Directors Duties in the UAE: Part 1 – Do you know your duties?

Middle East

Introduction

The global economy has been severely impacted by the COVID-19 pandemic, compounded by a steep fall in oil prices, resulting in significant challenges across a multitude of sectors. Directors of companies in the UAE are doing all they can to maintain their businesses and protect the short and medium term. In doing so, directors must pay greater attention than ever to their duties under law and the potential consequences of not fulfilling them.

While the law sets out what the basic duties are in generic terms, it is important to bear in mind that the duties owed by directors of a particular company will be almost entirely unique to them. Directors will need to consider how to comply with their duties in the context of their present circumstances and considering what the future may bring. This can change depending on the nature of the company and board the director sits on, its internal corporate governance arrangements, the market conditions and prevailing laws, its financial circumstances, the nature and extent of its creditors, the nature of its cashflow and annual cycles, how it utilises its assets, the profile of its workforce, the nature of its shareholders, the location of its operations and how the company fits within an overall group structure and so on. 

This note is the first of a three-part series, where we discuss the duties and responsibilities owed by directors of onshore LLCs and PJSCs in the UAE. The second note will examine these duties in the context of DIFC and ADGM holding companies, and what additional considerations need to be borne in mind where the directors may be part of a corporate group with multiple layers in the UAE (as is becoming increasingly common). We will finish the series with a discussion of how these duties change in the context of companies in financial distress.

Duties in context

Companies in the UAE have separate legal personality, meaning they can sue and be sued, own assets and enter into legally binding contracts in their own names. Third parties dealing with the company in good faith can rely on the fact that the actions of the directors will generally be binding on the company. As a result, actions of directors and the consequences of those actions are generally for the account of the company they represent (i.e. the contracts signed would bind the company, not the director etc). However, this does not absolve directors of liabilities where their actions or inactions fall outside of their authorities or they fail to comply with their duties, thereby causing the company, its shareholders, employees, creditors and/or other third parties, loss or liability. This is where directors’ duties come into focus.

Directors’ duties are personal obligations attracting personal liability for the individual in question. The liabilities directors are exposed to can range from dismissal and disqualification as a director, to civil claims against the director brought by the company, its shareholders or other stakeholders, through to potential criminal sanctions of fines or, for more extreme cases, imprisonment.

It is surprising therefore that quite often individuals will accept a director position – a genuine director role, or a nominee on behalf of a third party (e.g. a shareholder or an absent director) – without fully appraising themselves of the duties they will owe as a result of accepting that position. This is compounded where individuals accept multiple director positions across different layers of a corporate group.

So what duties are owed?

The powers, duties and liabilities of directors of onshore limited liability companies (“LLCs”) and public and private joint stock companies (“PJSCs”) derive from a combination of UAE law, the corporate documents of the company, any employment or services contracts in place between the individual and the company, resolutions of the shareholders or board and any powers of attorney granted to the individuals.

The UAE Commercial Companies Law (Federal Law No. 2 of 2015, as amended) (the “CCL”) is the main source of legislation regulating the duties, obligations and liabilities of directors for LLCs and PJSCs. While the CCL has separate sections for onshore LLCs and PJSCs, under Article 104, the provisions relating to PJSCs also apply to LLCs giving consistency across those corporate vehicles in this regard.

Several other pieces of legislation, including Federal Law No. 5 of 1985 (the “Civil Code”), Federal Law No. 3 of 1987 (the “the Penal Code”) and Federal Law no. 4 of 2000 concerning the Emirates Securities and Commodities Authority and Market (the “SCA Law”) provide for other statutory duties and liabilities for directors, although the provisions of the SCA Law are outside the scope of this note.

The CCL

The CCL sets out the obligations and liabilities of managers and directors of an “onshore” company and prohibits any provisions of the articles of a company which might seek to exempt any individual from personal liability.

The authority of a director is assumed to cover the full powers required in order to manage a company to perform the business it is intended to carry on, unless there are specific restrictions set out in the company’s corporate documents, i.e. its memorandum of association (“MoA”) or in any other document under which the director derives their authority. As a result, absent any specific restriction, the directors are assumed to have full authority and discretion to manage the company, and those acts shall bind the company, provided the director has made it clear that they are taking such actions in their capacity as a director of that company.

The primary duties and liabilities of directors and managers under the CCL are:

(i) to manage the company and preserve its rights to the level that a “diligent person” would. In this context, a “diligent person” is defined as a “person having sufficient experience and commitment required in the performance of his work”. This is the main basic standard of care expected of directors of companies under the CCL and is similar to the objective standard under English law, with the main difference here being that, under the CCL, there is no second subjective test (i.e. the CCL does not require courts to take into account the experience and commitment you actually possess), giving a lower overall threshold, comparatively;

(ii) to work within the objectives of the company and not to exceed the powers specifically granted to the director (e.g. under the MoA, any power of attorney or similar).  In this context, the CCL specifically prevents any company from carrying out certain material actions such as entering loans with a period in excess of three years, disposing or pledging the property of the company, mortgage its movable or immovable property discharge debtors of their obligations or make a compromise or agree on arbitration unless doing any of these actions is “in the nature” of the company, is authorised by the company’s MoA or is approved by a shareholder resolution;

(iii) not to commit any fraudulent act or misuse of power;

(iv) not to breach any applicable law or any provision of the company’s MoA or any contract appointing the director (e.g. a service contract/employment contract);

(v) not to make any “gross error” or “error in management”. While these terms are not defined, we can take some indication from the definition of what a “diligent person” is deemed to be (see above). In that case, a court would need to consider if the actions or inactions which allegedly amounted to a gross error or error in management fell below the standards that would be expected of a person having sufficient experience and commitment in the performance of that role on an objective basis; and

(vi) not to put themselves into any position of conflict, take part in the management of any entity which competes with the UAE company, or make any trade or other deals in competition with the business of the company. Any conflict should be declared at any board meeting convened to discuss the matter in question, where the director in conflict shall not be permitted to vote, failing which the conflicted contract may be annulled or the contravening director may be required to account to the company for any profits made.

In addition, the directors have a variety of other duties under the CCL generally in relation to the exercising of their reporting functions, distributions, share issuances and general meetings.

If the action causing any of these situations was considered and approved at a meeting of directors, then all directors shall be jointly liable, except for any director who objected to the action where such objection was noted in the minutes of the meeting.

Directors and managers also have specific duties in situations where the company is not profitable, such duties vary depending on whether the company is a PJSC or an LLC:

(i) if the losses of a PJSC exceed 50% of its issued share capital, its chairman (or directors at a later stage) have a duty to call for an extraordinary general assembly where the shareholders would either resolve to continue with the activities of the PJSC or to dissolve the PJSC. The chairman of a PJSC shall be liable to a fine of AED50,000 – 1,000,000 for failing to call the required extraordinary general assembly in that situation; and

(ii) if the losses of an LLC reach 50% of its issued share capital, the directors or managers are required to refer the issue of dissolution to a shareholders meeting and a resolution to dissolve can be passed by the same majority required to change the memorandum of association of the company (usually 100%). If the losses reach 75% of the company’s issued capital, a resolution to dissolve may be passed by shareholders holding only 25% of the capital. Given the relatively small amount of capital LLCs are usually set up with in the UAE (usually AED 100,000 to AED 300,000), this is something for the managers and directors to be mindful of if the company finds itself in a loss-making situation.

The Civil Code

In addition to restrictions set out in a company’s MOA or in any other document under which the director derives his or her authority, the Civil Code refers to “limits of custom” and provides that even if the MOA of an LLC or a PJSC do not specify any restrictions on the capacity of a director’s actions and powers, he may still be liable under the Civil Code for actions that the court may deem as exceeding the “limits of custom”. There is no official definition of “limits of custom” under the Civil Code, therefore this term would be interpreted by the relevant court on a case-by-case basis.

The Penal Code

While there is no comprehensive law that relates specifically to the criminal liability of directors or managers in the UAE, most criminal offences that are punishable under law are based on a director or manager’s power to represent the corporate body they are acting for. Therefore, such offences can be equally punishable against any other employee of the company depending on the powers granted to them. The criminal liability of directors, managers or other authorised individuals is generally provided for under the Penal Code.

Under the Penal Code, individuals (including directors) can be found criminally liable for a wide variety of actions. In the context of a director of a company, this includes:

(i) fraud or embezzlement in respect of property or a legal right;

(ii) unauthorised disclosure of confidential information or use of that information for a personal benefit;

(iii) health and safety failures which result in a serious incident leading to death or injury – a topic particularly pertinent to directors of businesses that are continuing to operate during the COVID-19 lockdown; and

(iv) writing a cheque on behalf of the company which is not honoured, where the cheque was drawn in “bad faith” and there are insufficient funds to honour the cheque, or if there were sufficient funds when the cheque was drawn, but those funds were withdrawn prior to presenting the cheque, and related matters. (Click here for more details on this topic.)

Directors and Officers Insurance

Directors’ and officers’ insurance policies are available in the UAE and take up has increased over the years as the regulatory framework has developed, in particular for financial institutions although perhaps less so for family companies where the risk of claims from shareholders may be considered lower. D&O insurance is designed to protect a company’s directors and officers from personal liability and expenses in the event of claims for failure to fulfil their duties or arising as a result of their actions in their roles as a director or officer. However, directors and officers cannot simply rely on any insurance policy in place and will need to pay close attention to the limits of protection provided by any such policy. In most cases intentional breaches or anything amounting to criminal conduct will not be covered and of course an insurance policy will not assist in any cases where a custodial sentence is handed down against an officer for any breach amounting to criminal conduct. Directors and officers will also need to consider how “claim” is defined and the extent of awards, losses or expenses covered by any policy, for example, are any out of court settlements or regulatory proceedings covered, does the coverage extend to fines imposed by regulators or administrative authorities? International groups will also need to ensure they have a local policy in the UAE and are not relying on a global policy as all UAE risks are required to be insured by UAE insurers.

Managing your risk

Before accepting any appointment to a director or manager role, and in carrying out your duties, it is important to fully appreciate what your responsibilities and duties are, what the implications are for not fulfilling them and what steps you can take to protect yourself from potential claims and liabilities. The following recommendations will be of general guidance to directors and managers in their decision making and management duties:

(i) appraise yourself of the duties you owe under law, the company’s MoA, your service contract, any internal authority matrix and any powers of attorney;

(ii) give careful consideration to your circumstances and the stakeholders to whom you would owe duties, being particularly mindful of any conflicts of interest with such stakeholders. Also give careful thought to whether you will have the time available to give the directorship role the commitment and expertise required – do you need to make compromises in other areas of your day to day work?;

(iii) if it is unclear what the nature or limits of your authority are, recommend to the board and shareholders that an appropriate corporate governance structure is put in place, with a clear authority matrix for key decisions. The authority matrix should be tailored to the nature of your business and identify where the relevant expertise lies within your organisation to ensure you make best use of that to reach fully informed decisions. For example, decisions involving financial matters should gather input from your Finance Director/Controller, accounts team and (where appropriate) external advisors and auditors, while decisions involving HR matters should be made in consultation with your HR team, remuneration committee (if you have one), general counsel and external lawyers and so on. For decisions which are of a sufficient magnitude, or which under the shareholders agreement, MoA of the company or CCL require shareholder consideration, ensure such matters take input from the shareholders in the correct manner before proceeding and full records are retained;

(iv) keep a close eye on the financial performance of the company and its ability to meet upcoming obligations, particularly important for officers who may not be involved in the day-to-day management of the company, but who may be held to account for decisions taken at board level where they do not register and minute their dissent;

(v) always maintain well documented records of meetings, including noting any absences or dissentions in relation to decisions taken;

(vi) when dealing with a particularly sensitive matter, where your judgement could be called into question, always consider what external advice or support should be sought, and if you believe external advice should be taken, raise this at an appropriate level, always maintaining appropriate records; and

(vii) keep up to date with the latest developments, challenges and opportunities in your sector, advice from your insurers and your regulators. If you have not already done so, sign up to our Law-Now email alert service to receive our articles and updates.