For centuries, trust and traditional networks sustained trade and business in the Middle East. As the region transitioned into a modern economy, people here used their innate skills to build a formidable small-to-medium-sized enterprise (SME) sector. Private entrepreneurs now play a crucial role in the economy of the UAE, providing employment to large number of people across the country.

The importance of small businesses cannot be emphasised enough, contributing as they do to 60 per cent of UAE’s GDP. According to the UAE Banks Federation Annual Report-2014, financing SME activity is now vital for a burgeoning economy like ours. However, the challenge before banks, governments and entrepreneurs now is to plug various lacunae in the law, so that the UAE becomes an attractive, business-friendly destination for innovative businesspeople.

An impediment to private enterprise and a major risk for banks has been the lack of a viable insolvency law. Ironically, UAE, which is an important international financial and business hub, has functioned without effective insolvency laws, which hurt its international reputation.

Prior to the global financial crisis of 2008, business failures were dealt with in an ad hoc manner and conflicts, when they rose, were often resolved through informal arrangements, facilitated by external negotiators.

Past imperfect

Unfortunately, informal arrangements often break down if one of the parties goes to court.

Moreover, the penalty for failure in business was harsh, as dishonoured cheques counted as “criminal” offences and arrest warrants for bounced cheques were commonplace. This tough provision in existing insolvency laws was a major dampener for failing businesses. There was little option for institutionalised solutions and avenues for a genuine entrepreneur to get his business back after a financial setback.

This problem became more acute after the Dubai property bubble exploded in 2008, when the lending cycle halted abruptly, and the region was saddled with a lot of insolvent companies. In this financial chaos, SMEs suffered the most, as they were first in the line to lose bank credit. Non-functioning insolvency laws added to the confusion and many profitable businesses had to shut down, due to the absence of provisions to restructure financing and bail out both banks and businesses.

The global financial crisis thus was a wake-up call to review and strengthen the insolvency law — one that is aimed at saving enterprises, rather than punishing those who fall on the wrong side of the business cycle.

Creative law: Push to entrepreneurship

All this is set to change. In July this year, the long-awaited new insolvency law was approved by the Cabinet and is indeed a creative institutional solution. The proposed draft law includes flexible strategies to bail out businesses in financial trouble, leading to possible bankruptcy. It aims to regulate accumulated debts, eases restructuring of companies as well as support troubled businesses.

Most significantly, the new law contains groundbreaking provisions regarding the decriminalisation of bounced cheques.

The ability to launch criminal charges against individuals who issue bad cheques has long been cited as one of the principal obstacles to doing business in the UAE. The government is determined to work on a law that mitigates the risk of insolvency and ensures a safe and reliable business environment in the UAE.

The key concept is therefore to provide a method by which companies can begin trading profitably or be liquated in a controlled manner, rather than simply facing liquidation that carries a stigma attached to it, as is often the case in the Middle East.

The effort is to move away from an arrangement where everyone would be a loser — the bank, as well as the entrepreneur. Under the proposed measures, any decision made will be reached through a negotiated agreement with creditors or a formal administrated process and will benefit all.

Significant amendments to the UAE’s penal code will be required for the draft insolvency law to take effect, after a series of approvals from the Federal National Council, the Rulers of the seven emirates and finally President His Highness Shaikh Khalifa Bin Zayed Al Nahyan.

Global solutions

In an attempt to be globally competitive, legal eagles have drawn heavily from the UK, Germany and Japan. The aim is to allow the debtor to retain control of his business and get court protection for a period of time while solutions are sought. For this purpose, the new law also draws heavily from provisions for corporate bankruptcy modelled on Chapter 11 proceedings in the US.

Chapter 11 proceedings allow companies to renegotiate the terms of financing, even before it hits rock-bottom. A commercial project may be successful, but could also be in need for restructuring. If the new law comes into effect, Chapter 11 provisions can be used by corporations and individual entrepreneurs to reorganise their business, if they are under stress. It does not put personal assets of the stockholders at risk, other than the value of their investment in the company’s stock. Business owners can continue to function and maintain ownership of all assets, even as a reorganisation plan is worked out to pay off creditors.

This will be better for the SMEs as well as their investors, who will have less fear of failure. A well-defined and honestly administered insolvency law will go a long way in giving businesses a second chance to rebuild or restructure their operations, and in the process helping banks cope with business failures: a win-win for all stakeholders.

Hussain Al Qamzi is CEO of Noor Bank. The opinion expressed here is his own and does not necessarily reflect that of Noor Bank or the newspaper.