dated cheques in existence.
  
  
• act early, before the company’s finances spiral out of control. Under the UAE Bankruptcy Law, where a company is wound up and its assets are insufficient to cover twenty percent or more of its liabilities, a UAE court may hold that a director is personally liable for all or part of the company’s debts.
  
  
• be proactive. Where a director fails to take appropriate and timely action and is deemed to have “mismanaged” the company or committed “gross error”, the company, its shareholders or third party creditors may bring a claim against the director directly under the UAE Companies Law.

Our message is clear. Be prepared and implement good corporate governance procedures now to prevent any fall-out when sustained or even temporary financial difficulties arise in your company.

What are the rescue remedies under the UAE Bankruptcy Law and how can I avail my company of such schemes?

Early action is not just a personal risk mitigation tool; it will allow a company early access to some of the rescue remedies available under the UAE Bankruptcy Law. Along with courses of action under the UAE Bankruptcy Law such as (i) an insolvent restructuring scheme and (ii) a traditional insolvent liquidation process, the law introduces a course of action for solvent companies known as “Preventative Composition”. With early action, Preventative Composition arrangements enable companies (as debtors) to continue to trade and to reach a mutually favourable settlement with their various creditors. With the approval of the UAE courts and with varied input and supervision from a court appointed trustee, debts are theoretically paid on fixed dates and in turn, cashflow can be better managed. In the meantime, all judicial asset enforcement proceedings are stayed pending court approval of the Preventative Composition scheme.

For a company to avail itself of such Preventive Composition arrangements and in fact any of the proceedings under the UAE Bankruptcy Laws, directors should act fast. A company has a mere thirty business day window, from when it defaulted in paying its debts, to file its application with the UAE courts.

What if a director cannot procure approval to such Preventive Composition and bankruptcy is the outcome?

If you are left managing the business through a financial downturn and your company is subsequently rendered bankrupt, you should take steps to mitigate and manage some of your personal risk including avoiding the risks set out above. Further, to avoid action being taken against you, we recommend that you at all times:

• avoid approving the repayment or granting of any form of special payment privilege to one creditor to the detriment of others. This will constitute an offence under the UAE Bankruptcy Law if the preference was granted after the company ceased to pay its debts as they fall due (even in the context of a financial restructuring or preventative composition).
  
  
• do not make any sale of the company’s assets at a deemed undervalue. Seek market value and ideally source a professional valuation of any significant asset, which the company intends to sell.
  
  
• do not embark upon any transactions that may be considered of a speculative nature or outside of the company’s core business. Even in hindsight, if these transactions are considered significant enough to have contributed to the company’s downfall, liability may arise.

Of course, if you are able to prove that the acts were taken with a view to minimising the loss incurred by the company and its creditors, you may not be held liable. To bolster any defence, we recommend that clear, contemporaneous resolutions are passed setting out clear rationales and any steps carefully justified.

Summary – How to protect yourself as a director?

Fear not, with good governance and record keeping, many of the deemed risks to directors when things go wrong, can be managed in good times and implemented even in bad. We have compiled the following reminders, which we hope you will find helpful:

• Act promptly when you see the company’s finances and cashflow go bad or in times of global economic tension, where it is possible your company may be impacted.
  
  
• Seek professional (legal and accounting) advice in times of early or anticipated financial difficulty.
  
  
• Maintain a good dialogue with your creditors but in no way show any preferential treatment to one. In times of financial crisis, avoid repaying just one creditor (who is shouting the loudest) at the expense of the other creditors.
  
  
• Exercise strong corporate governance: hold regular board meetings and carefully minute such meetings including providing rationales for why company decisions are made.
  
  
• Keep a strong dialogue going with your shareholders and stakeholders: keep them informed and make sure that you are aligned on decision making and the company’s financial predicament. Document such consultation and call a general assembly, where needed and appropriate.
  
  
• Always keep accurate, timely and contemporaneous financial records.
  
  
• Seek valuations of assets you are looking to sell and at the very minimum, ensure that assets are sold at an objective market value.
  
  
• Avoid issuing cheques when cashflow is uncertain and carefully document all issued post-dated cheques.

The UAE Bankruptcy Law is a relatively new piece of legislation, but in times of economic strain, we expect it to be increasingly tested in the courts and used by companies, shareholders, directors and creditors alike.