Bindingness of a shareholder agreement – Mainland and Free Zone comparison

Introduction – why is it important to specify what binds your shareholder agreement?

1. Distinguishing Mainland and Free Zone

The purpose of understanding what governs your shareholder’s agreement is, with reference to the previous publication in this series, to know how laws function in your shareholder agreement under Federal Decree Law No. (32) of 2021 on Commercial Companies. This requires shareholders to be precise to include all necessary laws in their shareholder agreement. Moreover, this series will explore how these laws and the rights of shareholders differ depending on where the company has been formed. The law rules distinguish whether the company is construed in the i) Mainland or ii) Free Zone. It is important to be aware of these differences and, thereby, be precise that all binding law rules of the specific Free Zone or Mainland where the company is formed are included in the shareholder agreement and shareholders’ obligations specified therein. This is noteworthy, as the Free Zones may differ in their rules; thereby, you must be precise to ensure that all necessary information is included with respect to the specific Free Zone in which your company is formed. This is because the different rules of the Free Zones may affect the shareholders differently.

2. Different Free Zones

Different Free Zones give different rights and benefits to the shareholders of a company. Highlighting the distinction given by the DMCC Free Zone, which is unique for shareholders from all the other Free Zones in the Emirate of Dubai. Choosing the correct formation for the company enables the shareholders to tailor their rights and obligations to suit the purpose of the business and, thereby, ensure the company’s smooth operation. This publication will explore these differences by first establishing a comparison between Mainland and Free Zone companies for the purpose of shareholders and then analyze the differences between Free Zones.

Mainland and Freezone comparison for shareholders

There is no longer a distinguished difference between Free Zones and Mainland companies since the UAE waived the obligation to have 51% ownership of a UAE national in Mainland companies. However, the Mainland may offer some unique benefits that may be attractive to businesses. These are explored followingly by setting out the difference between Mainland and Free Zone companies:

1. Mainland

Article (5)(1) of the Federal Decree LAW No. (32) of 2021 on Commercial Companies lays down the definition of Mainland companies by excluding Free Zone companies. Accordingly, Mainland companies are formed outside the Emirates’ Free Zone. A Mainland company must be registered with the Emirates Department of Economic Development (DED), which issues its license. This license benefits the business by allowing it to participate in several different commercial activities, enabling it to reach its maximum revenue potential. Having an address in Dubai boosts the company’s reliability in the eyes of the government and banks. The formation of a Mainland company no longer requires a 51 % UAE national partner with the company, except for very minor selective activities. Moreover, the Mainland formation has no restrictions on companies’ employee visas. The number of visas issued will only be subject to the number of square meters of office space, which a bigger office can increase. Mainland companies will be granted three free visas to the employees, and the company location has no geographical requirements. Thereafter, companies are guided to prime locations where they get the best exposure for their business. These aspects ensure a prompt setup of a business. On the other hand, Mainland companies have higher fees for their formation, which may affect their profitability.

2. Free Zone

If you seek more flexibility in the company’s set-up, a Free Zone company is a good alternative, as you can obtain the license without renting an office, unlike a Mainland company. Moreover, the Free Zone company shall be operational inside the Free Zone, where each Free Zone has a specific area for renting an operational office; if desired to rent an office and operate outside of the Free Zone, the company shall be subject to obtaining a non-objection letter from the Free Zone. With regards to visas, Free Zone companies are restricted in the number of visas they can apply for. Depending on the specific Free Zone regulations, this can range from 4 to 5 before you are requested to change from a shared workspace to an independent workspace or an office. Moreover, the Free Zone companies also have a lower formation fee than Mainland companies, making it easy for start-ups and smaller companies. Unlike Mainland companies, the banks do not see Free Zone companies as trustworthy. This is due to their shared desks and the absence of a physical office requirement.

3. Take out

Hereby, there are no significant differences between Mainland and Free Zone companies from the business and operations point of view, except for minor distinctions in visa issuance, preference of UAE government and banks, as well as the easiness of establishing Free Zone company compared to a Mainland Company. Moreover, the Free Zones may be excluded from Federal Company Law. However, it does mean that it is excluded from all applicable federal laws, such as tax law and VAT law. In conclusion, the preference depends on the company’s specific business purpose and operations.

Laws and regulations in Free Zones

If the company is formed in a Free Zone, it is essential to seek the laws of the particular Free Zone where it was formed and ensure that these are drafted in the shareholder’s agreement according to the roles and obligations of the shareholders. This is because the regulations of the Free Zones may vary from one another. Free zones in the UAE include the Meydan Free Zone, Dubai International Financial Centre Free Zone and DMCC Free Zone. Most of these have similar rules for shareholders; however, some provide unique regulations, such as the DMCC Free Zone, which grants an exception to the general prohibition on class shares and exclusion from Federal Company Law. This will be explored in detail below. 

Why is DMCC unique for shareholder agreements?

Generally, in the UAE, it is prohibited to serve class shares to shareholders, nor is it allowed for shares to hold different voting rights. This prohibition is laid down in Article 208 of the Federal law No. (32) of 2021 on Commercial Companies, stating that (1) ‘’unless otherwise provided for in this Decree-Law, the rights attached to all shareholder shares shall rank pari passu and the Company may not issue different classes of shares’’. This applies to both Mainland and Free Zone companies, which are subject to Federal company law; most Free Zone regulations apply the same restrictions. However, the DMCC Free Zone provides a distinctive exception to this rule by permitting different class shares. It is the only Free Zone in the Emirate of Dubai that allows this for its shareholders. Section 6 (27.1) of the DMCC Company Regulations 2022 permits classes of shares, which are subject to complying with the rights of each type of share specified in the regulations. Section 25 (184.9) excludes DMCC companies from Federal company law on commercial companies.

An exception to the above, Mainland companies may be permitted classes of shares, possibly through section (2) of Article 208 Federal law No. (32) of 2021 on Commercial Companies; ‘’…the cabinet may, based upon the proposal; of the chairman of SCA, issue a resolution specifying other classes of shares…’’ Thereby granting the exclusive right to exercise different classes of shares.

1. Different classes of shares

If the shareholders wish to adopt this provision, the best way is to form the company in the DMCC Free Zone, and it shall comply with its rules and regulations with respect to class shares. The DMCC Company Regulations 2022 sets the rule book for class shares. It outlines the rules by identifying the operations and types of class shares permitted and existing in the DMCC Free Zone. Different classes of shares refer to each share’s different costs, characteristics and rights. This way, the shares can be defined and classified into their class. For instance, the shares can be labelled as a ‘Class A Share’ or a ‘Class B Share’. The Free Zone of DMCC exclusively grants this possibility through share capital alterations, such as i) alteration consisting of an increase in share capital by creating new shares or ii) consolidation of all or issued shares in shares of more considerable sums than existing shares and iii) the possibility of subdividing the shares into smaller sums of shares than the ones that were existing. This gives the shareholder flexibility to execute his share class in the most preferable way to him.

2. Increase and decrease in share capital

The ways to increase the share capital with class shares in DMCC can be done in various ways: through an injection of cash, a non-cash consideration or an ‘in kind’ payment. The share types have no payment restrictions; these can all vary. The way the reduction in share capital is granted is by extinguishing or reducing liability on any of its shares, cancelling paid-up share capital, which is lost or unrepresented by available assets, reducing the number of such shares, paying off any paid-up share capital which is more than the requirements of the company, reduce the share premium account or other reserves. However, if a company has voluntarily suspended its license, a restriction shall apply, not granting the company to apply for an alteration or reduction in its share capital. Moreover, if any transfer of shares is made with the sanction of the liquidator or if any other alteration is made in the shareholder’s status after a voluntary winding up, it shall be void. However, there shall be no sanctions according to the DMCC Company Regulations 2022 or the DMCC Practice Note 2023.

3. Share structure

Each shareholder is permitted to hold different classes of shares, adhering to the rule that 80% ‘should’ be ordinary shares. If, in any case, the company’s new shares are other than ordinary shares, the company is suggested to incorporate non-standardized articles of association to define the rights of such shares. Moreover, if any share capital decreases, a publication shall be implemented for 14 days. With respect to an increase in share capital, a board resolution shall be drafted to approve the increase in the company’s share capital. The documents required for class shares include a certificate of incumbency, which shall be legalized and notarized in the place of issuance of the UAE embassy, and a shareholder’s resolution, which shall be printed on the DMCC company’s letterhead with a stamp. It must be noted that the above rules are considered from the point of view of corporate shareholders; the rules may differ for an individual or an individual + corporate shareholder.

Conclusions

In summary, each Mainland, Free Zone, or specific Free Zone company is equally suitable for its shareholders for the purpose of shareholder agreements. The company formation platform depends on the company, its purpose, and its aims. Accordingly, the shareholders’ rights and obligations shall be drafted in the shareholder agreement according to the specific rules and regulations of the Free Zone or mainland. This way, you can ensure that your shareholder agreement is binding on the company’s shareholders, with the specific laws therein.

Table identifying the critical distinctions between Mainland and Free Zone company formation.

Nour Attorneys and Legal Consultants can help you form your company in the Mainland or Free Zone according to your business’s aims and objectives.

Jasmine Dear

Legal Consultant