Revisiting the DIFC Insolvency Law in the Context of the COVID-19 Crisis: An Innovative Toolkit for the Turnaround of Troubled Enterprises

In the wake of the high profile collapse of the private equity firm Abraaj Capital, the Dubai International Financial Centre (“DIFC”) updated its insolvency regime with the introduction on June 13, 2019 of the new DIFC Insolvency Law (Law No.1 of 2019) (the “DIFC Insolvency Law”). The recent DIFC Insolvency Law represented a significant enhancement to the previous regime and was enacted following a comprehensive consultation process with insolvency practitioners and a thorough comparative law analysis which helped ensure that the recent DIFC Insolvency Law adheres to global trends and best practice in insolvency.

The DIFC Insolvency Law takes inspiration from some of the key features of the U.S. Chapter 11 rescue mechanics, the English law schemes of arrangements, and the continental law “procédure de conciliation”. In keeping with modern insolvency regimes, its focus is very much on restructuring and rescuing troubled businesses rather than liquidating failed debtors. As such, and with a view to maximizing returns to creditors, debtors and other stakeholders, it provides all classes of stakeholders with the required tools to rescue distressed businesses and help increase the chances that businesses can successfully emerge from distressed situations as viable going concerns. The enactment of the DIFC Insolvency Law (together with the suspension of certain wrongful trading rules on a temporary basis in response to the COVID-19 crisis, as further discussed below) is rather timely in light of the financial pressures that a number of businesses will most likely experience as a result of the COVID-19 crisis. It is a welcome addition to the DIFC’s already robust environment and further establishes the DIFC’s preeminence as a regional hub.

The new rehabilitation (debtor-in-possession) and administration regimes included in the DIFC Insolvency Law improve upon the previously available tools (that is, company voluntary arrangements (CVAs), receiverships, and liquidations) which are retained and have been enhanced. It also retains important protections for creditors, including providing that certain transactions (such as preferences, granting security for existing debt, or disposals without adequate consideration) that take place within periods ranging from six months to two years prior to the start of insolvency proceedings may be declared as invalid and unwound by the DIFC courts. Directors should be mindful, however, that they may be exposed to personal liability in relation to such transactions or their course of conduct prior or during insolvency proceedings.

This briefing supplements our previous Dechert OnPoint entitled “The UAE Bankruptcy Law: Stepping up to the challenges raised by the COVID-19 crisis” which focuses on the “onshore” UAE insolvency regime (which does not apply in the DIFC).

This alert focuses on the following notable features of the DIFC Insolvency Law (but is not intended to be a comprehensive analysis of all features of the DIFC Insolvency Law):

- The new Rehabilitation (or debtor-in-possession) regime;

- The Administration process; and

- Enhanced cooperation in the context of Cross-Border Border Insolvency Proceedings.

This alert also looks at the recent temporary suspension of the wrongful trading rules introduced as a result of the COVID-19 pandemic.

1. Rehabilitation (debtor-in-possession) regime

The rehabilitation regime allows creditors to vote on a rehabilitation plan promoted by the debtor with a view to restructuring its business. As a debtor-in-possession regime, the Rehabilitation mechanics allow the debtor to remain in control as the directors are authorized to continue managing the company’s affairs except in limited circumstances where there is evidence of fraud, dishonesty, incompetence or mismanagement of the company (in which case an administrator may be appointed, as discussed in section 2 below). The debtor’s board shall appoint one or more rehabilitation nominee(s) who must be registered insolvency practitioner(s) and whose role is to assist the debtor and its board with the implementation of the plan (but not run the business). Some of the notable features of the Rehabilitation regime are as follows:

• The main benefit of the Rehabilitation procedure is that, unless otherwise ordered by the court, an automatic moratorium of 120 days shall immediately apply to all creditors (secured or unsecured and without their consent), thus freezing any enforcement proceedings against the debtor. The imposition of a moratorium will restrict the availability of certain further actions to be taken against the debtor while the moratorium is in place; such as, for example, the submission of a petition for the winding up of the company or seeking the enforcement of a security interest in the company’s property.
• During the moratorium, so-called “ipso facto” clauses (that is, clauses providing for specific termination rights for creditors where the solvency of the counterparty is potentially at risk) would not be effective unless termination is expressly agreed to by the debtor, the court or in relation to debts arising after the start of the moratorium period, which have been agreed to by the debtor and remain unpaid after payment falls due. 
• Creditors are entitled to apply to the court to terminate the moratorium for cause (including evidence of bad faith) and the court can grant relief from the moratorium on terms and conditions which it deems to be equitable.
• The creditors are invited to consider the Rehabilitation Plan and if at least three quarters in value of any class of creditors or shareholders agree to the Rehabilitation Plan and it is sanctioned by the court, it then becomes binding on all persons within such class. Two welcome notable features which take their inspiration from the U.S. Chapter 11 Reorganization Procedures are as follows:
  • In certain circumstances, as long as (i) at least one class of creditors affected by the plan approves it; (ii) no creditor is worse off than in liquidation (under the so-called “Liquidation Test”); and (iii) no junior creditor gets paid before senior creditors are paid, the court may still approve the plan.
  • The court is able to approve new financing (also known as “debtor-in possession financing” or “DIP-financing”) during the Rehabilitation process, whilst ensuring that existing secured creditors remain protected.
• If, following the vote of each class of creditors and shareholders, any member of a class considers the Rehabilitation Plan to be unfairly prejudicial or not in good faith or believes that a violation of the requisite procedures has taken place, an application challenging the Rehabilitation Plan may be submitted to the court.

2. Administration

The DIFC Insolvency Law sets out a process for ‘Administration’ which may be applied for by one or more creditors, either jointly or separately, in circumstances where an application for Rehabilitation has been made and there is evidence of misconduct, as noted above. If appointed, the control of the company’s affairs then shifts from its directors to an ‘Administrator’ (who shall be a registered insolvency practitioner). The Administrator shall have wide ranging powers to manage the affairs, property and business of the company including taking possession of the property of the company, selling any property, raising or borrowing money and granting security over the property and bringing and defending actions or legal proceedings.

In considering the application, the court may appoint an Administrator if it is satisfied that the company is, or is likely to become, unable to pay its debts; and (i) it considers that the appointment would likely achieve the approval of a Rehabilitation Plan (as discussed in section 1 above), a CVA (a proposal made by the directors of the company to its shareholders and creditors for an arrangement of its affairs – not discussed in this article but provided for in the DIFC Insolvency Law), or a Scheme of Arrangement under the Companies Law (DIFC Law No. 5 of 2018); or (ii) if the appointment is required in order to facilitate the investigation of any wrongful acts such as fraudulent activity in anticipation of winding up, falsification of company books or transactions at an undervalue. Upon appointment, any application for winding up of the company shall be dismissed and a moratorium shall apply.

3. Cross-Border Insolvency Proceedings

A notable addition in the DIFC Insolvency Law is the incorporation of the UNCITRAL Model Law on Cross-Border Insolvency (as modified by the DIFC) in respect of foreign registered companies (i.e., those incorporated in a jurisdiction other than the DIFC) that are the subject of insolvency proceedings.

The UNCITRAL Model Law will apply where:

• Assistance is sought in the DIFC by a foreign court or representative in connection with a foreign proceeding;
• Assistance is sought in a foreign jurisdiction in connection with a proceeding under the DIFC Insolvency Law;
• Proceedings in respect of a debtor are taking place in both the DIFC and the foreign jurisdiction at the same time; or
• Creditors or other interested persons in the foreign jurisdiction have an interest in requesting commencement of proceedings in the DIFC.

The UNCITRAL Model Law was designed to assist states to allow for more effective cross-border insolvency proceedings by authorizing and encouraging cooperation and coordination between jurisdictions. Given the high number of foreign registered companies in the DIFC, the incorporation of a respected and globally recognized model law is certainly a welcome addition to allow for a streamlined approach to cross-border insolvency proceedings.

4. COVID-19 Measures

In response to the COVID-19 pandemic, the DIFC issued Presidential Directive No. 4 of 2020, effective from April 21, 2020 to July 31, 2020 (subject to extensions) (such period being the “Emergency Period”). In addition to the Presidential Directive’s primary goal of providing more flexibility for employees and employers to deviate from the DIFC Employment Law obligations during the Emergency Period, the Presidential Directive also suspends during the Emergency Period rules relating to wrongful trading. Per the DIFC’s official release of the Presidential Directive, “[t]he wrongful trading suspension is designed to ease the pressure on DIFC company directors fearful of being held personally liable for continuing to trade in a period of heightened uncertainty created by the steps taken to combat the consequence of the COVID-19 pandemic”. It remains, however, prudent for directors of DIFC-based companies to ensure that they carefully consider their decisions, sufficiently document their decision-making process, and seek expert advice early before serious difficulties arise.

Conclusion

The recent enactment of the updated DIFC Insolvency Law represented a significant step forward for insolvency statutory reform for the GCC region. In particular, the rehabilitation regime provides a flexible and modern framework for the rescue of troubled enterprises with a number of innovative features, including not only an automatic moratorium but also contractual termination protections and the ability to bind creditors across classes - as would be the case, for example, in a U.S. Chapter 11 rescue process. Furthermore, the adoption of the UNCITRAL Model Law will significantly improve upon the overall efficiency of cross-border insolvency procedures where there is a nexus to the DIFC. The timely adoption of this enhanced insolvency regime, coupled with the recent suspension (albeit on a temporary basis) of the wrongful trading rules, should provide debtors, creditors, and other stakeholders with an advanced set of tools and a resolutely modern legislative framework to help rescue and turn around DIFC-based businesses experiencing financial difficulties, be it as a direct result of the COVID-19 crisis or otherwise.