IBA Paper Sept 2010 SAH

 

How has the global economic downturn had an impact on the construction industry? - Project insolvency issues

- Getting paid when the money stops flowing 1 By

Stephen A Hibbert2

Introduction  For a consideration of these topics, at this time, you could choose no better region than the Middle East and especially the 2 principal states of the UAE – Dubai aand nd Abu Dhabi.

The events of the GFC, and the ensuing few years, exposed in the UAE the difficulties, complications, inadequacies and incapacity of every element that make up the equation of project solvency/ involvency and getting paid.

Indeed, I would advance the proposition proposition that the impact impact of the GFC, and its aftershocks have been, by an order of magnitude, far more significant in the Middle East, than anywhere else in the world. To support that proposition, I need to set the context in which the GFC affected the Middle East, and then identify what what I submit are the key ingredients in any legal and commercial setti setting ng to address project solvency issues, and to manage the “getting paid” objective.

Some Statistics (UAE) May I concentrate on the UAE, on the basis that, within this region, all of the propositions I wish to advance can be identified and illustrated.

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IBA 4th Biennial Conference on Construction Projects, 17-18 Septmeber, 2010; Brussels, Belgium 2 Director, Abu Dhabi Office, Habib Al Mulla & Co.; www. habibalmulla.com; habibalmulla.com; [email protected]; Adj. Professor, University of New South Wales; B.Eng. (Civil) (Syd); LLM (Syd).

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The geographical size of the UAE approximates to the State of Maine in the USA. The total population of the UAE is about 5-6 million people.

A Federation The UAE is a federation of the 7 states formed in 1971 and ‘72. Of those 7 states, the Emirate of  Abu Dhabi – both a city and a state – occupies ¾ of the UAE’s area, and is also the Fedreal Capital of the UAE.

Wealth For 2010, the GDP of the UAE is expected to be about $350 billion; of which near 70% will be spent on projects and construction. (To put that figure in context, for Australia, with a workforce of about 12 million, it’s 2009 GDP is about $900 billion. The UAE is planning to pass that figure by 2015).

Value of “acitive” projects in the region The significance of the UAE market was highlighted in the just published Dubai Chamber of  Commerce & Indusrty report, where it identified that there are presently $714.9 billion of  construction and infrastructure projects still active in the UAE, out of a total of $1,368 billion in the GCC.

Population vs Wealth Of the 5 million, or so, people in the UAE, only about 20% are nationals, or Emirates. Accordingly, the per capita/GDP, taken in relation to the national population, population, places the UAE, 1st or 2nd on world rankings, to, in 2009, Belgium.

Growth – oil and gas reserves An investment report released by Isthmus Partners, 31 March 2010 said that, based on current utilization levels, the UAE’s oil reserves (95% of which are in Abu Dhabi), will last for at least 150 years.

1998-2008 in the UAE

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There was, and continues to be, a contrast in the strategies for economic development and growth in each of Dubai and Abu Dhabi.

Dubai has pursued the business sectors of being a finance hub (witness the Dubai International Financial Centre – DIFC); the world’s largest port operator (Dubai Ports); tourism and real estate.

Abu Dhabi, to a certain extent, avoided the frantic pace of development Dubai sought to achieve. You will see in the Abu Dhabi 2030 plan ( www.abudhabi.ae and search for “2030 plan”) that the government plans to build a substantial city, centered around international universities and museums. The University of New York has a campus in Abu Dhabi. Both the Guggenheim and Louvre are building new museums and art galleries. The Cleveland Clinic has just commenced construction of the world’s largest hospital in Abu Dhabi. Abu Dhabi’s new Formula 1 GP track – reputably the best in the work (Yas Marina Circuit) - will host its second GP in November 2010.

On the eve of the GFC just how busy was it in the UAE? The most quoted measure of the fenetic pace in Dubai (and, to some extent, Abu Dhabi) was that, in 2007-2008, 27% of the world’s cranes were at work in Dubai.

I prefer, however, this statistic, statistic, in July 2008 - the total value of developments developments underway in Dub Dubai ai exceeded the equivalent total value in all North America.

How did the GFC affect the UAE? It is a debate for others as how to classify the GFC – the USA real estate bubble bursting; a seemingly overnight evaporation in bank liquidity; a loss of confidence in the market (or all markets); the coming home to roost of massive country debt, or, even further, financial mismanagement by governments, corporates and, of course, individuals.

In the UAE, the immediate, short term, impact of the GFC was to cause almost all projects to halt. At the heart of things, money stopped flowing, real estate buyers delayed payment installments, or stopped them altogether. The secondary market for residential and commercial real estate dried-up overnight. Banks stopped lending. Real estate valuations meant little.

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Caught in the middle, were a massive number of contractors, contractors, consultants and suppliers suppliers waiting to be paid for work already done, and unable to assess with any confidence the likelihood of being paid, or their projects continuing.

In the legal-contractual setting of the UAE , what issues then presented themselves in the context of project solvency and getting paid?

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The capacity of the underlying legal system to cope, in terms of:

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the scope and nature of the laws generally

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specific aspects of the laws, such as the insolvency provision in

Federal law No18, 1993 (Commercial Transactions Law); the Real Estate laws; the true or enforceable security of lenders to projects

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laws that were suddenly needed, but not yet in place, eg the new

laws introduced in December 2009 to address the insolvency of Dubai World

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the application, in practice, of what were thought to have been

effective laws to protect real estate buyers and investors, the Escrow account laws and regulations, which were exposed as deficient in many respects

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Freedom of Contract: 

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how pre – GFC enthusiasm enthusiasm had encouraged major international international

contractors to sign up to the most m ost Draconian contract terms imaginable.

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The role and true effectiveness of key, 3 rd parties in the construction process: -

the Engineer  

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project finan ancciers

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desi design gn and and cer certi tify fyin ing g co cons nsul ulta tant ntss

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The value (or otherwise) of the ADR procedures in project contracts:

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interim DAB processes in the FIDIC forms

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the process of arbitrating in the region

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the ability to enforce an arbitration award in the UAE,

and hence the effectiveness of non-court based dispute determinations in the UAE

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Islamic financing issues, especially the rights of investors in instruments like sukuk’s - when things go wrong.

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The capacity of the court systems to cope, and their response to disputes which involved complex and highly technical and commercial issues.

May I make some more detailed observations on certain of these issues.

Freedom of Contract and Contract Interpretation A western-trained, common law, lawyer might find it either refreshing, or somewhat disconcerting, to be in a jurisdiction where there is the degree of freedom in contracting last experienced in the Bristish common law system over 50 years ago.

Certainly, as a general proposition, civil law countries, not being burdened with the common law’s history of precedents, and the deveolopment of text book – thick laws of contract, can contract more freely, or or with greater flexibility. flexibility. In the pre-GFC perio period d in the Middle Middle East, many project contracts were not only written in the harshest, and most one-sided, manner, but then accepted, and entered into, by many ma ny of the world’s majors.

Below I identify some of these types of provisions relating to getting paid and the flow f low of project monies. Additionally, many contractors are, today in the UAE, paying a very heavy price for 

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agreeing to take over design responsibility and complete what are, in many cases, “ leading edge” architectural or engineering designs.

Let me illustrate freedom to contract in action in the UAE with a few examples.  “Paid–when-paid” – although a concept almost universally legislated-out in the UK, Australia, Singapore and in many States in the USA, back-to-back payment schemes are found in almost every construction contract in the Middle East.  Termination for conveniece – also universally common, but rarely if ever 

matched by a fair, post-termination, quantificat quantification ion of the entitlement of the contractor, or the contractor actually getting paid in a timely way.  Non payment in any period of non-excusable delay- capable of being

classified as one of the most “deadly” provisions in any building contract, this type of clause is only now surfacing for serious attention. Example: Consider a project with with an intial contract sum of $ USD 700 700 million; 60 plus floors of combined residential and commercial premises; overlooking the sea, with world class finishes and its share of unique (read “difficult to build”) architectural features. Construction commenced 2007, and by July 2010 the project is at the 65% completion point. Variations claimed but unpaid say $100m. EOT claims number now #6 and, together, seek a 16 m month onth extension. FIDIC ’87 and special conditions, with one clause stating (to the effect): “If at any time hasEmployer not reached  Taking Over bythe theContractor due date, the shall  have no obligation to make any further  payments to the Contractor until a Certificate of  Taking Over has been achieved.”

The Contractor is presently in a period of non-excusable delay, as none of the six eot claims have been addressed. He seeks your advice: Q: Does the clause mean what is says? Q: If it is triggered now, and then some, or all, eots are granted, does it cease to apply? a pply? Q: Is this type of provision “legal” in the UAE? Q: If we took it to court, what would the courts say?

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Rewriting the role of the Engineer (and Employer) In 2007, in the Emirate of Abu Dhabi, the government determined to produce its own, bespoked, version of the FIDIC’99 – for “construct only”, and for ““design design and contruct”, and published by decree an amended version to be used on all government projects.

One stream of changes seeks to do two things: –  a) replace the Engineer with the Employer in certain key functions or processes; and b) to control (and thereby limit) any descretion the Engineer might otherwise have had, particularly relating to money matters.

Two examples: •

Cl 8.4 Extension of time – notice of claim is to be given to the Employer  and the Employer determines the amount, if any, of time to be extended.

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The authority of the Engineer under Cl. 3.1 has now been conditioned by the following: “The Engineer is required to obtain the written approval of the Employer before exercising the following authority: (a) Instructing the Contractor to suspend progress of  part or all of the Works in accordance with clause 8.8 of these conditions; (b) Issuing a Taking-Over Certificate in accordance with clause 10.1 and/or 10.2 of these conditions; (c) Issuing a Performance Certificate in accordance with clause 11.9 of these conditions; (d) Initiating and evaluating Variations in accrodance with clauses 13.1 and 13.3 of these conditions respectively;

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(e) Certifying the payment of Retention Money in accordance with with clause 14.9 of these cond conditions; itions; (f) Issuing a Final Payment Certificate in accordance with clause 14.13 of these conditions; and  (g) Authorising any changes in Materials or suppliers previously proposed or agreed”.

On the face of it, you might believe that these amendments are somewhat benign, However, in practice, they can create very significant issues for a contractor – seeking to finish and get paid.

It is a commonly accepted axiom regarding the role of the Engineer under FIDIC-styled contracts that, at critical times, his obligation to act fairly, and as a certifier and valuer, is relied upon by the contractor in his day to day running of the project.

Commonly, the Engineer is ever-present on a project, and is progressively involved in design development and the choice of materials and supplies.

Imagine, then, the case of the detached Employer, who rarely participates in progress meetings and generally has little direct contact with the contractor, but is presented from time to time with, say, variation valuations that, to him, seem expensive. You can predict his reaction.

Additionally, the laws of the UAE are nowhere near clear enough as to whether the Employer can withhold approval at will. The jurisprudence does not know of the doctrine of  implied coprovisions like the above above literally. operative duty, and the courts interpret provisions

Force Majeure – in the wake of the GFC, clause 19 of FIDIC’s ’99 version, and its equivalent in

most project contracts, has been, naturally, the “got to” provision for Employers and developers seeking to avoid paying contractors.

For those seeking a detailed analysis of the (quite complex) jurispurdence involving the interperation and application of “force majeure” under the national laws of Arabic countries, a

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good starting point is the work of Dr. Sue Rayner in her book, The Theory of Contract in Islamic Law (1991) (Graham and Trotman, London)

For a project based on a contract like FIDIC ’99, with an express term such as Cl 19 in which Force Majeure is defined, and a code sets out what the claiming party needs to do, you can have comfort that the court systems in the UAE (and Middle East generally) will enforce those terms.

Where complexities arise is, in particular, where the “head contract”, or the development contract, is written with its proper law being, say, England – a not uncommon situation for major  projects, especially if lenders are in involved volved – but in the the building contract, contract, and then the the Sale and Purchase Agreements, or Agreements to Lease, or the hotel operating contract, the proper law is the law of the UAE, or the relevant Middle East country.

Consider then the same event (here (here the GFC) being claimed as a Force Majeure Event by each of  the parties in that contractual chain, but accompanied by legal assessments grounded, in one case, in the UK’s common law system, and, for the other(s), derived from applying the received principles of the UAE’s laws (in that area), supplemented by the occasional reference to the Napoleonic Code, together with how Force Majeure has been judicially commented upon in Europe, notably the French Courts.

It is a sufficient form of victory for Employers if this debate at least creates an impass, and payment obligations are suspended, pending the decision of courts or arbitrators.

The role and true effectiveness of the “Engineer” and other project 3 rd parties. It is necessary to make this initial observation to set the scene. It does not, at all, sit comfortably with either government or private sector principals in the Middle M iddle East to have the concept of a 3 rd party, like the Engineer under a FIDIC styled contract, creating time or money m oney entitlements with the contractor, without the prior consent of the Employer.

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The concept of the Engineer’s independent duty and auto autonomy nomy has evolved in both the common law, and civil law systems (in Europe), over many years.

Historically, the Engineer almost always was the project designer, and his role was mainly to see that his designs were properly constructed, value monthly progress claims and to administer the contract. As times changed, and project values, complexity and speed of construction all increased, the “Engineer’s” single role, as we all know, was taken over by architects, project managers, quantity surveyors and professional client representatives.

Indeed, there is an argument that the power and contractual presence of the “Engineer” most probably peaked in the 1960’s and 1970’s, as described in the forms of contract that then existed (e.g the early editions of the FIDIC Red Book the ICE Conditions).

But the UAE does not have that history. Nor does the Middle East generally. It has become painfully clear to many contractors that to do construction business success successfully fully in the Middle East they must recognise and understand that you cannot simply sign up to a FIDIC-form of  contract, and expect the Employer, Employer, or the “Engineer”, to behave as they do in, say, the UK or  USA.

In the Abu Dhabi government FIDIC ’99 contract there are, as noted above, some clear signposts that confirm that, in most cases, the Engineer is the “Employer’s man”. Even if the contract is not so clear, the same is true in practice.

The value and effectiveness of ADR processes in major projects in the Middle East In the Middle East, almost every building or construction contract contains an arbitration clause, or agreement.

Via Article 203(5) of the UAE’s Civil Procedures Law (1992), if the parties have agreed to refer a dispute to arbitration, an action on that dispute cannot be brought before the courts.

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If you then consider that by mid-2010, the courts of Abu Dhabi had pending before them approximately 320,000 cases, making arbitration work in the UAE is a necessity. (Note: the vast  majority of court cases relate to employment and labour issues and real estate disputes.).

The UAE does not presently have an arbitration law. It does have, in the UAE’s Civil Procedures Law (1992), Articles 203 to 218 which specifically address arbitration; aspects of it’s process and the enforcing of awards. But, with respect, those provisions were not designed in anticipation of  the current dimensions of project disputes and major, complex, arbitrations arbitrations in the UAE in 2010.

It has been predicted that the UAE will receive a new arbitration law in 2010, as part of a broader  package of new laws laws for the commercia commerciall & business sectors. sectors. A draft is circulating circulating for comment. comment.

Presently, the only real alternative to litigation in the UAE is via commercial arbitration, whether  pre–agreed, or via an ad–hoc reference.

So how efficient or effective is the arbitration process? Let us assume for present purposes purposes that the project in questi question, on, or the relevant relevant commercial commercial transaction, does have an arbitration agreement in it, which is recognized by the courts and enforced.

In many ways, arbitrating major disputes in the UAE can be a far more complex process than in, say, the USA, UK or Europe.

First, what needs to be understood is that the list of criticisms and “adverse” features of modern comercial arbitration, arbitration, enumerated by Thomas Stipanowich recently recently in his paper  “Arbitration: The New Litigation” (Univ. Illinois Law Review 2010) are all present and accounted for in the

UAE. But, in the UAE, their mix and relative weightings differ to their equivalants in western countries.

300 plus years of common law litigation in both the USA and UK has produced such a detailed set of procedures for litigation, that their almost complete adoption into major arbitrations, has done arbitration a great dis-service.

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In these Western countries, the Medieval processes of the merchants ( the “sniff & smell” arbitrations) have now been replaced by processes quoted by Thomas Stipanwich as being similar  to civil litigation – judicialized; formal; costly and time consuming. We all know what the elements are, in the arbitration process, that lend themselves to this criticism. criti cism. They include include discovery discovery (especiall (especially y nowadays nowadays “e” discovery) discovery);; accessing accessing 3 rd party documents; prehearing procedures; factual and expert reports (for both claimant and respondent); a “hearing” process of some form, including possibly oral testimony and cross- examination.

Next, and quite critically, once an award is delivered, while there should be a clear pathway to enforcement, in some jurisdictions the relevant arbitation arbitation law will permit appeals – allowing time to run on, and further costs to be incurred. It is unfair unfair to generali generalise se too much as there there are, are, of course course,, many many exampl examples es of succes successfu sfull arbita arb itatio tions ns.. But let us accept accept for presen presentt pur purpos poses es that that in th thee Gu Gulf lf most most arbitr arbitrati ations ons over  over  significant sums of money, or complex technical issues, do involve these traditionally “litigious” styled steps and processes.

Now consider a scenario under under which the concept of “jud “judicialized” icialized” does not, in effect, exist.

“Judicialized” can of course mean many things, but to western lawyers it is, perhaps, the briefest way of starting with “due process”; moving though “natural justice and fairness”; touching upon the independence of experts experts and the arbitrator(s); hav having ing the abitlity to verify facts, facts, and ending with a comprehensive, detailed, judgment, with reasons.

Accordingly, a fair deal of the debate on arbitration arbitration reform, especially in th thee USA and UK, has been framed on the basis of a comparative comparative analysis with the processes in the respective respective court systems of these countries. But what if, in the country of your arbitration, there were not so similar court processes? What would then be the dimensions of the arbitration debate? Less clear, and more open to argument on the the fundament fundamentals. als.

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The court system in the UAE copes with technical or complex construction matters by essentially referring the issues out to court appointed appointed “experts” . In construction construction matters, those experts experts are generally engineers, fluent in Arabic. The expert will submit his report (in Arabic) to the court, and the court will decide whether to adopt it or, if the findings are contested, the court might be persuaded to refer the matter to another expert. This whole process can take 3-6 months and be entirely based on the materials submitted by both parties. Rarely, if at all, is there a hearing with oral testimony in civil cases.

Accordingly, there has not been, and, indeed, there cannot really ever be, a “judicialisation” of  arbitration in the UAE – if by that term we refer to the processes of civil litigation in western common law and mature civil law systems.

Accordinly, in the UAE, the responsibilities that then devolve to the relevant arbitration bodies and arbitrator(s) are far more m ore significant than in Western countries.

Put another way, for disputes arising from major projects, or complex commercial transactions, the pressure on the arbitration process (and institution) to get it right, and to deliver an outcome that is just, fair and within an acceptable time frame, is probably no greater anywhere than in the the UAE at present – given the sheer size of the UAE’s build and investment programme.

And that is not at all to say that the arbitration institutions in the region have not risen to the challenge. They have, and continue to do so. But the sheer size and volume and complexity of  many man y of the dispute disputess in the region region have have never really really had to be addres addressed sed by such a small small artibration community.

Further, Furth er, what the Global Financial Financial Crisis has thrown thrown up in the Gulf, in the context context of dispute dispute resolu res olutio tion, n, is the rol rolee and legiti legitimat matee intere interests sts of th thee financ finance/b e/bank anking ing sector sector and invest investors ors.. Unfortunately, the “system” in the UAE, has had difficulty coping with the combination of  insolvent developers; defaulting purchasers and defacto “mortgagees in possession”.

Add to that that the fact that that mos mostt of the buildin building g contra contracts cts and real real est estate ate sale and purchase purchase agreements included arbitration clauses, then for some developments there are literally hundreds

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of disgruntled purchasers, who have to initiate individual arbitrations to try to either get back  their deposits and partial partial payments, or to seek some form of remedy.

The challenge therefore, particulary in the UAE, for the legal profession, and for the government seekin see king g to secure secure intern internati ationa onall inv invest estmen ment, t, is to design design and implem implement ent di dispu spute te res resolu olutio tion n processes proce sses that recognize recognize the realities realities and limitatio limitations ns of the underlying underlying court court system(s) system(s) and respond to the demands for investor certainty, and enforceable outcomes.

What about the use of Dispute Adjudication Boards? Turning more specifically to engineering and construction projects, the most commonly used form of construction contract in the Gulf is the FIDIC form.

Although the developmen Although developmentt of the FIDIC forms, forms, for project procurement procurement and consultan consultantcy tcy services, progressed slowly over over the years, culminating in the burst o off “colours” in the suite of  contracts issued in 1999, 1999, some parts of the Middle East still use the 1987 1987 (Red Book) version. Indeed, most government contracts in Oman are based on the 1981 version of the Red Book, updated marginally in clause 67.

As noted above, above, in Abu Dhabi, Dhabi, some years ago, a decisio decision n was made by the government government to prepare, under license from FIDIC, two bespoked forms of the co contract ntract – build only, only, and design and build. Those forms were issued in 2007, accompanied by the requirement that they be used as the form of contract c ontract by all government departments in the Emirate of Abu Dhabi.

The centrepiece of the ADR process in that new form of contract is the mandated use of a Dispute Adjudication Board (DAB) as a pre-cursor to arbitration. It is not the purpose of this note to review the quite lengthy and detailed DAB and related dispute resolution procedures set out in that form of contract.

What is perhaps more relevant, relevant, in terms of focusing on ADR in the the Abu Dhabi major projects market , is the fact that, via this mandated form of FIDIC, the dispute resolution process proceeds first to the DAB (cl20.4), i.e the use of of a DAB is now the default default rather than, in earlier v versions, ersions, an option.

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The Abu Dhabi Dhabi govern governmen ment’s t’s versio version n of the FIDIC FIDIC contra contract ct do does es mainta maintain in cl20.5 cl20.5 which which expressly encourages amicable settlement at any time.

Finally, if those two processes do not resolve the matter, the dispute is referred to “final and bindin bin ding” g” arbitr arbitrati ation. on. The defaul defaultt bod body y and and rul rules es are th those ose of the Abu Dhabi Commer Commercia ciall Conciliation and Arbitration Centre (ADCCAC).

In theory, of course, it is possible for some of these provisions to be amended by a government authority for a specific project. But what is more relevant for this note, is that after a detailed review and consultation process, the decision was made to mandate the use of a DAB.

Many in the region see the introduction of DAB’s as a very valuable, and important, step to facilitate the resolution of major project disputes in Abu Dhabi.

In theory, a project-specific DAB, properly appointed and constantly in touch with a project’s progress and the development of a dispute, seems like not just a good solution, but an almost “must have” for the demands created by projects in the Middle East in 2010 and onwards.

But as good as they appear to be in theory, DABs seem to have a chequered history, and more of  a “B” rating, than an A+, in some countries.

In many jurisdicti jurisdictions ons D DABs ABs compete compete with with an array array of offerri offerrings ngs from from

commercial commercial

ADR 

institutions advancing advancing solutions that that are quite varied and not limited to just just arbitration (see for  example AAA’s and the ICC’s extensive menus of ADR solu solutions). tions).

So what are, or should be, the drivers in the UAE market for making this DAB process work? First, speed to an initial decision. Around the world, and particularly with in-house counsel, the constant and resounding criticism of arbitration is that it takes too long, and is too appealable (ie even even long longer er). ). In almo almost st all all surv survey eyss of arbit arbitrat ratio ion n us user ers, s, time time an and d dela delay y ra rank nkss fa farr more more

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significantly than cost as a source of criticism. The case for arbitration, for major project and construction disputes, disputes, is not helped these days by by being almost always a very expens expensive ive process. But, speed of decision consistently comes first in surveys of in-house counsel, and the users of  the ADR systems, as the key factor in choosing an ADR solution, or in measuring its success or  value to them.

Consistently with the views of Tom Stipanowich (Arbitration: the New Litigation (Univ. Illinois speedy proce process ss must, must, by its very nature nature,, req requir uiree the setting setting of tig tight ht Law Review 2010) 2010) a speedy boundaries on evidence, submissions and expert repo reports. rts. And the surveys tend to indica indicate te that a controlled, and ostensibly fair, but speedy system, is what most large organisations are looking for these days.

Witness the outstanding success of the statutory adjudication system in England. In England, and in Australia Australia where it has been almos almostt uniformly uniformly adopted in all States, States, it has had the effect of  greatly reducing the number of disputes that go to arbitration or court.

Adjudication has, however, had some adverse side effets. It has produced a large number of court cases, at the stage when the court is asked to adopt the adjudicator’s report. In the first 6 years of  its introduction in Australia, there were over 100 cases which addressed issues ranging from statutory interpretation of the legislation, through to whether the adjudicator had exceeded his jusrisdiction, as well as a full suite of administrative law issues. The outcome being that now, a relatively short statute needs to be read and interperted in the light of a number of important judicial pronouncements. Another side-effect is that the lawyers running these matters regularly have only 14 or 28 days to prepare claims and evidence that otherwise would take many months in an arbtiration or even in court. So, will the the use of DAB’s produc producee a better result result than say arbitr arbitration ation?? Or is there a bet better  ter  alternative in this region, and at this time in the cycle of major projects?

On any view the introduction of a mandated DAB is a very good first step. The essence of an effective DAB is a decision making process, in real time, by people who can see and view the project and fully understand the issues.

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It is the complete converse of a project-specific DAB, that, years after construction is completed, three learned arbitrators have a sitting lasting lasting mouths, to hear and conside considerr expert debate on what did happen and more theoretically, what should have happened or been done, as they look at “asbuilt” programmes and the true audited accounts of the builder (did he really suffer a loss?). If you therefore set the scene as being the UAE in 2010 and onwards, looking to attract and secure investment; seeking to give transparency to the dispute resolution process; and both physically and commercially just purely managing the massive volume of work (and hence disputes) - there can be no argument against doing everything that is sensibly possible to make the DAB system work.

One real concern I have is that this initiative is not backed by my professional collegues, or their  clients, in Abu Dhabi. If that were to happen, I do not believe that the “system”, absent a DAB process, will cope at all.

Islamic Financing – you need to understand how it affects your project, or  investment. The comments here are more by way of a footnote to the pri principal ncipal issues canvassed abo above. ve. In Middle East projects Post-GFC, there will be present a far greater role for Islamic financings.

Further, with the world-wide contraction in sovereign funds, and the project finance market generally, the availability of funds via the Islamic finance market cannot be ignored.

The Dubai-World /Nakheel events of December 2009 involved two quite complex issues, leading to a solution that failed to provide clarity for either. First, within the terms of the Nakheel sukuk, were the interpretation of the default provisions and the assessment that the investors had to make regarding the true value of their, ostensibly, assetbacked security.

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Secondly, in parallel, and for this particular transaction, was the perhaps more significant issue of  whether or not the Dubai World entity would be backed by the government of Dubai, even if  ultimately some form of work-out was needed.

The resolution of these issues is still on going. One part of the solution was for Dubai to rush through special Dubai World insolvency legislation on the eve of the sukuk default in mid December 2009. As of September 2010, creditors are still in negotiations and some payments have been made to small creditors.

Relevantly for this note, is the fact that across the Middle East, it is likely that Islamic financing for major projects will become more common. (For more on the intricacies of Islamic Financing  a good reference is www.financeinislam.com, and see there the paper on the Equate Petrochemical project by Benjamin C. Esty.)

Knowing how to work with the various forms of Islamic financing, and especially, how investor  rights can be enforced, will be critical to getting paid and projects remaining solvent.

Stephen Hibbert Habib Al Mulla & Company Abu Dhabi September, 2010 [email protected]

www.habibalmulla.com

Appendix: Attached is a 2010 paper prepared by Mazen Boustany, Head of Banking and

Finance, Habib Al Mulla and Company, which summarizes the insolvency provisions in the UAE law and canvasses the scope for reform. It is extracted here in full as the paper has been recognized as one of the best, and most comprehensive statements on the topic and, importantly, a synopsis prepared post Dubai World.

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Mazen can be contacted on:  on: [email protected]

UAE INSOLVENCY LAW EXISTS! Mazen Boustany

 

Head of Banking and Finance Habib Al Mulla & Co

DURING THE BOOM TIMES, DUBAI AND THE UAE seldom experienced insolvency cases, so it became a widespread rumour that the UAE does not have an insolvency law. In addition, it had also been widely speculated that the UAE has a very archaic regime in which debts can lead a debtor to jail. By opposition to such rumour, an insolvency law does indeed exist and it is shockingly modern in more than one aspect. Looking more deeply at this law might be very useful in the near future, due to the credit and financial crisis that is affecting Dubai and its business sector. By looking at Federal Law No 18 1993 (Commercial Transactions Law) it is clear that out of 900 articles of which this law is composed, 255 articles are dedicated to insolvency and an d ba bank nkru rupt ptcy cy pr proc oced edur ures es,, wh whic ich h me means ans th that at al almo most st a th thir ird d of th thee Co Comm mmer ercia ciall Trans Tr ansac acti tions ons La Law w is de dedi dicat cated ed to su such ch pr proc oced edur ures es.1 .1 Th This is is no nott bad in a cou count ntry ry considered to be without insolvency law. The provisions apply solely to both individual traders traders and comme commercial rcial companies companies when they have stopped paying their due commercial debts (Articles 645 and 650). The articles are subdivided as follows: • • • •

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• •

Articles 645 to 763 are related to insolvency; Articles 764 to 799 are related the arrangement by the court; Article 800 relates to small insolvencies; Articles 801 to 816 are related to companies insolvency (although Article 801 specifically provides that all above articles are applicable to companies in addition to the articles in this section); Article 817 to 830 are related to the rehabilitation of the insolvent individual (such as traders and partners in partnerships); Articles 831 to 877 are related to voluntary arrangement; and Articles 878 to 900 are related to bankruptcy.

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It is clear that this a very comprehensive law with specific procedures. Unfortunately, it remains largely untested and only two judgments are published on the Dubai Courts’ website: 1) a Dubai Supreme Court judgment dated 9 September 2008, which provides that a single unpaid commercial debt is enough to provoke the insolvency of a company; and 2) an older, more interesting, judgment by the Dubai Court of Appeal dated 25 May 1998, where the court considered that the insolvency provisions and procedures are of public order since they were meant to promote confidence, and have been put in place to protect the creditors and to safeguard the debtor of good faith).²

The above judgment has clearly defined what the UAE insolvency law is all about: protec pro tectin ting g the credito creditors rs and saf safegua eguardi rding ng the debtor debtor of good fai faith. th. The differe different nt procedures that are outlined in the Commercial Transactions Law are described in the remainder of this article.

BANKRUPTCY

In the event of bankruptcy (whether fraudulent, negligent or gross negligent bankruptcy), the Criminal Court shall be competent and shall shall sentence the bankrupt trader trader or manager  of a company, or the member of its board or its liquidator, to a prison term that may not excee ex ceed d fi five ve ye year arss in th thee eve event nt of fr frau audu dule lent nt ban bankr krup uptc tcy y (A (Art rtic icle less 87 878 8 an and d 879 879). ). Alternatively, a fine of 20,000 dirhams in the event of a gross negligent bankruptcy (Article 880) and no more than two years of prison or a fine of 10,000 dirhams in the event of negligent bankruptcy (article 881) may be issued. In addition to the above, Federal Law No 3 1987 (the Criminal Code) contains provisions related to bankruptcy in Articles 417 to 422. Articles 417 to 419 of the Criminal Code are very similar to Articles 878 to 881 of the Commercial Transactions Law, while Article 420 provides: If a commercial company is bankrupt, its board of directors and managers shall be convicted with the sentencing related to fraudulent bankruptcy if it was proven that they have committed any of the acts provided in Article 417 of this Code or assisted in the company compan y ceasi ceasing ng its payment, payment, wheth whether er by declaring wrongful facts about its subsc subscribed ribed capital or its paid-up capital, or by publishing wrongful balance sheets or by distributing fictious dividends, or by taking to themselves more than they are entitled to in the company articles of association. The discussion in this article does not apply to the member of the board of directors or  the manager who proves that they were not involved in the crime or their objection to the resolution that was taken in its respect. It can be deducted from the above provisions that

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a shareholder of an insolvent company who was not involved in its management may never be considered as bankrupt. The board of directors or managers of a company that neverr com neve commit mitted ted any of the actions actions men mentio tioned ned abov abovee sha shall ll neve neverr be cons conside idered red as bankrupt themselves.

INSOLVENCY Insolvency is covered by Articles 645 to 763, 800 and 801 to 816. Companies insolvency Focus shall be made here h ere on the articles more specifically related to companies.

Article 802 provides for the declaration of insolvency of a commercial company when it ceases payment of its commercial debts, due to the disruption of its financial activities. Article 806 is very interesting, since it entitles the court, de facto, or on the request of the company to postpone the declaration of insolvency for a period not exceeding a year, if  its financial position is likely to be supported or if the interest of the national economy so requires. The court can order that appropriate measures should be taken for maintaining the assets of the company. This article article is in additi addition on to the provis provisions ions related to the arrangement arrangement that are discussed later, which gives the company a breath of fresh air, allowing it to arrange itself before being declared insolvent. Article 809 provides that if the assets of the company are insufficient to satisfy at least 20% of its debts, the court who has declared the insolvency may order the members of  the boards of directors, or some or all of the managers, jointly or individually, to pay the debts of the company, in whole or in part, in the cases where they are held responsible, in accordance with the provisions of the Commercial Companies Law (CCL). The articles in the CCL provide for the liability of the chairman and members of the board of directors towards the company and its shareholders for all acts of fraud and abuse of power, and for any violation to the CCL or the articles of association, or the management violations, and any provisions to the contrary shall be annulled (Article 111 of the CCL). The liability mentioned in the previous article shall be borne by all the board members if  the violation violation has arisen as a resul resultt of a unanim unanimous ous decision. decision. Other Otherwise, wise, if the resolution resolution was approved by the majority, the opponents shall be absolved if they prove that they had opposed the resolution in the minutes of a meeting. An absentee may still be liable unless

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they prove that they were unaware of the resolution or were aware of it without being able to object to it (Article 112 of the CCL). It is important to remember that Article 237 of the CCL provides that the liability of the manager of a limited liability company is similar to that of the board members and any stipulation to the contrary shall be annulled.

Procedure The insolvency is declared on the request of the commercial company or on the request of one of its creditors. The court may declare the insolvency on the request of the public prosecution or ipso facto (Article 647).

The commercial company may reques requestt to be declar declared ed insol insolvent vent if its financial financial activ activities ities are disrupted and it has ceased paying its debts. Such a request becomes mandatory if 30 days have elapsed since the cessation of payments, otherwise this would be considered a case of negligent bankruptcy (Article 648). The request shall be submitted within a report explaining the reasons for the cessation of  payment and to which shall be attached several documents, such as the accounting books, the last audited financial statements, the profit and loss account, a detailed statement of  movable and immovable assets, a statement of the names of the creditors and the debtors, their address, their rights and obligations, and security (Article 648). In its insol insolvency vency judgment the court shall determine determine a provi provisional sional date for the cessation of payment, shall seal the debtors premises and shall appoint a trustee (Article 655). In all events, the date of cessation of payment may not be deferred back to more than two years prior to the insolvency judgment date (Article 659). In the insolvency or in a subsequent judgment, the court shall appoint a remunerated attorney to manage the insolvency: the insolvency trustee (Article 668). The judgment shall be published in the Trade Register and in the Court’s Board for 30 days. The trustee shall take care of the publication of the judgment in a daily newspaper, as determined by the court, with all the details pertaining to the insolvent company and the summon to the creditors to come forward with their debts. The judgment shall also be published in the name of the Assembly of Creditors at the Land Register within 30 days of the issuance of the judgment (Article 661). The insolvent shall be prohibited from managing its assets or disposing of them (Article 685).

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Article 691 provides that any lawsuit emanating from the insolvent or against them shall be prohibited. Any activities undertaken by the insolvent that are detrimental to the Assembly of  Creditors may be cancelled if the counterparty cou nterparty was aware of the cessation of payment of  the insolvent (Article 697). An Assembly of Creditors shall be created by law on the issuance of the insolvency judgment judgme nt compos composed ed of the insolvent’s insolvent’s ascertained ascertained credi creditors. tors. Any holder of mortgage or  special privilege shall not be a member of the Assembly of Creditors (Article 703). This is because these secured creditors are at liberty to sue the insolvent individually (in contradiction to Article 691 and 704) and they have preferential rights over the attached assets.³ Competent court As mentioned above, the competent court to oversee the insolvency is the Court of First Instance in whichever jurisdiction the headquarters of the insolvent company is located (Article 653).

In the Dubai Court of Appeal judgment, the insolvency is related to the public order of  the state and is therefore closely linked to its judicial system. Any arbitral proceeding should therefore be excluded. However, Article 747 entitles the insolvency judge, after hearing the supervisor (being the creditors’ representative) and the insolvent, to allow the trustee to settle or approve the arb arbitr itrati ation on in any dispute dispute rel relate ated d to the insolvenc insolvency, y, eve even n if rel relate ated d to rig rights hts in rem(Article 678). This coul This could d mea mean n tha thatt the arbitrat arbitration ion agr agreem eement entss exe execut cuted ed bef before ore the launch of the insolvency procedure may still be valid after such a launch. The arbitral tribunal will only be in a position to declare a debt and determine its amount without being able to sentence the debtor to pay. Nevertheless, providing such a clause in the insolvency law is very innovative of the UAE legislator, considering the public order nature of the UAE insolvency law. ARRANGEMENT BY THE COURT AND VOLUNTARY ARRANGEMENT Arrangement by the court Thiss pro Thi procedu cedure re inv involv olves es the inv invit itati ation on of the cre credit ditors ors by the ins insolv olvenc ency y jud judge ge to deliberate delib erate on the arrangement arrangement (Article (Article 764). The creditors creditors may attend personall personally y or  through an attorney. However, the insolvent must attend personally (Article 765). It is

assumed that in the case of a company, it should be its authorized signatory (ie the manager in an LLC and the chairman of the board or the CEO in a joint-stock company).

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The trustee must submit a report to the meeting, related to the insolvency procedure and their opinion about the arrangement. The insolvent shall also be heard (Article 766). The arrangement shall not be approved unless a majority of creditors, holding two thirds of the debts, agrees. Any creditor not attending the meeting shall be considered as dissenting to the arrangement (Article 767). The secured creditors are not part of the Assembly of Creditors and shall not be entitled to vote on the arrangement, unless they waive their privileges (Article 769). However, no arrangement is possible in the event of fraudulent bankruptcy (Article 771), but it is possible in the event of negligent bankruptcy (Article 772). The arrangement might involve delays for the insolvent to pay its debts or a waiver by the creditors of some parts of the debts (Article 773). The arrangement shall not be applicable on the secured creditors for the reasons mentioned earlier. Nor on the ordinary creditors where debts d ebts have arisen during the insolvency procedure (Article 775). The arrangement shall remove all effects on the insolvency, without prejudice to any criminal crimi nal pursuit. pursuit. The debtor shall shall be reinstated reinstated with all their belongings belongings and effects effects (Article 777). This is This is,, wh when en goi going ng th thro roug ugh h th thee vo volu lunt ntar ary y ar arra range ngeme ment nt,, a def defic icie ienc ncy y in th thee UAE insolvency law, which has failed to give enough power to the judicial authority, allowing it to take the necessary steps to allow a good company to survive without its failed or  dishonest management. Since at the exception of the criminal pursuits that shall de facto lead to the insolvency of the company again, no provisions entitled the judicial authority to replace former management of its theratification, company its is staff . Indeed, the arrangement arran gementthe shall be disso dissolved lved if, after ratifica tion,to theprotect insolvent insol vent condemned condemn ed with the crime of fraudulent bankruptcy (Article 778). Voluntary arrangement 46 articles (from Article 831 to Article 877) are related to a voluntary arrangement by the company, with the assistance of a trustee appointed by the court (Articles 843 and 844 of  the law). The trustee’s role in this procedure is only as formal as evidenced in Articles 844 and 852, and the trustee will not intervene at all in the management of the company.

The voluntary arrangement may be initiated before or after the launch of the insolvency procedure.

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These articles are progressive and protective of the company, provided that the latter  submits a comprehensive plan evidencing means to continue operations and secure at least a payment of 50% of its debt within a period not exceeding three years. Such a volunt voluntary ary arrangement arrangement applies to both secured and unsecur unsecured ed credi creditors, tors, and thus the secured creditors are bound by the voluntary arrangement and are not at liberty to pursue with their individual lawsuits. However, as pointed out above, in relation to the arrangement by the court, very little is provid pro vided ed in rel relati ation on to the managemen managementt and operation operation of the com company pany during during the volun vol unta tary ry ar arra rang ngem emen entt per perio iod. d. No Noth thin ing g is pr provi ovide ded d in re rela lati tion on to th thee fa fate te of th thee management manage ment of the company, since Article Article 846 of the law provi provides des that the debtor shall continu cont inuee to man manage age it itss ass assets ets and sha shall ll per perfor form m all regular regular act actss nec necess essary ary for the management of the business. In that sense it may be argued that UAE insolvency law is not in tune with modern insolvency laws which have made a distinction between the failed management of a comp co mpan any y and it itss su surv rviv ival al,, ma main inly ly to pr prot otec ectt it itss st staf aff. f. In ot othe herr wo word rds, s, in mo moder dern n legislation, if a company is able to survive, it should do so. However, it should not necessarily survive with the same management that could be subject to civil and criminal sanctions. In this sense the UAE insolvency law does need improvement and evolution. evo lution. CONCLUSION

The UAE has a very v ery modern and comprehensive insolvency law, which has unfortunately been unnoticed by the most prominent legal experts, since they ask for its amendment without even having read it. The main impediment for the application of insolvency law is the security asked by the creditors credi tors and mainl mainly y post post-dated -dated cheques, which if not honored would consti constitute tute a crim crimee leading its drawer to jail. So the creditors, instead of having recourse to the normal insolvency procedure, prefer  resorting to a speedier process consisting of filing a criminal complaint for a dishonored cheque, thus avoiding any chance for the company to survive. Therefore Theref ore,, it is bes bestt pra practi ctice ce to dec decrim riminal inalise ise the che cheque, que, and thi thiss sec securi urity ty may be replaced by other security and further information on the debtors. A credit bureau was envisaged last year by the UAE, which could be the first step towards decriminalising the cheque and towards applying the insolvency law. By: Mazen Boustany Head of Banking and Finance Habib Al Mulla & Co. – Dubai office E-mail: [email protected]  

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Mid - 2010

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