Understanding DIFC’s new insolvency law: What kind of an impact will it have?

In a region where there has traditionally been an inherent stigma attached to business failure, the inevitable by-product is a decreased appetite for risk.

However, as the UAE’s economy has matured and become more global in its outlook, a more sophisticated and less risk averse insolvency regime is required – one that can deal with volatile economic cycles and at the same time promote an entrepreneurial business environment.

The new insolvency law adopted by Dubai International Financial Centre (DIFC) to replace the existing regime that had been in place since 2009 incorporates provisions intended to promote the rehabilitation of viable businesses, and it is perhaps worth focusing in more detail on how they achieve this.

Read: New insolvency law enacted by Dubai’s DIFC, lawyers say move will boost confidence

The provisions support the fundamental principle that distressed businesses that are capable of being rehabilitated should be given that opportunity.

In the event that this is not possible, then businesses without a future should be capable of being wound-up in an orderly manner with a view to maximising creditor returns.

The new insolvency law has essentially adopted a ‘debtor in possession’ regime: managers of distressed businesses will enjoy a moratorium during which they retain control and have the legal right to secure protection from their creditors, to maximise the chances of returning to financial health.

Specific provisions include an obligation on suppliers to continue with existing commercial arrangements, in the absence of which many businesses would lose their ability to trade.

Further, a supplier with a contractual right to cease to supply upon the occurrence of an insolvency event, will no longer be able to rely automatically on such a provision.

Management may also be able to access priority financing, again with the objective of being able to continue as a functioning business.

While providing latitude to new distressed business, the new law also incorporates the necessary checks and balances so as to ensure that provisions such as the imposition of a moratorium are not abused by permitting applications to court to be made in circumstances where it would be inequitable for the moratorium to continue.

It is important to appreciate that any legislation is, in effect, only as good as its supporting infrastructure.

In the case of the DIFC, the sophisticated nature of the judiciary enables the checks and balances inherent in the legislation to be applied appropriately.

The principle that underpins the legislation is to facilitate business rescue while protecting the legitimate interests of all stakeholders.

To this end, creditors have the right – indeed are required – to vote upon whether to allow management to retain control. They also need to accept the various compromises that each class will have to make in the event of a liquidation, given that their respective interests differ according to order of priority.

Achieving a balance between the interests of the various stakeholders while not overriding existing rights is critical; for example, those of secured creditors. The new law expressly protects those rights.

Not every investment will be successful. Investors accept commercial risk as an inherent part of entrepreneurship.

However, a legislative system that ensures fairness and preservation of stakeholder rights while providing a mechanism for the preservation of stakeholder value plays a part in any risk assessment. The new insolvency law achieves that balance.

Creditors may also apply to the courts to challenge the validity or appropriateness of a restructuring proposal, if they can show sufficient evidence of fraud, dishonesty or incompetence. But at that point, the business may move one step closer to liquidation and one step further away from rehabilitation, which means such a move by the creditors is not without risk and needs to be carefully considered.

Ultimately, though, there is a bigger prize at stake. Both the idea that a struggling company can be rescued as a going concern and that creditors can be reassured that their interests will be safeguarded are important from a macroeconomic perspective, because the confidence of both borrower and lender is crucial to a healthy economy.

Secondly, a key part of the legislation is the fact that the new regime recognises other insolvency jurisdictions, by adopting a modified version of the United Nations Commission on International Trade Law (UNCITRAL) Model Law.

This is perhaps one of the most important aspects of the new regime, because it will potentially make insolvency situations involving multinational corporations much easier to manage efficiently and with better outcomes for both creditors and investors.

If the overall result is that the DIFC becomes more strongly embedded in the global financial system and investors take comfort from that, the benefits to the regional economy could be far reaching and long lasting.

Peter Somekh is managing partner at DLA Piper Middle East and global co-chair of the firm’s Restructuring and Insolvency Practice