Directors’ duties and distress situations involving venture-backed companies across MENA
The current economic climate following the COVID-19 pandemic, political turmoil, and rising inflation continues to have a significant impact on the financial and operational aspects of companies around the globe. Whatever their size, geographical spread, or group structure, companies face challenges relating to cash flow, revenue, and bad debts.
In times of distress, the decisions company directors and managers make are likely to be under the spotlight. Recent cases like the bankruptcy of the retail group Marka Holdings PJSC’s in the UAE and the decisions of the Dubai Courts to find the managers and directors personally liable to repay a significant amount of Marka’s debts to its creditors mean that directors and managers involved with companies across MENA should remain vigilant and mindful of their duties under the relevant laws within the jurisdictions in which they operate.
To help you navigate economic uncertainty, in this article we look at the key duties and laws concerning founders, managers, and directors of companies and highlight liability risks that exist in times of distress.
The Dubai Courts ruling in the Marka VIP case should serve as a warning sign for directors and managers of start-ups in the UAE. Start-ups are inherently risky endeavours but managers and directors have to be intimately familiar with where the red lines are and, when difficulties arise, must be laser focused on not crossing them.”
Generally speaking, many MENA tech start-ups are structured with a 'holdco' domiciled in a common law jurisdiction, with one or more wholly owned 'opcos' sitting in countries where they are operational (refer to our article on Pan-MENA tech companies corporate structuring for venture readiness for more information on optimal structures for VC-backed start-ups in the MENA region).
Founders and directors often sit on the board of both the 'holdco' and the 'opco(s)', therefore, they should be aware of the duties they have in relation to those appointments due to the personal liabilities that may arise as a consequence of any decisions made.
The duties and liabilities of UAE directors and managers are derived from various sources of legislation. The principal source in the UAE mainland is the Commercial Companies Law (Federal Law No. 32 of 2021 (as amended)) (the CCL) as well as Cabinet Resolution No. 77 of 2022 regarding limited liability companies, but provisions are also found in other laws such as the Civil Code (Federal Law No. 5 of 1985 (as amended)), the Penal Code (Federal Law No.31 of 2021 (as amended)), and the Bankruptcy Law (Federal Law No. 9 of 2016 (as amended)) (the Bankruptcy Law).
Some free zones have enacted their own laws and regulations which contain separate provisions regarding directors’ duties, such as the Abu Dhabi Global Market (ADGM) and the Dubai International Financial Centre (DIFC).
The CCL provides that the person authorised to manage a company shall exercise due care and diligence for the benefit of the company as expected from a 'prudent person' and states that such person shall perform all such acts that are consistent with the objectives of the company (ie. its constitutional documents).
Directors and managers should ensure that a company always practices good corporate governance and keeps detailed records of any decisions that are made, including the reasons why such decisions are made.
The duties and obligations of the directors and managers set out in the CCL are broadly in line with other international jurisdictions, and include:
- acting in accordance with the company’s objectives
- preserving the interests of the company and exercising the care of a diligent person in performing their duties
- ensuring they don't act fraudulently, improperly use the powers granted to them under the laws or the constitutional documents or any service/appointment contracts or otherwise breach applicable law
- declaring conflicts of interest and refraining from voting on conflicted matters
- preserving the confidentiality of company information
- not competing with the interests of the company.
Generally, under the CCL the managers of a company will be liable for the damages sustained by the company, the partners, or third parties due to any breach of the provisions of the constitutional documents or any negligence or error committed by the manager while performing their duties. However, when a company is in financial distress, its duties (and by default the duties of its directors and managers) extend to all stakeholders, including any creditors.
The Bankruptcy Law applies to all companies established under the CCL and most free zone companies, except those free zones, including the DIFC and ADGM, that have implemented their own bankruptcy/insolvency laws.
There are two main options for companies in financial distress under the Bankruptcy Law: preventative composition and formal bankruptcy. Preventative composition is a process initiated by a company where it obtains the court’s assistance in settling its debt with its creditors with a view to trading out of its position. This is only available to companies that don't meet the formal bankruptcy tests.
Under the Bankruptcy Law, a company will be formally insolvent if it ceases to settle debts at maturity for more than 30 consecutive business days due to its financial position (the cash flow test) or if its assets are insufficient to meet its current liabilities (the balance sheet test). If either test is satisfied the directors and/or managers of the company are required to file for the company’s bankruptcy in UAE Courts.
These tests are likely to be of key concern for founders or anyone involved in the management of the company as they'll need to ensure that the company has sufficient liquidity to meet short-term and medium-term obligations while trying to utilise capital and funds to achieve key business milestones. The actions and decisions of the directors and managers are likely to be carefully reviewed by the courts in times of financial distress.
Due to the wide definition of a ‘manager’ under the Bankruptcy Law, a holding company’s directors, founders and anyone that plays an active role in a company may be caught within the definition and subsequently held personally liable for penalties that may be applied under the Bankruptcy Law.
Breaches of the Bankruptcy Law may result in civil liability for directors or 'managers' of a company where:
- a company is declared bankrupt, and the court determines that the company’s assets are insufficient to cover 20% of its debts due to a breach of directors or managers duties.
- a company is declared bankrupt, and the court determines that in the period of two years before the company declared bankruptcy, the company has entered transactions at less than market value or given preferential treatment to creditors to the detriment of other creditors.
In these circumstances, the courts may declare that the directors or 'managers’ (or any one of them) shall be liable to pay all or any of the company’s debts to its creditors.
Criminal sanctions may also be imposed on directors and those deemed to be managers under the Bankruptcy Law. However, for criminal liability to arise an element of fraud or deceit is required. For example, covering up the company’s financial position, concealing company property from the courts and/or creditors and concealing or destroying the company’s records with the intention of harming creditors may result in imprisonment and large fines being imposed.
It’s important to note that criminal and civil sanctions may not apply to a director or manager where they are able to prove they didn't participate in the act that gave rise to the offence or who objected to the decision leading to that activity.
Given the potential for managers and directors of companies to be held personally liable for acts of the company under relevant laws, founders, directors and those in management positions should pay close attention to their duties and powers when making key financial decisions in respect of a company, particularly if the company is suffering from or is forecasting cash flow difficulties.