Directors’ duties are currently in sharp focus as a result of the economic conditions caused by the COVID-19 pandemic and the decisions directors are being required to make in relation to their businesses. Here we examine how directors’ duties change in the context of group structures and the additional considerations which must be factored into the decision making process.
This note is the second note in a series of three covering directors’ duties for companies operating in the United Arab Emirates (“UAE”). The first note (click here) covers the basics of directors duties for “onshore” LLCs and PJSCs operating in the UAE, while the third note will cover scenarios of financial distress.
Shifting structures and a typical scenario
Over the past few years we have increasingly seen a change in the way Middle Eastern businesses have structured their corporate groups. Previously many Middle Eastern groups were held via a holding structure in the BVI or Cayman Islands, largely to avail of robust corporate laws allowing for multiple share classes, drag/tag and put and call options and so on, which were generally not available for UAE vehicles. However, regional and global developments in recent years have led to a move away from this.
The factors that once led businesses to use BVI and Cayman holding structures are becoming less compelling, while the domestic options in DIFC and ADGM have become more compelling.It is now commonplace – and increasingly becoming market standard - for Middle Eastern businesses to look towards using DIFC and AFGM vehicles in their corporate structures.
A typical scenario could be a business with trading operations in Kuwait, the Kingdom of Saudi Arabia (“KSA”) and the UAE (for example), where those businesses are conducted by separate companies registered in Kuwait, KSA and UAE (which we’ll refer to as “OpCos”). Those OpCos would commonly be owned 100% by a single corporate vehicle (which we’ll refer to as a “TopCo”), which would be a DIFC or ADGM holding company, and which would be owned by the ultimate beneficial owners/shareholders (the “UBOs”).
There is good and compelling reason for this of course. Consolidation under a single corporate TopCo allows the shareholders to make shareholder decisions with a view to the entire group at TopCo level, rather than for each individual OpCo, it allows for financial consolidation of all OpCos into a single set of accounts and the financial and tax benefits that can bring, and for applying common management and back office systems across the group for greater efficiency, amongst other upsides.
While examples like this are very common, it is also common to see one individual acting as a director of multiple companies across that group, either as active/operational directors, or as nominees for one or more UBOs.
Quite often, companies appoint directors in this manner, and directors will accept those appointments, without paying careful consideration to the risk and liability implications this can give rise to. These risks arise both for the director in their personal capacity, and they can also arise for the parent companies in the group where they may be seen to be piercing the corporate veil, acting as shadow directors, or unlawfully enticing directors to breach their duties owed to subsidiary companies – situations which can often affix a parent company with liabilities suffered by its subsidiary.
In times of financial hardship, these duties come more fully into the spotlight and are complicated by extra corporate structuring layers and the applicability of different regulatory regimes to different group companies.
But if it is all one group - where is the risk?
Continuing our example above, let’s imagine the UBOs decide to appoint one individual to the boards of TopCo, Saudi OpCo, and UAE OpCo. This gives rise to situations where that individual may become under pressure to compromise their director duties owed to one company in the group, in favour of another.
For example, consider what happens if the Saudi OpCo is required to issue a performance bond on a lucrative contract tender in Saudi Arabia. Saudi OpCo may only have modest trading history and balance sheet, so the issuing bank has asked for guarantee from TopCo and UAE OpCo. The director would need to consider the pros and cons of this for all three companies separately to decide if it was in their best interests:
- wearing the director’s KSA OpCo hat, it is a relatively straightforward decision – is the potential profit, profile and opportunity from the contract sufficient to justify the risk of agreeing a performance bond and other direct liabilities under the contract, when considering the business of KSA OpCo, its employees, its creditors, and the interests of its shareholders as a whole? Generally speaking, if the transaction is profitable and has a sensible payment/cashflow profile, then this is a straightforward “yes”;
- wearing the director’s TopCo hat, there would be more to consider. TopCo would not receive the direct benefit of the contract - it would only receive indirect benefits as the value of its shareholding in KSA OpCo is likely to increase, and its profile/brand in the Saudi market may be boosted. TopCo needs to weigh those indirect/reflective benefits up against the risks it would be exposed to by agreeing to give the guarantee. In doing so, TopCo will need to consider its own business, staff, creditors and the UBOs as a whole. Perhaps TopCo is already heavily indebted or does not have regular cashflows or other liquid assets that it could use to meet any demands on the guarantee. Perhaps there is a greater opportunity elsewhere in the group, but TopCo can only give a guarantee in relation to one project. Perhaps TopCo is considering bringing in extra equity investors or considering a listing on a stock exchange, where that capital raising might be jeopardized if TopCo gives the guarantee requested by KSA OpCo and its bank. All of these considerations are largely irrelevant to the director when wearing their KSA OpCo hat, but must be in the front of the director’s mind when considering this matter in relation to TopCo; and
- wearing the director’s UAE OpCo hat, it is a similar story as TopCo, but UAE OpCo would have no direct or indirect financial benefit from the underlying contract, meaning it will have even less of a positive to weigh against other potentially negative impacts of giving the guarantee.
This requires the individual director to consider his or her personal obligations under the laws of Saudi Arabia (for Saudi OpCo), onshore UAE (for UAE OpCo), and ADGM or DIFC (for TopCo, depending where that is registered). Those duties may have some overlapping and common features, but there will also be differences too. That, coupled with the different considerations each company’s board needs to weigh up, means a “one size fits all” approach to making a decision is not possible. Separate and careful consideration needs to be given for each company and the director must be mindful of applicable duties under each set of laws.
It is important, therefore, for individuals appointed as directors in these scenarios to be informed about their directors duties and the scope of their authorities and to take extra care to ensure that they familiarize themselves with their obligations, that may be different for each company whose board they sit on.
What obligations are owed then?
We discussed the duties of directors for onshore UAE companies in Part 1 of this series – click here.
As for ADGM and DIFC, the governing laws applicable in these financial freezones are based on English common law. In ADGM these duties are set out in the ADGM Companies Regulations 2015 (the “ADGM Companies Regs”), and in the DIFC, DIFC law No. 5 of 2018 (the “DIFC Companies Law”) and the DIFC companies regulations (“DIFC Companies Regs”), in each case supplemented by the relevant company’s articles of association, and other documents under which the director is appointed and exercises their authority for the relevant company.
The ADGM Companies Regs, DIFC Companies Law and DIFC Companies Regs generally grant directors very wide powers to manage the affairs of the relevant company, however, these authorities may be restricted or extended in the relevant company’s articles of association. The main statutory duties applicable to directors of private ADGM and DIFC companies include:
- to act within their powers: to act in accordance with the company’s constitution (articles of association) and other appointing documents, and only use their powers for the purposes to which they have been conferred. This can often be different from company to company within a group – just because one company has granted the directors broad authority to enter into certain types of transactions, does not mean that the director has authority to bind other members of the group in similar circumstances. A separate consideration needs to be given for each company – do you have the required power in relation to that company to proceed with what is being proposed?;
- to promote the success of the company: to act in good faith and consider the likely consequences of any decision they take in the long term, the interests of the company’s employees, the company’s business relationships, the impact of the company’s operations on the community and environment, the maintaining of the reputation of the company and the need to act fairly between different members of the company. This is a duty which comes most sharply into focus in situations like the above example, where there is a single circumstance/project/opportunity which might impact multiple companies in a group in a different way for each company;
- to exercise independent judgment; this is one of the most relevant duties and comes under most pressure in the context of group structures where a director may be appointed by UBOs or a parent company as a nominee, and is put under pressure to exercise their votes in a manner that their appointing UBO/parent company may direct, but which might not always be in the best interests of the company whose board the director sits on;
- to exercise reasonable care, skill and diligence: to exercise the diligence that would be exercised by a reasonably diligent person with the general knowledge, skill and experience that may be reasonably expected of a person carrying out the functions carried out by the director in relation to the company (i.e. the objective test) and with the general knowledge that the director has (i.e. the subjective test);
- to avoid conflicts of interest: to avoid situations that conflict with, or may possibly conflict with, the interests of the company (in relation to the exploitation of any property, information or opportunity). This is most relevant where the director may have a personal benefit in relation to a matter outside of the interests they have in it as a director of the company in question; for example, if the company was considering a contract with a third party company which was partially owned by the director;
- to not accept benefits from third parties: to not accept a benefit from a third party where the benefit is conferred on him due to his position as a director of the company or from doing (or not doing) anything as a director of the company; and
- to declare interest in a proposed transaction or arrangement: to make a declaration with regards to the nature and extent of his interest to the other directors of the company, which can often be overlooked in a group structure scenario.
Any breach of these duties may result in a director’s disqualification from his position as a director of the company and may subject the director to personal civil liability, with imposition of fines in addition to obligations to pay damages to the company in respect of losses suffered by it.
For more extreme breaches which may trigger issues under the UAE Penal Code. The Penal Code applies to all criminal offences committed in the DIFC and ADGM, and a director may face criminal proceedings in instances where any of the acts or omissions committed by him constitute a criminal offence under the Penal Code. This can include fraud or embezzlement in respect of property or a legal right, unauthorised disclosure of confidential information or use of that information for a personal benefit, health and safety failures which result in a serious incident leading to death or injury and writing a cheque on behalf of the company which is not honoured. (Please see Part 1 of this series (link above) and also click here for more details on this topic.)
It is worth noting that directors of DIFC and ADGM companies may be able to shield themselves from personal civil liability towards third parties by seeking indemnities from the company, however, this protection will only be limited to civil liability from third parties and not their liability to the shareholders or the company. The indemnities will also only be applicable to civil liability and not criminal liability under the Penal Code as detailed above.
A quick note on nominee directors
It is common to see directors nominated by a shareholder to represent the interests of the shareholder, for example a board representative appointed to represent a VC or PE investor. In general, there is nothing wrong with this as long as the director is mindful that the fact of them being a nominee does not dilute in any way the personal duties they owe as a director of the company in question. They must remain free to exercise their best independent judgment and make decisions in the interests of the company which they serve, which can sometimes mean departing from instructions of their nominating shareholder.
Difficulties and potential liabilities arise where the director is not free to act in the interests of the company whose board they are appointed to, but are instead pressured to act in line with the instructions given to the director by their appointing shareholder. There are many examples of such situations arising, particularly in times of financial hardship, where a shareholder may instruct a director to take actions that have the result of extracting value for the shareholder (e.g. disposing of core assets to create distributable reserves for shareholders or taking loans for the benefit of other group companies) and effectively prejudice claims of the company’s creditors (e.g. by reducing cashflow and the company’s ability to meet its obligations to third parties or depriving the company of assets required to remain balance sheet solvent or continue trading).
Please click here for a more in depth look at situations involving nominee directors, and the potential risks that could be run by individuals accepting those appointments, but also the shareholders/investors who appointed the nominee.
Please do get in touch if you would like advice on your duties and potential liabilities in the current climate or in your specific circumstances.
 The Organization for Economic Cooperation and Development (“OECD”) Inclusive Framework on Base Erosion and Profit Shifting (“BEPS”) initiative, now acceded to by 137 states, has resulted in economic substance and operating requirements being adopted by the UAE, the BVI and Cayman Islands (click here: https://www.cms-lawnow.com/ealerts/2019/08/brave-new-world-economic-substance-requirements-introduced-in-the-uae?cc_lang=en). This has the basic effect of reducing the benefits, and increasing the burden, of using foreign holding vehicles where the operational business underneath that vehicle is located in a different jurisdiction. At the same time, the Abu Dhabi Global Market (“ADGM”) and Dubai International Financial Centre (“DIFC”) financial free zones have enacted laws enhancing the corporate options available in the UAE, and making it possible to put in place group structuring options held within the UAE with the kind of robust corporate framework that investors previously looked towards the BVI and Cayman Islands for, and at increasingly more competitive costs than in previous years.