Is the UAE Financial System strained by sufficient securities for credit?

The recent legislative changes, including Federal Law No. 50 of 2022 (the “New Commercial Code”) and Federal Law No. 23 of 2022 (the “New Banking Law Amendment”) has impacted the financial system in the UAE. These laws have introduced new provisions and obligations for licensed financial institutions, emphasizing the need for ‘sufficient guarantees’ in all types of facilities provided to natural clients and private sole proprietorships. As a result, there is concern within the financing community regarding the interpretation of these provisions and the potential prohibition of unsecured financing under UAE law.

I. Are the legislative changes a concern?

Analysing the language and intent of the new laws is essential to answering this question:

1. The New Commercial Code (Federal Law No. 50 of 2022) has come into effect, superseding the Old Commercial Code (Federal Law No. 18 of 1993). Under Article 409(2) of the Old Commercial Code, loans could be secured with assets and conditions of the agreement. However, Article 409(2) of the New Commercial Code stipulates that banks must now have sufficient assets or guarantees for all loans they provide.

2. The New Banking Law Amendment (Federal Law No. 23 of 2022) came into effect, introducing several modifications to Federal Law No 14 of 2018 (the Banking Law), particularly new Article 121 (bis) (Credit Facility Guarantees), which mandates that:

  • licensed financial institutions secure “adequate guarantees for all types of facilities extended to natural clients and private sole proprietorships, in accordance with the client’s income or the guarantee, if any, and the size of the required facilities, as determined by the Central Bank.”
  • It is specified that “no application, action, or claim submitted by any licensed financial institution to the competent authorities or arbitration tribunals regarding a credit facility granted [to such an entity] shall be accepted if the financial institution fails to obtain [sufficient guarantees].”
  • Furthermore, the Central Bank may impose administrative and financial penalties as it deems appropriate on licensed financial institutions that violate these provisions.

On the face of these provisions, it is possible to interpret them as prohibiting unsecured lending in the UAE. The New Banking Law Amendment requires that “all” financing facilities provided to “natural persons and private sole proprietorships” be backed by “sufficient guarantees”, further supporting that interpretation. Here, the word “guarantees” seems to be used in the broader sense of collaterals as a whole (i.e. both guarantees and security, as opposed to strictly guaranteed credit support, or in another way, “in-kind guarantees” as opposed to “purely personal guarantees”). 

If a financial institution does not satisfy the requirement of ‘sufficient securities’, it runs the risk of being unable to file a claim against the relevant borrower to enforce the debt claim under Article 121 (bis). In addition, the Central Bank may impose an administrative and/or financial penalty on the institution. There is a degree of unease in the UAE financing community as a result of the combination of these provisions. In the absence of any official clarification when these provisions took effect, financiers were unable to get a sense of what the UAE legislators meant by these provisions, and this remains the case (subject to the judgments and circulars referred to below, among other things). 

II. How did the UAE judiciary interpret the laws?

The ambiguity surrounding the interpretation of these recently implemented legislations has arguably intensified as time has passed. Specifically, the issuance of inconsistent judgments and circulars in Abu Dhabi and Dubai has further aggravated uncertainty regarding the application of these laws across different courts in the UAE. 

A. Position of Abu Dhabi:

1. The Head of Judiciary Counsel of the Judicial Department in Abu Dhabi issued Explanatory Circular No. 3 of 2023 (the Abu Dhabi Circular) regarding the execution of Article 121 (bis) and affirmed that:

  • The retrospective effect of Article 121 – the amendments shall apply to all ongoing legal disputes that are based on facility arrangements, with no regard as to the date of signing the facility and relevant guarantee(s);
  • Personal Guarantees are not sufficient – The banks may not grant banking facilities based on securing a personal guarantee only (i.e. a guarantee from an individual (i.e. a natural person) or, it is submitted, possibly a guarantee from a sole trader company (i.e. a private sole proprietorship). However, they should acquire additional securities for that purpose. Therefore, credit facilities that solely possess a “pure personal guarantee” rather than an “in-kind guarantee” (i.e., backed by security) are not legally binding according to UAE law;
  • Cheque as a Guarantee – To the extent a cheque is given as a guarantee, any execution proceedings arising from a default thereof would be limited only to the extent of the value guaranteed. The execution proceedings would not extend to all the personal assets of the defaulter, and neither can he be imprisoned nor a travel ban be imposed against him; and
  • Broader Application of the Circular – In contrast to Article 121(bis), which only applies to “natural clients and private sole proprietorships,” the Abu Dhabi Circular expansively applies the interpretations to “individual institutions and companies,” leading to further uncertainty about whether LLCs are included in Article 121(bis).

            (hereinafter the “ADJD Interpretation”).

Based on the ADJD Interpretation of Article 121(bis) [prior to the Abu Dhabi Cassation Court decision, which is discussed below], the Abu Dhabi Court of Execution had stayed several execution proceedings against judgment debtors. 

2. Subsequently, the Abu Dhabi Court of Cassation (in Appeal No. 102/2023 and Appeal No. 111/2023) (the Abu Dhabi Cassation Decision) held that Article 121 (bis) does not have retroactive effect and does not apply to credit facilities pre-dating 2 January 2023. 

B. Position of Dubai:

In Dubai, however, Court of Cassation in Appeal No. 995/2023 held that Article 121 (bis) does not extend to a limited liability company which borrows money (i.e. its remit is narrower) (the Dubai Cassation Decision). Amidst the contradictory positions taken in Abu Dhabi, the Dubai Cassation Court has rendered its decision in line with Article 121 (bis) which only applies to “natural clients and private sole proprietorships”.

III. Is the position clarified now?

Unfortunately, no. It is difficult to fathom the ADJD Interpretation, in particular:

1. There is no express reference to all companies in Article 121 (bis). It only refers to the narrower “natural clients and private sole proprietorships”. The reference to “companies” could have been a mistake or a deliberate attempt at a broader interpretation of the protection intended by Article 121 (bis), but there is no clear reason to support such an interpretation. The Dubai Narrow interpretation better aligns with a straightforward reading of Article 121 (bis).  This is supported by the fact that Article 121 (bis) is found under “Customer Protection” in the Banking Law. This implies it applies to consumer lending, meaning to individuals and not companies. 

2. The retroactive effect of Article 121 (bis) goes against the principles outlined in Article 112 of the UAE Constitution, which prohibits the retroactive application of laws unless there is a necessity for it and the law explicitly allows for it, excluding criminal cases. The Abu Dhabi Cassation Decision aligns with the UAE’s Constitutional position on retroactivity. 

3. The Abu Dhabi Circulars pertain to the local judiciary, whereas Article 121 (bis) is a law enacted at the federal level. According to UAE law, the local judiciary circulars cannot alter the interpretation of federal statutory provisions. This raises doubts about the proper recognition of the Abu Dhabi Circulars under federal UAE law. However, in practice, federal-level laws must still be enforced by the courts of each Emirate, making the Abu Dhabi Circulars relevant, particularly for those involved in Abu Dhabi.

IV. What does the High Court of England and Wales think about Article 121(bis)?

Following a comprehensive examination of the legal framework in the UAE, including the ADJD Circular and the judgments made by the Abu Dhabi Cassation and Dubai Cassation, as well as the Constitution of the UAE, the High Court of England and Wales has issued its perspective on Article 121 (bis) in the case of InvestBank v. El Husseini & Others [2023] EWHC 2302, dated September 23, 2023 (InvestBank Judgement).

In this case, the High Court of England and Wales concluded that Article 121(bis) does not encompass corporate borrowing or personal guarantees related to corporate borrowing. The judge further clarifies that the term “limited liability company” refers to a separate entity from sole enterprises or joint stock institutions. The judge acknowledges that if this interpretation were to be reviewed by the highest court in the UAE, it is likely that they would adhere to the plain wording of the article, considering its purpose of consumer protection. 

The court also concluded that Article 121 (bis) should not be applied retroactively, based on the UAE Constitution. The law’s purpose of promoting consumer protection indicates that it is meant for loans granted to individuals and sole trader companies only, not for corporate or commercial lending. The Abu Dhabi Circulars, being decisions of local courts and not federal courts, were not given much weight. However, it remains to be seen how the UAE courts will interpret the InvestBank judgment in the future.

Even though the courts of England and Wales have no formal jurisdiction in the UAE to decide on matters of UAE law, this case will be of great interest because of the emerging trend of increasing reciprocity between the courts of England and Wales and the courts of the UAE.

V. How does DIFC Court interpret Article 121(bis)?

In the case of Punjab National Bank v. NMC Healthcare Ors, it is interesting to observe that the applicability of Art 121 was raised before the DIFC Courts. On 19 Jan 2024, the DIFC Court issued its judgment, which coincided with the positions held by Abu Dhabi Cassation, Dubai Cassation, and the High Court of UK. 

In this case, an Indian bank had lent to NMC Healthcare and the facility was secured through corporate guarantees as well as personal guarantees. While the facility itself was governed by DIFC laws, the guarantees were governed by UAE laws. 

In this instance, the DIFC Courts concurred with the decisions issued by Abu Dhabi Cassation, Dubai Cassation, and UK High Court, and ultimately determined that (“DIFC Decision”):

  • Art 115 of the New Banking Amendment does not apply to financial free zones such as DIFC.
  • The Indian Bank’s branch in DIFC was regulated by DFSA and fell outside the purview of the New Banking Amendment.
  • Article 121 bis does not apply to make the corporate guarantee unenforceable because it does not apply to lending to a corporation.
  • Art 121 bis applies to “facilities provided to the natural clients and private sole proprietorships”, A corporation is not a natural client or private sole proprietorship.
  • Art 121 bis does not apply retrospectively to any loans given prior to 2 Jan 2023

VI. Conclusion

Unfortunately, there is still not a definitive answer to the question posed above. Although the UAE court system is federal in nature, it lacks a precedent system, rendering judgments less informative for market participants. Ideally, a consistent interpretation of the new laws in the UAE would have developed by now, either with the assistance of the Federal Supreme Court or through other means. Unfortunately, official clarification is still pending, leaving market participants guessing the precise meaning of these provisions. Given the varying interpretations across different UAE judiciary bodies, federal-level guidance is needed to address this issue, similar to the approach taken with the New Banking Law Amendment and the New Commercial Code.

While the decisions of the Abu Dhabi Cassation Court, Dubai Cassation Court, the High Court of England and Wales and DIFC Court have had a stab at some of the key points of concern on how Article 121 (bis) is likely to be construed, what is clear is that there remain many points of detail to be ironed out, and this should ideally be done at a federal level. Until these matters have been unequivocally determined, financial institutions would be well advised to tread very carefully and to ensure they structure their financings.