Background to the existing regime
Under the existing regime, UAE law provides that foreign investors generally can only own up to 49% in a UAE mainland company. At least 51% of the shares in a UAE mainland company must be owned by one or more UAE nationals, or a company which is itself wholly owned by one or more UAE nationals. This means that the constitutional documents of a UAE mainland company would state both the name of the local shareholder, as the legal owner of not less than 51%, and the foreign shareholder, as the legal owner of not more than 49%, making the foreign shareholder a minority shareholder.
In addition, the conduct of certain commercial activities such as those relating to real estate, general transport, certain media activities and labor supply is reserved exclusively for UAE nationals or companies owned exclusively by UAE nationals. Accordingly, foreign investors are restricted from carrying out such activities and from investing in companies that carry out such activities.
An exception to the foreign ownership restriction,
UAE companies may be owned entirely by nationals of Gulf Cooperation Council (GCC) countries or companies owned by nationals of GCC countries. However, any direct or indirect non-GCC shareholding in the UAE company would mean that the principle described in the first paragraph would again apply and at least 51% of the shares would have to be held directly or indirectly by UAE nationals. In these circumstances all non-UAE shareholders, including GCC individuals and companies, would be deemed to be foreign investors.
A further exception to the foreign ownership restriction is within Free Zones. Free Zones are specially designated areas within the Emirates established to attract foreign investment by encouraging companies to set up businesses and locate their operations in the UAE. Each Free Zone has its own administration and licensing authority responsible for issuing Free Zone licences and registering companies. The key difference between a Free Zone and mainland entity is that a Free Zone entity may be wholly owned by non-UAE nationals, meaning that foreign investors can own up to 100% of the shares in Free Zone companies.
Use of side agreements under the existing regime
To overcome the disadvantages associated with the foreign ownership restrictions in the UAE, many foreign investors carry out business in the UAE mainland by engaging a UAE national to hold 51% of the share capital of the UAE company, effectively as a nominee shareholder, on behalf of the foreign investor (UAE Nominee), with the foreign investor holding the remaining 49%. Typically, a separate set of private, meaning not subject to registration, ‘side agreements’ are put in place between the foreign shareholder and the UAE Nominee.
Collectively these side agreements seek to transfer the beneficial ownership, meaning the benefits and rights associated with holding the shares, from the UAE shareholder to the foreign shareholder in return for a fixed annual fee. This transfer of beneficial ownership tends to:
- place the control of the company in the hands of the foreign shareholder;
- distort the distribution of profit share and dividends in favor of the foreign shareholder; and
- limit the UAE shareholder’s involvement in operational matters, meaning that the UAE shareholder effectively becomes a silent shareholder.
As the UAE is a civil law jurisdiction, there have been historical concerns in the UAE regarding the legal validity of these side agreements and their enforceability in the case of a dispute, creating risks such as an enforceability risk considering the UAE Anti-Fronting Law. Parties to such agreements may put in place sophisticated corporate structures involving Free Zone holding companies – such as special purpose vehicles (SPVs) in the Abu Dhabi Global Markets Free Zone (ADGM) or special purpose companies (SPCs) in the Dubai International Financial Centre Free Zone (DIFC) – to take advantage of the common law regimes which allow for more sophisticated contractual structures to be put in place. However, the validity of side agreements has not, to date, been tested in a court of law in the UAE so, despite the risk mitigation efforts of various companies, their true enforceability has never been an absolute certainty.
The introduction of the new FDI law has therefore come as a welcome development for foreign investors and, with its introduction, we may see a more streamlined approach to investment in the UAE with a reduction in the need for side agreements.
UAE Anti-Fronting Law
In November 2004 the UAE enacted a law aimed at preventing arrangements which seek to circumvent the restrictions surrounding foreign ownership of UAE companies (‘Anti-Fronting Law’). One of the rationales behind introducing the Anti-Fronting Law is to prevent the use of side agreements /arrangements with UAE nationals similar to the ones described above.
The Anti-Fronting Law provides that “it is prohibited to act as a front for any foreigner – whether a natural person or a body corporate – by using the name, license or commercial register of the front…”. The Anti-Fronting Law defines the term ‘front’ as “any natural or body corporate enabling a foreigner – whether a natural person or a body corporate – to practice any economic or professional activity he is prohibited to do inside the UAE”.
The Anti-Fronting Law not only renders such arrangements invalid, but also imposes sanctions for breach of the law. Sanctions can be imposed on both the local partner and the foreign investor and include fines of up to AED100,000 (US$27,000) and possible imprisonment for a period of up to two years. In addition, any ‘condemnation judgment’ issued following a breach of the Anti-Fronting Law will provide that the name of the ‘front’ be deleted from the commercial register, effectively requiring the foreign company to close its business or make alternative arrangements in strict compliance with the regulations. A company involved in a ‘fronting’ arrangement will be deregistered from the commercial registry with respect to the activity involved and its license may be revoked.
Although the Anti-Fronting Law is technically in force and effect, there has been no indication that the relevant authorities would take a proactive role in enforcing it. In addition, we are not aware of any instance whereby the Anti-Fronting Law was enforced despite foreign investors becoming more open about their side arrangements with UAE Nominees.
in September 2017, the Government of the UAE amended the UAE Commercial Companies Law¹ to allow the UAE Cabinet of Ministers the flexibility to permit increased levels of foreign ownership by non-AGCC nationals (Foreign Investors) in certain companies and sectors of the economy². The UAE Foreign Direct Investment Law (the FDI Law)³ introduced a framework under which foreign investors may apply to own more than 49% of the shares in the capital of companies incorporated ‘onshore’ in the UAE.
Negative list
Under the FDI Law, foreign investment above a 49% will not be permitted in sectors of the economy which appear in a “negative list”. The UAE Cabinet has discretion to amend the “negative list” by adding or removing sectors. There are currently 13 sectors specified in the “negative list”, including banking, insurance, and commercial agencies.
Positive list
The FDI Law provides for a “positive list” of activities in which up to 100% foreign ownership by Foreign Investors may be permitted, subject to certain criteria being satisfied. The FDI Law stated that the UAE Cabinet had the discretion to issue and amend the “positive list” by way of resolution. Reports emerged in mid-2019 that the UAE Cabinet had approved the “positive list” but that list was not formally adopted or published in the UAE Official Gazette. On 17 March 2020, the UAE Cabinet issued a Cabinet Resolution setting out the ‘Positive List of Economic Sectors and Activities in which Foreign Direct Investment is Permitted’ (the Positive List Resolution)⁴. The Positive List Resolution is expressed to become effective from the day on which it is published in the Official Gazette. The Positive List Resolution has been published in the Official Gazette dated 31 March 2020 so is now in effect.
122 economic activities are specified in the “positive list” that is attached to the Positive List Resolution, including (amongst others) activities in the following sectors:
- agriculture
- manufacturing
- transport and storage
- hospitality and food services
- information and communications
- science and technology
- healthcare
- education
- art and entertainment, and
- construction
The Positive List Resolution also provides, on a case by case basis, minimum share capital requirements which will need to be met for companies that are or become owned 100% by Foreign Investors and are licensed to carry on activities contained in the “positive list”, and imposes other requirements that will need to be satisfied by Foreign Investors in relation to certain activities. It also allows the competent licensing authority in each Emirate and industry specific regulators to impose additional conditions on such companies and provides that Emiratization requirements may be imposed by the UAE Ministry of Human Resources and Emiratization on companies that are owned 100% by Foreign Investors.
The UAE Cabinet has further confirmed that it will be left to the discretion of the local governments at an Emirate level to decide on the percentage of foreign ownership for each sector/activity. Notably, the FDI Law leaves room for each of the seven Emirates to permit up to 100% foreign investment for different activities, subject to the Federal authority’s approval. To date, no confirmation has been provided in respect of the sectors and corresponding percentage ownership restrictions that will be adopted in each Emirate.
Activities not falling on either the positive list or the negative list (i.e. activities which are not expressly permitted or restricted) will be subject to the discretion of the authorities to determine whether up to 100% foreign direct investment will be allowed on a case by case basis.
Foreign investment companies
Companies incorporated under the new FDI Law, Foreign Investment Companies (FIC), will be registered in a special FIC register held with the Ministry of Economy and will be treated as UAE companies. The process for registering an FIC will be largely similar to registering a mainland company in the UAE, with the application first being submitted to the local licensing authority, then to the relevant authority in the Emirate for approval. The FDI Law also allows the foreign investor to appeal in the event an application is rejected.
It is unclear whether existing UAE onshore companies could be converted to FICs. In any event, we expect to see an increase in M&A/corporate restructuring activity in the UAE as a result of the FDI Law.
In practice, applications to set up FICs will only be accepted once the relevant authorities are duly formed and the sectors and corresponding percentage ownership restrictions that will be adopted in each Emirate have been confirmed.
Whether companies should consider whether existing UAE on-shore companies should be converted to FICs – noting that any conversion from a limited liability company to a FIC could open the doors for further negotiations between shareholders, particularly where a conversion may result in a buy-out of existing shareholders
