2- The Invalidity of Limited Liability Company (LLC)

Problems, Risks and Court Precedents

 

The Invalidity of Limited Liability Company (LLC) that have Nominee Shareholder and/or Trustee to meet National Partner ratio (51:49) as per UAE laws.

 

Introduction:

 

Foreign Investors who want to start an investment in the UAE in the form of a LLC in the Mainland with 100% foreign ownership, should invest in a company with exempted activities authorized with 100% foreign ownership and shall invest the minimum company capital plus fulfill the requirements mandated by the concerned authorities to confirm the exemption for full foreign ownership of the LLC. Most of the Foreign Investors will not be able to meet the capital requirements to obtain such exemption, which forces the Foreign Investors to have a National Partner with minimum ownership of 51% of the company shares.

 

There is limited availability of the of National Partners, who are willing to contribute 51% of the company’s capital plus further Capital Contribution as per the business needs. Due to this, most of the  advisors and consultants advise their clients to have a UAE National acting as a Nominee Shareholder and/or Trustee to hold the shares in favor of the Foreign Investor. However, this solution is illegal and not recognized under the existing laws. In order to deal with this situation, there is another alternate remedy formulated by Nour Attorneys which will ensure that the requirements of law are fulfilled and the legality of the investment is maintained. This will result in protection of the LLC from liquidation and will also ensure that the partners are protected from criminal charges.

 

To find a list of the exempted activities and minimum capital requirement to start an LLC with full foreign ownership in a Mainland, check the “Cabinet Resolution No. 16 for 2020 Concerning the Determination of the Positive List, Economic Activities which is subject to Direct Foreign Investment and Raito of Ownership”.

 

First: The Requirement of Law for holding 51% ownership share by the National Partner and its effect on the Legality of Investment.

 

Every company that is established in the United Arab Emirates, Mainland is regulated under the Federal Companies Law except Free-zones and Financial Zones. The best choice for the  investors to start the investment is in the form of an LLC to ensure that their liabilities are limited to the capital of the company and to protect their personal properties. The law requires the National Partner to own a minimum of 51% of shares in the LLC formed in Mainland, except for the exclusive activities stated in the new Cabinet Resolution.

 

Moreover, it is pertinent to note that the companies in general are also regulated under UAE Federal Civil Transactions Law. The articles related to formation of the companies are stated in Chapter 3, First Branch, Articles between 654 to 709.

 

The Law requires that minimum of 51% of shares in LLC must be owned by a National Partner, however, this will result in specific legal concern with respect to ensuring that the ratio of share percentage of the National Partner is as per the below mandate:

 

  • A Limited Liability Company must have a National Partner owning 51% of the Company’s Shares as per the Federal Companies Law. However, there are some exceptions as per the new Cabinet Resolution, otherwise the Company will become invalid and that will result in liquidation of the company.

 

The National Partner must own a minimum of 51% shares of the LLC as per Article 10 of the Federal Companies Law. Any assignment, selling or transferring of the ownership of the National Partner’s shares to a Foreign Partner that prejudices the 51% share ratio prescribed by the above article shall nullify the company and the company’s partners may face criminal charges.

Article 10 of Federal Companies Law:

  • With the exception of general partnerships and limited partnerships in which joint venture partners must be citizens of the State, each company incorporated in the State must have one or more national partner holding not less than 51% of the Company’s capital.

 

  • By way of exception from the provisions of item (1) above, Cabinet may, upon a proposal from the Ministry and in coordination with competent authorities, issue a decision,- determining category of activities that may only be practiced by citizens of the State.

 

  • Any assignment of shares to any partner resulting in violation of the percentage set out in items (1 and 2) of this Article shall be null and void.

Accordingly, any Foreign Investor who wants to establish an LLC in the UAE must have a National Partner holding at least 51% of the total shares of the company, whereby the Foreign Investor shall own 49% of the total shares of the company.

 

  • If proven that any statement in the MOA is not matching the true partnership terms, the company shall be declared invalid, which will result in the Liquidation of the company.

 

As per the Court precedents included in this Publication, if any statement mentioned in the MOA violates the existing partnership or is contrary to the terms of the partnership, the company as well as the partnership will become invalid and void thereby constraining the court to independently issue its judgement enforcing liquidation of the LLC without the request of the parties

This kind of disputes commonly arises between the partners of the company having MOA in violation of the existing laws or when the heirs of the UAE National Partners are not aware about the true terms of the partnership. In both the scenarios, if it has been brought to the courts attention that the MOA of the company is in violation to the actual partnership terms i.e. violating the 51% share ratio of the National Partner, the courts issued the judgement enforcing liquidation of the LLC.

  • Partners are subject to criminal penalties for violating the Federal Law No. 17 of 2004 concerning Combating Commercial Fronting.

 

The law concerning Combating Commercial Fronting prohibits any kind of Side Agreements which will violate the National Partner shares ownership ratio by assigning it to Foreign Investors. However, we are not aware of any implementation of this law till the present day but it is still a valid and active law. Violation of this law can result in levy of AED 100,000.00 fine for each covered activities. In case such violations are repeated, the punishment shall be jail for two years and a fine of AED 100,000.00. This law is applicable to professional activities and commercial activities. This scenario shall only occur if the shares of the Foreign Investor exceeds the National Partner’s shares.

 

Article (2) of Fighting Commercial Cover Law

It is prohibited to act as a front for any foreigner – whether a natural person or a body corporate – by using the name, license or commercial register of the front or by using any other method in light of the definition of fronting stated in Article (1) of this law.

 

  • A true National Partner shares will entitle him to have the majority of voting rights, powers in all the general assembly meetings which may raise other concerns according to the Federal Companies Law.

 

Even if the Foreign Investor bring a National Partner to meet the legal requirements with minimum profit ratio and a loan to the National Partner that will justify the Capital Contribution on behalf of the National Partner, without signing any Side Agreement, the  National Partner will still have a major control and say in the management of the company through the voting rights attached to his shares in the general assembly meetings.

 

National Partner will hold 51% of the voting rights of the LLC, which are attached to the ownership of the shares; this is a majority of voting rights in the company’s general assembly meetings. The relevant article is produced below:

 

Article (95) of Federal Companies Law:

 

General Assembly Meeting Attendance

 

Any partner shall have the right to attend the meetings of the General Assembly whatever the number of shares owned thereby and he may delegate by a special authorisation another non-manager partner or any other third party permitted by the memorandum of association to be appointed for the representation of the partner in the General Assembly. Each partner shall have a number of votes equal to the number of shares owned or represented thereby.

 

There are other concerns/ risks  that may rise with respect to the National Partner’s voting rights.  The solution for mitigating/ minimizing this risk is  explained in detail in the next Article.

 

Second: The Common Practice of signing Side Agreements with National Partner resulting in the invalidity of LLC

It is a general practice followed by some advisors and consultants in the UAE to recommend the execution of Side Agreements to a Foreign Investor who wishes to avoid the ratio of the National Partner and have the full ownership and control of an LLC in the UAE Mainland. The Side Agreement is introduced with the objective of assigning the true ownership of all the company’s shares including the 51% shares registered under the name of the National Partner to the Foreign Investor. This shall include all beneficial interest and/or economic benefit in the shares while paying the National Partner an agreed fixed annual fee as mentioned in the Side Agreement, as well as exempting the National Partner from all the risks, liabilities and losses.

Side Agreements are usually signed confidentially between the parties and shall only be revealed when it is required to disclose the actual partnership terms to a third party or to the court. The National Partner (who may be either a UAE National or a company fully owned by a UAE National) agrees to waive all rights to (i) receive dividends accordingly; (ii) exercise voting rights in the company’s General Assembly meetings; and (iii) receive any proceeds of the sale of the shares nominally held by them. Also, it will include the declaration by the Foreign Partner stating that the National Partner shall not be liable for any losses, liabilities and/or dues pertaining  to the LLC.

The National Partner is usually considered as a Nominee Shareholder of the company, holding shares nominally, that is, only in name and as a Trustee holding the shares based on trust for the benefit of the Foreign Investor who is the Actual Owner of the shares and is solely entitled to the income and capital gains as well as the full annual dividends of all the shares.

However, these Side Agreements are very risky and do not adequately protect the investments of the Foreign Investor as they are: (i) invalid ab initio because they violate articles of the Federal Companies Law and Civil Law which are part of the Public Order; and (ii) not recognized by the UAE Courts in all court precedents including the cases briefed below.

Third: Court Precedents that state/ mention about

 

the illegality of the general  practice of Side Agreements

It is pertinent to note that any assignment, transfer and sale of National Partner’s ownership of the shares to a Foreign Partner which  prejudices  the 51:49 ratio prescribed by the Federal Companies Law is null and void ab initio. Accordingly, Side Agreements are void as they do not meet the legal requirements of UAE Federal Companies Law and the Courts will not recognize any Side Agreement as stated in the following precedents in different scenarios:

 

  1. Dubai Court Precedents:

 

  • Judicial Commercial Cassation No. 195 Year 2011, Dubai

The claimant has filed a claim against one LLC and its three partners claiming AED 1,761913.73 plus 9% interest based on bounced cheques which equals to an amount of AED 1,545,931 and outstanding invoices of AED 212,982.73. The claims are based on the invalidity of the LLC as the two partners did not pay the capital contribution as per the statement in the MOA of the LLC.

The claimant argued that the LLC is invalid as the second partner has submitted the Nominee Shareholder Agreement and this agreement stated that the payment of the company’s capital shares did not occur as stated in  the MOA as well as, the Nominee Shareholder Agreement stated that he is a Nominee Shareholder which is against the Federal Companies Law. The claimant has requested the court to force the Foreign Partners to pay all LLC liabilities as per their Side Agreement according to the terms of the Side Agreement that they will be personally and fully liable for all the debts of the company.

The court has set the principle that any person that states any misleading or untrue information or any statement that is against the principles of the MOA will cause the absolute invalidity of the company. This shall include reducing the National Partners shares to less than 51% or whoever paid the capital of the company or any detail stated on the MOA.

The court has stated that any partner that joins such a company at the time of its formation or after its formation shall be personally liable for all its debts against other third parties.

 

  • Judicial Commercial Cassation No. 7 Year 2009, Dubai

The court has set the principle that any person that states any information which is untrue or against the law/ principles as mentioned in the MOA will cause the absolute invalidity of the company. The parties in this case has claimed that the National Partner is not a true partner in the company and only a Nominee Shareholder.

 

  • Judicial Commercial Cassation No. 46 Year 2010, Dubai

The claimant is a National Partner who has filed a case against the manager of the company for manipulating the accounting books and stealing company monies. The manager argues by defending himself by stating that he is the true owner of the company and the National Partner owns 99% of the company and the remaining 1% are registered in the name of father of the National Partner as a Nominee Trust holder. The court has confirmed the principle that any person that states any information that is not true or against the law/ principles as mentioned in the MOA will cause the absolute invalidity of the company.

 

  1. Abu Dhabi Court Precedents:

The following are the briefs of the Court precedents issued by Cassation Court of Abu Dhabi Emirates:

  • Judicial Cassation No. 166 Year 2017, Judicial Year 11 Abu Dhabi

The claimant has been a partner in a company owned by a UAE National Partner where he has purchased 50% of the company’s shares and assets. He requested the court to compensate him with AED 401,000.00 plus interest and compensation as well as claim the nullification of LLC as the National Partner ratio has become less than 51% of the shares.

The court has issued its judgment declaring the LLC as invalid and thereby liquidating the company. The parties on the case were arguing about the effect of liquidation from the date of judgment or date of partnership.

The concerns related to our Publication are that the company will be invalid and/or void if it has been formed with a UAE National Partner owning less than 51% of the shares of the company.

 

  • Judicial Cassation No. 153 Year 2012, Judicial Year 7 Abu Dhabi

The owner of a company has requested the court to nullify the decision of the Second and Third Party issued on 8/8/2007 by removing him from the management and to return all the company’s related documents, papers, contract seized by them, with subsequent request to liquidate the company and allow him to replace the current UAE National Partner owning 51% shares of the LLC. The argument is that the Third Party was a solo Nominee Shareholder for a “Personal Establishment company” (not an LLC) receiving only 25% of the profit without bearing any liabilities or losses. Then, on the date of 22/10/2007 the company was converted to a limited liability company and the Third Party became a Nominee Shareholder for 51% shares required to be owned by a UAE National Partner for an annual fixed fees. The Third Party who is a National Partner kept receiving a fixed lump sum amount. The Second Party later on joined as a partner owning 24% of the company. The Second and Third Partner later issued a decision to remove the Actual Owner from the management of the company and seized the documents, papers, contracts and assets of the company.

The court has issued its judgment to reject the main request and accepted the reserved request of liquidating the company and appointing a liquidator to liquidate the company assets. The court’s judgment did not state the reason of rejecting the main claims, but it is because the invalidity of the company’s conversion to an LLC as well as the National Partner has requested for the liquidation of the company and not restating the company to a previous state.

The concern related to our Publication is that the court will liquidate the company in case the ratio of the National Partner is less than 51% of the company shares.

 

  • Judicial Cassation No. 462 Year 2017, Judicial Year 11 Abu Dhabi

On the date of 1/5/2005, the owner of Restaurant has sold 50% of his shares in the restaurant  to a Foreign Investor. Later on 23/8/2016 the owner sold the other 50% of the shares. The owner promised to transfer the ownership within a month but did not complete the transfer of the sales that is equal to an amount of AED 660,000.00. The buyer has filed the case claiming a full refund of sales consideration plus a penalty charge that is equal to AED 300,000.00.

The Court has declared that the sales are invalid, and the owner has to refund the full sales consideration to the buyer and reject the claim for agreed penalty. This is due to the fact that the sales contract has been declared invalid due to it being not registered and not being attested by the Notary Public and all changes with company shares shall be made in writing according to the law.

The concern related to our Publication is that the court will reject the Side Agreement as it is not registered within Notary Public who will not accept to attest any agreement that violates the Federal Companies Law concerning the National Partner ratio.

 

The Solution

The only solution to the problem of the invalidity of LLC with the Nominee Shareholder Agreement is to allow the National Partner to be and act as a definite and true partner in the company. However, the risks that are raised with the National Partner owning 51% of the company shares should be minimized by a legal solution such as limiting the voting rights and reducing the profits distribution ratio to the minimum under the law as well as distributing the assets of the company during liquidation in accordance with the profit distribution ratio and other concerns are elaborated in the following  Articles.

Nour Attorneys have taken into account the potential risks that may be faced by the Foreign Investors and carefully examined them against (1) the laws and regulations in the UAE as well as; (2) the judicial precedents in the UAE Courts (Abu Dhabi, Dubai and Federal Courts);  (3) the judicial references from legal scholars with proposed legal solutions; and (4) the formalities required for each legal solution to ensure that it cannot be challenged in the courts for invalidity neither can it be terminated under any circumstances.

Nour Attorneys have reached a legal solution which is a combination of legal agreements, process and formalities that will settle the risks that are raised with the 51% shareholding of the National Partner, as well as, give full control to the Foreign Partners over the LLC in accordance with the law. Additionally, Nour Attorneys may bring a corporate National Partner in the LLC that is willing to sign all these Agreements and execute them, because the interpretation and contents of aforesaid documents may not be readily accepted by the individual National Partners, however, the corporate National Partner which we will suggest will sign these documents and proceed will all the agreed process and formalities without any hassle.

 

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Lawyer & Legal Consultant
Mr. Mohamed Nouredin