4- Profit and Loss Distribution Ratio in LLCs

1. Business Practices to Invest in a Limited Liability Company in the UAE

2. The Invalidity of Limited Liability Company (LLC)

3. The National Partner Controlling the Majority of the Voting Rights in LLC’s

4. Profit and Loss Distribution Ratio in LLCs

5. Distribution of the Company Assets (Fixed and Movable)

6. Invalidity of Fixed Payment Agreements

7. Invalidity of the LLC due to Non-Capital Payment

Introduction

It can be a general notion that appointment of the corporate National Partner as an actual partner, as per our solution may increase the risk, as one may perceive that the corporate National Partner shall be paid as per the percentage of shares owned by the corporate National Partner. However, this requirement is not mandatory and the LLC doesn’t have to pay an equal amount of profit based on the amount of shares held by the corporate National Partner.

First: The  Principles of Law for the distribution of Profit and losses

The partners in an LLC receive dividends for profits but the losses are limited to the share in the company’s capital. The following is the theory laid down by the law concerning the distribution of profit and losses:

1. The Profits Distribution:

According to the Federal Companies Law, the National Partner will automatically be entitled to the profits of the company as per articles 29 (1) of the Federal Companies Law, which states the following:

Article 29 (1) of Federal  Companies Law:

“(1) If the percentage prescribed for a partner in  profits and losses is not specified by the company memorandum, the share of such partner shall be in proportionate to the share thereof in the capital. If the memorandum is limited to the percentage prescribed for the partner in profits, the share of such partner in losses shall equal the share thereof in profits and vice versa.”

Federal Civil Transactions Law on Company advises the same as well, the law did not define a minimum ratio or required it to be reasonable:

Article 659 (1) of Civil Transactions Law:

“(1) The profits shall be distributed as stipulated in the contract.

(2) If the company contract does not state the share of each of the partners in the profits, they shall be distributed in accordance with the share of each of them in the capital.”

In view of the aforesaid, it is clear that the laws does not define specific ratio for profit distribution of the partners and the same is subject to the mutual agreement executed between the partners thereof.

1. The Losses Distribution:

Another principle relating to the distribution of losses as laid down in the Federal Companies Law i.e. as per Article 29(1) the profit ratio shall be equal to the losses ratio. The Federal Civil Law requires that the losses ratio to be equal to the shares owned otherwise the agreed clause is null and void:

Article 659 (1) of Civil Transactions Law:

“(3) Losses shall be distributed among the partners in proportion to the share of each of them in the capital of the company, and every provision to the contrary shall be void.”

In this publication, we will conclude that the parties have to apply the ratio as per the Federal Companies Law as it is the private law specifically for companies and its articles shall overrule the Federal Civil Transactions Law articles pertaining to the company regulations in case of conflict.

If the MOA has violated the Federal Companies Law concerning the losses ratio then what are the consequences encountered? This will be discussed in future publications.

Second: The Limitation under the Laws

In general, the Law sets limitation on the fact that the partners cannot receive a fixed profit ratio and partners are unable to exempt one of them from losses, the limitation laid down by the law to LLC are  as follows:,

1. The Profit cannot be a fixed amount; otherwise the company’s contract i.e. the MOA is invalid.

The law prohibits that the profit sharing ratio be a fixed amount to be paid to a partner. Any such arrangement wherein the profit sharing is set as a fixed amount will be declared invalid and the profit distribution will be set in accordance to the shareholding ratio of the partners (if such partner is not a Nominee Shareholder or Trustee) according to the following articles:

Article 29 (3) of Federal Companies Law:

“(3) If it is agreed in the company memorandum to deprive any of the partners from profit or exempt him from loss or to make such partner receive fixed interest for his share in the company, the memorandum shall be null and void.”

Presuming that the partners set a clause that is external to the MOA to prevent/prohibit the partner from profiting or granting the partner a fixed amount, the Federal Civil Transactions Law has prevented this as well as the reversing of the profit distribution ratio to be the ownership ratio (if such partner is not a Nominee Shareholder or Trustee), according to the following article:

Article 660 of Civil Transactions Law:

“If the partners agree that the share of any of them in the profits should be a fixed sum of money, that condition shall be void, and the profits shall be distributed in accordance with the share of each of them in the capital.”

The Profit ratio shall be a percentage and not a fixed amount and a partner cannot be prevented  from getting his share of profits which he is entitled as per the shareholding.

1. You cannot exempt a partner from profit or losses; otherwise the company’s contract (MOA) will become invalid or ratio will be revered according to ratio of ownership of the shares.

From the bare perusal of Article 29(3) of the Federal Companies law, it is established that the exemption of partners from profit or losses of the company will invalidate the company’s MOA and in case, if the agreement has been concluded outside the contact (if such partner is not a Nominee Shareholder or Trustee) then the profit ratio shall be reversed in accordance to article 660 of Federal Civil Transactions Law as per the shareholding ratio of the partners.

1. The Profit ratio for the National Partner:

For the National Partner, the law does not define any minimum ratio, but the common practice prevailing since long time in the UAE as we can notice is that the minimum profit ratio for the National Partner in the MOA’s is 15% to 20%, however, recently we came across 10% profit ratio as well. If we presume this is an ongoing practice followed  to avoid the Nominee Shareholders or Trustee then we can fix this with an external agreement to reduce the profit ratio to the minimum, as long as we commit to the given solution. In general this profit ratio has no limitation and can even be set at 1% or 0.5% (10,000 to 5,000 in a million) as long as it has been put with specific terms in an agreement.

Third: The Risks with common practice of Nominee Shareholder Agreements

Besides being against the law, the outcome would affect the LLC and might result in invalidation and liquidation of the LLC. Even if we were to pay the National Partner an annual lump sum amount, then it must be paid on the basis of variation ratio that shall not exceed the lumpsum amount but it may exceed in a very small ratio as fixed annual lumpsum amount will be held invalid.

Fourth: The Solution

To avoid the illegality, the assignment of the profit and loss ratio to the National Partner shall be at the minimum ratio of 1% or 0.5% (or even less) with some limitation that will be elaborated in the subsequent Articles wherein we will discuss how to make the payment for fixed lumpsum. If in case, the shareholding ratio prescribed in the MOA cannot be less than 15-20% then we shall execute another agreement justifying the assignment of the 14-19% of the profit to the Foreign Partner.

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Lawyer & Legal Consultant
Mr. Mohamed Nouredin

Business Practices to Invest in a Limited Liability Company in the UAE

1. The Invalidity of Limited Liability Company (LLC)

2. The National Partner Controlling the Majority of the Voting Rights in LLC’s

3. Profit and Loss Distribution Ratio in LLCs

4. Distribution of the Company Assets (Fixed and Movable)

5. Invalidity of Fixed Payment Agreements

6. Invalidity of the LLC due to Non-Capital Payment