Bond Adams looks at the legal considerations when corporates and high net worth individuals are looking to invest into the UAE
In 2021, for example, the number of investors financing UAE-based start-ups and early-stage companies grew by 54% when compared to 2020 and there was a notably higher proportion of investors coming from outside of the region in 2022 compared to 2021.
For foreign Venture Capitalist (VC) investors, the main consideration is the jurisdiction of incorporation of the target company and its operating subsidiaries. It is also important to note where its overseas branches are based.
Companies in the UAE are either incorporated onshore or in a free zone.
Companies that are incorporated onshore are formed and managed within the mainland jurisdiction of the relevant Emirate. They have unrestricted access to the UAE market. Equally, they are subject to the laws and regulations passed by the local and federal Emirati authorities. Free zone companies are incorporated in special economic zones. They are restricted from dealing in mainland UAE and are largely governed by their own legal frameworks, whilst also remaining subject to many of the federal laws.
Considerations where the target company is incorporated in the UAE
In general, mainland UAE companies are not a popular choice for VC investors. This is because:
- the legislation governing mainland companies does not allow for the creation of more than one class of shares;
- parties are limited to the extent that they can amend the standard articles of association of the company;
- there is ambiguity regarding UAE courts’ willingness to enforce contractual provisions requiring specific performance, particularly regarding matters such as the mandatory transfer of shares, preferring to award damages instead, which is not always an appropriate remedy in VC scenarios. As these types of provisions remain largely untested for companies incorporated in the mainland, this can lead to uncertainty around an investor’s ability to enforce those types of rights, which is naturally a deterrent for sophisticated VC investors; and
- despite recent changes to the law, foreign ownership restrictions can still apply to certain activities and sectors which will potentially limit a foreign investor’s ability to hold both the legal and beneficial interest in their shares.
Similarly, many of the challenges described above also apply to companies established in the majority of the free zones established in the UAE.
Financial Free Zones
As a result, VC investors often prefer to invest in target companies incorporated in one of the recognised financial free zones which have common law regulatory and legal systems, such as the Dubai International Financial Centre (DIFC) or the Abu Dhabi Global Market (ADGM). This is because they allow investors to benefit from the more complex and flexible shareholder arrangements that are typical for venture capital investments. These are enforceable under the common law legal framework of these free zones. For example:
- it is possible to issue multiple classes of shares with different rights attaching to them and to create bespoke articles of association. This is provided they comply with the laws and regulations of the relevant free zone;
- generally, the procedural and administrative requirements for matters such as share transfers, amendments to constitutional documents or other company secretarial-type transactions are more straightforward and efficient; and
- investors can also obtain greater comfort that more sophisticated contractual rights such as ‘drag and tag’, good leaver / bad leaver provisions, put and call options and so on are generally recognised and enforceable in these free zones.
It is also worth noting that both the DIFC and the ADGM-free zones have their own courts. They are generally considered to be more efficient and transparent than the onshore courts. They benefit from proceedings being in the English language, which is often an important factor for foreign investors.
What to look out for where a subsidiary or branch within the target group is incorporated in the UAE.
A VC investor will need to have regard to the jurisdiction of incorporation of any of the target company’s subsidiaries. In particular, where a subsidiary is located onshore, the investor would need to understand whether that company remains subject to any foreign ownership restrictions.
Recent changes to the law have increased foreign ownership from 49% to up to 100% for many commercial activities. Despite this, if a local shareholder is required as a matter of law, the investor will need to consider its options in this regard. This includes the potential need to have a suitable local nominee shareholder, together with a full suite of nominee arrangements in place which provide the investor with the maximum management and economic rights permitted under law. Where these agreements are either insufficient or inadequate to protect the investor, the investor should ensure they are amended before completing their investment.
Jurisdiction
In some circumstances, a target or one of its operating companies may have established branch offices located in mainland UAE. A branch is not considered to be a separate legal entity but an extension of its parent company. It can carry out the commercial activities of its parent company in another jurisdiction – i.e., in the mainland. Investors will need to be aware that the liabilities of a branch are not ringfenced from the parent as they would be with a separate limited liability company subsidiary.
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