Dubai: The rise in the number of companies facing severe financial distress is an unavoidable fact in today’s market, especially given the current health crisis and tightened business environment.
In response, the UAE had enacted a Bankruptcy Law, which provided new avenues to remediate a situation wherein your business might need to file for insolvency.
It is part of the global wave of insolvency reform referred to as the "rescue culture", in line with the practices of other international commercially prominent jurisdictions such as the US and UK.
Accordingly, the law provides for a process in which the injection of new capital can be arranged, while at the same time claims based on existing debt can be both managed and mitigated, using a fixed legal process.
The Bankruptcy Law was also amended in late 2020 in response to the COVID-19 pandemic to provide for various forms of enhanced debtor protection.
This includes, in several cases, to suspend the need to file for insolvency, expedited procedures for claims of relief and settlement, and a deferral of bankruptcy proceedings filed by a creditor.
In extreme cases, sometimes filing for bankruptcy is the only way out of a bad financial situation – but keep in mind you wouldn't be bankrupt unless you filed a case in court. On the other hand, insolvency can be fixable without having to go to court.
Individuals can use these tactics, too. People who have found themselves owing more than they own have turned insolvency around by increasing income, cutting expenses, and working with lenders or credit counselors to work out a plan for repaying debts to avoid the legal process of bankruptcy.
It may not be an easy task, but working your way out of insolvency can be far more preferable than filing for bankruptcy. Bankruptcy should always be your last resort.
Signs of insolvency – how to spot them?
For almost all companies, there are likely to be times where the company experiences cash flow problems. Let’s discuss the early warning signs of insolvency, so you can be prepared and take action hopefully before a crisis occurs.
A company is insolvent if it is no longer able to pay its debts as they fall due. There are various insolvency rules in place, and procedures available for an insolvent company.
Cash flow problems: Cash flow problems aren’t necessarily an indication of company insolvency. Many factors cause cash flow problems, such as poor sales and a lack of credit control, and many problems are just temporary. However, understand what is causing problems, and manage cash flow on a daily basis, detailing incomings and outgoings, to stay on top of any issues.
Reaching the borrowing limit: If your company regularly has to borrow money to pay creditors and staff wages etc., this is referred to as ‘ceiling borrowing’, and often suggests a company may be on the brink of insolvency. If your creditors feel that you are no longer able to pay your company debts, they can apply to the courts for a winding up petition for compulsory liquidation.
Investors are not paid: Another sign of company insolvency is a director pay freeze. If a director’s wages are affected and, effectively, stopped – even for the good of the company assets – this conveys serious problems. Directors must act in the best possible interests of the creditors should their company head into insolvency.
Other signs of insolvency: Some other common reasons as to why a business may fall into company insolvency include: high staff turnover and lack of money to pay wages, delays in providing financial information, loss of major contracts, profit decline in a particular industry.
Can I protect my company from bankruptcy? What steps should I take?
A company considering filing for protection under the UAE Bankruptcy Law should take steps prior to filing, so as to ensure that the process goes as smoothly as possible.
The first step is to make a robust risk assessment to determine whether the filing is necessary, in view of the fact that such is not without some significant risks.
However, when making a risk assessment to determine whether the filing is necessary, what are the factors involved in making this assessment?
First consider if there a realistic path to restructuring, or will the company have to be liquidated. Check whether the company reasonably has assets to meet at least 20 per cent of its debts should it be liquidated.
Next, understand whether the business managers prudently operated the company and looked after its affairs in a diligent manner insofar as the keeping of accounts and engaging in proper corporate governance.
It is vital to understand if the company or its managers engaged in any acts that they would not want scrutinised, particularly anything that damaged the company's shareholders or third parties.
Importantly, pursuant to Bankruptcy Law, if the debtor’s assets are insufficient to satisfy at least 20 per cent of its debts, the court may obligate members of the board or managers to pay these debts, in cases wherein their responsibility for the company’s loss is evident.
In what cases can company owners face criminal prosecution?
Keep in mind that the directors, managers of your business or company may face criminal prosecution in the event of a host of improper actions taken prior to the filing of bankruptcy or thereafter.
These include circumstances where in some cases, liability may even extend to the shareholders or investors themselves, if they have been found to have been involved in improper actions relating to the debtor company’s money management.
These prohibited actions include those that may be expected to attract criminal sanctions, including fraud, embezzlement, disposal of assets in bad faith, and making false declarations.
However, it also includes making payments to one creditor to the detriment of others, while the debtor is in an insolvent state, as well as other actions that are considered acts of negligence (voluntary or reckless acts), which may lead to scrutiny.
Knowing what risks need to be factored
Thus, the risk assessment needs to include making both a clear-eyed estimate of the debtor’s net asset value in liquidation as well as an unbiased consideration of whether the debtor company’s management has engaged in any of the prohibited acts described in the Bankruptcy Law, as mentioned above.
Once this is done, and assuming the debtor makes the decision to file, the appropriate documents and approvals must be obtained for submission to the court to introduce the case.
Arranging these items and preparing the filing may take some time, so the debtor that is seriously considering filing a bankruptcy case needs to commence due diligence (investigation) and start gathering documents well ahead of time.
- Barry Greenberg is a lawyer part of the Restructuring & Bankruptcy, Corporate, Insurance and Reinsurance practices at BSA Ahmad Bin Hezeem & Associate LLP, DIFC, Dubai