Trade and Legal Risks to Businesses in the UAE

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Table of Contents

Introduction
Analysis
Conclusion
Works Cited

Introduction

There are several legal risks to businesses that operate in the UAE. Legal risks arise when the interpretation of part of the law creates uncertainty for businesses. There are five categories of legal risks. They include contractual risk, non-contractual rights risk, non-contractual obligations, dispute risk, and legislative risk (Berwin Leighton Paisner 8). Four of the risks exist in the UAE’s business environment. There is a reduced risk of non-contractual rights risk because there are several parts of the law that protect intellectual property. One of the legal business risks emerges when contracts are signed between foreign entities and local agents. It is a form of contractual risk. There is a difficulty in changing local agents. The UAE poses contractual risks due to the difficulty encountered when enforcing contracts. The average cost, as a percentage of the claim, is high. It also takes a long time to enforce contracts when a resolution has been sought from the courts. For a limited liability company (LLC), the liability of the managers may be extended to their assets. It occurs when they fraudulently engage in business with another entity. Directors have to provide the actual financial position of the firm to be protected under the limited liability provision. The UAE is a member of the Israeli products boycott agreement. It raises a business risk for American entities operating in the UAE because the U.S. prohibits the boycott for firms under its jurisdiction. Among other risks, there is the risk that foreigners are not allowed to control firms operating in the mainland. It reduces the ease that they can implement strategies that can help their businesses have a better performance. The Civil Code and Commercial Companies Law (CCL) expect firms to act in good faith.

Analysis

Legal risks arise when the impact of a piece of legislation poses threats to businesses. In some cases, there are parts of the law that are unclear about certain aspects of engaging in business. Berwin Leighton Paisner (8) discusses five categories of legal risks that may arise from the law. Legislative risk occurs when business is not aware of certain parts of the law. It is likely to occur when parts of the law are amended frequently. Legislative risk is also associated with regulations that may affect business operations negatively. Contractual risk is associated with the ability to enforce contracts. Non-contractual rights risk refers to the risk associated with the enforcement of intellectual property, such as copyrights, patents, and trademarks (Berwin Leighton Paisner 8). In the UAE, certain copyrights are automatically owned without the need for registration. In cases where the issue has not been addressed properly in the law, non-contractual obligations risks arise. Firms are expected to act in a manner that can be aligned with the spirit of the law. Dispute risk occurs when businesses’ operations fail to adhere to the agreements made during conflict resolution (Berwin Leighton Paisner 8).

One of the legal business risks emerges when contracts are signed between foreign entities and local agents. There is a difficulty in discontinuing contracts made against agents. One has to select agents cautiously because it is not easy to withdraw from agent’s contracts (The Canadian Trade Commissioner Service par. 18). Without a substantial cause for dishonoring the contracts, rulings are likely to favor the local agents. It may result in compensation for the local agents. In the UAE, the use of agents raises a legal risk because foreign firms have to use local agents to sell goods and services directly to the people. According to the law, the agents have to be locally-owned entities (The Canadian Trade Commission Service par. 19). Some agents may have exclusive rights to operate in an Emirate. It may lead to compensation if another firm mistakenly sells the product in the area. The firm violating the regulation may be required to pass over the benefits to the firm holding exclusive rights. The requirement to use agents and exclusive rights raises legislative risks for foreign entities operating in the UAE.

The UAE poses dispute risks due to the difficulty encountered when enforcing contracts. According to the World Bank (73), contract enforcement in the UAE takes more time and incurs more costs compared with some of its neighbors. In the UAE, on average, enforcing a contract takes 524 days. It is the time required to file a case, have the court proceedings, and enforce the rulings. On average, it requires 49 procedures and incurs a cost that covers 19.5% of the claimed value (World Bank 73). The UEA is ranked 121 out of 189 countries on the ease of enforcing contracts. It shows that firms run the risk of incurring additional costs and lose time when awaiting contracts to be enforced. It is a form of dispute risk arising from the cost and the amount of time needed to enforce contracts. The delay in contract enforcement can result in the loss of business opportunities. Businesses have to enter into contracts with entities that have a clear track record of honoring contracts to avoid risks associated with resolving disputes.

In the UAE, resolving insolvency is another legal risk because of the length of time it takes and the cost. According to the World Bank (80), on average, it takes 3.2 years and costs 20% of the debtor’s estate to find a legal redress to insolvency. There is a higher probability that the assets of the firm will be sold to settle the debts. Some firms would prefer to be given additional time to seek other alternatives to settle their debts. Some may want to restructure and continue with their operations. There is a low recovery rate for disputes resolved in the courts. On average, the recovery rate is at 28.6% for each dollar owed (The World Bank 80). Considering the ease of finding a resolution, the UAE is ranked 92 out of 189 nations. Suppliers and creditors have to examine a firm’s accounts to avoid firms with a weak financial position because of the low recovery rate during insolvency.

There is an increased risk of dissolution when a firm makes large losses. Under Article 289 of the CCL, a limited liability company has to convene a meeting to consider the dissolution of the firm when it has incurred losses amounting to 50% of the firm’s capital. Members holding a quarter of the shares may call for a meeting to dissolve the company when the losses reach 75% of the firm’s capital (Abdelhamid Article 289). Firms have to evaluate their business engagements when dealing with firms that repeatedly make losses.

There is the legal risk that the liability of an LLC may be extended to the personal wealth of directors if they are shareholders. Under Article 219 and Article 226 of the Commercial Companies Law (CCL), Bainbridge (par. 17) elaborates that the liability of an LLC may be extended to the personal property of the directors. However, the risk is limited because the courts will rely on substantial evidence indicating that the directors’ neglect resulted in the poor financial condition of the firm. Bainbridge (par. 19) expresses that the reasons that allow the liabilities to be extended to the directors’ personal property have to be those outlined in Article 219. Under Article 322, the falsification of the firm’s financial accounts is one of the reasons that make a director liable (Abdelhamid Article 322). Any other reasons do not qualify for the removal of the limited liability provision.

Directors’ and managers’ liabilities may not be limited when they misappropriate financial accounts. According to the case law, the liability of an LLC may extend to that of a manager’s personal property when he fraudulently engages in business dealings (Arab par. 1). In one case, the manager purchased commodities using post-dated checks. The checks bounced when they were presented to the bank because the LLC had insufficient funds in its account (Arab par. 3). The manager was held liable for the amount using his wealth.

Latham & Watkins LLP (9) explain that the UAE has set a limit on the minimum employment percentage of the UAE nationals at 15% in all private sector firms. Considering that the population is formed of about 90% expatriates, it becomes a difficult task to adhere to the standards set by the regulation. It would have been easier if the workforce were to match the population demographics. HSBC (24) discusses that preference for employment should be given to the UAE nationals. It raises the risk of hiring skills available in the population and those needed by the businesses.

The Federal Employment Law No. 8 of 1984 requires that employees are compensated once they have worked for an employer continuously for one year (Ernst & Young 27). The country’s laws do not have provisions for redundancy. As a result, it may require firms to compensate employees each time their number is reduced. Employees are not entitled to compensation when their work fails to meet the agreed standard. Employees are entitled to an end of service gratuity (ESG) payment (Latham & Watkins LLP 9). The lack of redundancy provisions makes it difficult for firms to reduce employees without incurring additional costs. Also, under the Pension & Social Security Law Federal Law No. 7 of 1999, employers are required to make a social security contribution equal to 12.5% of their payroll when they employ the UAE nationals (PKF 52).

The Competition Law that became operational in 2013 also poses legal risks to firms. The law seeks to prevent mergers and acquisitions that may result in the abuse of dominance and restrictive tendencies (Latham & Watkins LLP 13). The risk from the law arises from the fact that it is under the discretion of the Ministry of Economy to determine the concentration ratio that may constitute enhancing a dominant position. Firms may not restrict their partners from dealing with firms that may enhance competition. It creates a risk for firms that may want to restructure through mergers and acquisitions to increase their competitiveness.

Another legal risk occurs in the payment of income taxes. Ernst & Young (29) describes that income tax decrees pose a risk for firms that operate in the UAE. There is a difference between the tax decrees and the implementation of the income tax. All Emirates have set income tax decrees, which they may decide to enforce in any period. According to the Abu Dhabi and Dubai income tax decrees, businesses could be taxed up to 55% of their net earnings (Ernst & Young 30). However, on the implementation part, Emirates has decided to tax the oil & gas producing companies and the banks only. The implementation of the tax decrees remains under the discretion of the Emirates’ officials. Currently, other sectors do not need to pay income taxes.

Capital gains tax does not have a separate section in the law for its definition and taxation. It may be taxed as part of the net income (Ernst & Young 32). There is uncertainty in the description of capital gains tax. In the application of the law, it may be considered as legal risk. There should be clear tax rates for capital gains.

Foreign business entities may own buildings. However, they are not allowed to own land. According to the law that was passed in March 2006, foreigners may own property in certain areas (Ernst & Young 17). Among foreigners, only GCC nationals are allowed to own land in certain parts of the country. A business that needs to engage in manufacturing may find the rental cost to be higher compared with owning both the property and land. Property may be owned for 99 years. The sale and purchase of property incur a cost of 1% each for registration with the Dubai Land Department (Ernst & Young 33).

The Escrow Law reduces the risk associated with the construction of buildings that involves payment in installments and ownership by different business entities. The Escrow Law seeks to protect the buyers by ensuring that their contributions are used to complete the work assigned to the cost (Ernst & Young 18). The risk arises under Article 14 of the Escrow Law that requires that 5% of the funds be held by an agent in the verification period and the transfer of ownership. The contractor has to wait for a whole year, before the funds are released, after the verification of the completion. The delay in payment raises the risk for contractors.

The municipality charges on restaurant and hotel services raise legal risks. The charges may vary from 5% to 10%. It is also added to the annual rent that property owners charge tenants (Ernst & Young 33).

Dowling & Stovall (2) discuss that companies that operate in the UAE without a physical presence run the risk of being forced to observe the same laws as those that have a physical office in the UAE. The regulations may require the firm to make contributions to the social security fund, the same way as firms with a physical presence. Firms may avoid the risk by partnering with firms that have a physical presence in the UAE (Dowling and Stovall 2).

Countries in the GCC region observe the agreement to boycott Israeli products. Ernst & Young (14) discusses that the only restriction on the exchange market is that Israeli currency should not be traded in the UAE. Bryan Cave LLP (9) states that the U.S. prohibits firms from boycotting Israeli products. American firms that operate in the UAE may face penalties for boycotting trade with Israel. There is a legal risk because the firms operating in the UAE have to adhere to the UAE laws.

Another legal risk arises when the UAE government allows the enforcement of awards and court rulings conducted outside the country. Under Article 235 of the Federal No. 11 of 1992 and the New York Convention, the courts may not need redress to certain legal cases resolved outside its jurisdiction. Bainbridge (par. 8) discusses that awards in foreign jurisdictions may be upheld without rehearing the cases if they are not covered by the UAE law. The risk means that firms may be forced to adhere to rulings determined outside the UAE without a new hearing of the cases.

There is uncertainty about the level of minimum capital used to start an LLC in Abu Dhabi and Dubai. The minimum requirement has been reviewed. It allows officials to determine the level of minimum capital depending on the sectors and type of business (Bainbridge par. 21). The review has caused a new level of uncertainty because higher levels of capital may be required in some sectors.

Firms are expected to act in a manner that promotes the public good. Berwin Leighton Paisner (8) explains that non-contractual obligations risk involves firms to act in a manner that is deemed to be appropriate to the spirit of the law. Under Article 246 of the Civil Codes, Bainbridge (par. 26) explains that organizations are expected to act in good faith. Sections of the Commercial Companies Law also expect those who enter into contracts to demonstrate good faith. Business entities may be liable when their actions are considered to be in bad faith.

There is a business risk associated with the lack of complete ownership for foreign firms because they will lack the ability to control the firm. In the mainland, the Commercial Companies Law limits the ownership of firms to 49% for foreigners (PKF 36). Only GCC nationals are exempted from the restriction. Foreign owners, who have invested a lot of capital, cannot make strategic decisions for their accumulated knowledge and technical skills. The free zones allow 100% ownership for expatriates and foreign entities. It may seem a better option for firms that manufacture goods for export because they will not be affected by customs duties and taxes. However, if their goods are consumed locally, they will meet custom duties that are similar to those on imports.

Conclusion

Several business risks emerge from the UAE laws that create uncertainty in running businesses. One of the agreements that create uncertainty is the New York Convention, which requires the UAE courts to uphold court decisions from the jurisdiction of member states. The UAE may decide to rehear the case only when it qualifies to be heard under its jurisdiction. Businesses may be affected by decisions made in other jurisdictions. Uncertainty emerges from the amended minimum capital requirement for LLCs because there is no fixed amount. The officials shall decide the minimum capital depending on the type of business. The UAE is a member of GCC countries with an agreement to boycott trading with Israel. The U.S. prohibits firms, falling under its jurisdiction, from boycotting Israeli products. It creates a risk for American firms operating in the UAE. There is a high risk of insolvency when a business makes a loss that exceeds half its capital. The average recovery rate for debtors raises concern for businesses. The enforcement of contracts is costly and takes a long period. It may result in the loss of business opportunities.

Works Cited

Arab, Hassan. Liability of Directors in an LLC. 2011. Web.

Abdelhamid, Mohammad. UAE Commercial Companies Law: Commercial Laws and Regulations. 2014. Web.

Bainbridge, Alan. Six key legal points when investing and contracting in the UAE. 2012. Web.

Berwin Leighton Paisner, n.d., Legal Risk Benchmarking Survey: Results and Analysis. Web.

Bryan Cave LLP, 2004, Legal Issues Related to Doing Business in the United Arab Emirates. Web.

Dowling, Donald, and Howard Stovall. Legal Risks Arising from “Floating” Employee Arrangements in the Arab Middle East. n.d. Web.

Ernst & Young, 2011, Doing Business in the United Arab Emirates: Country Profile. Web.

HSBC, 2013, Doing Business in the UAE. Web.

Latham & Watkins LLP, 2014, Doing Business in the United Arab Emirates. Web.

PKF (2012). Doing Business in the UAE. Web.

The Canadian Trade Commissioner Service. Doing Business in the United Arab Emirates. Web.

World Bank, 2014, Doing Business 2015: Going Beyond Efficiency. Web.

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Trade and Legal Risks to Businesses in the UAE

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