It may have gone unnoticed by many, but on 2 January 2023 two interesting UAE law updates simultaneously came into force. Hopefully, those involved in financing under UAE law have now picked up on them. Those who have not need to be made aware of the following:

• Federal Law No. 50 of 2022 (the New Commercial Code) came into force, replacing Federal Law No. 18 of 1993 (the Old Commercial Code). Article 409(2) of the Old Commercial Code provided that "loans may be guaranteed with securities and according to such conditions as agreed" whereas Article 409(2) of the New Commercial Code now requires that "banks must have sufficient securities or guarantees against loans they provide".
• Federal Law No. 23 of 2022 (the Banking Law Amendment) came into force, bringing into effect a number of changes to Federal Law No 14. of 2018 (the Banking Law), in particular new Article 121 (bis) (Credit Facility Guarantees) which introduced the requirement for licensed financial institutions to obtain "sufficient guarantees for all types of facilities provided 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 goes on to provide that "no application, action or plea filed to the competent authorities or the arbitral tribunals by any licensed financial institution in respect of a credit facility provided [to such an entity] shall be accepted if such financial institution fails to obtain [sufficient guarantees]" and furthermore that "the Central Bank may impose administrative and financial penalties which it deems appropriate on licensed financial institutions [that breach these requirements]".

In the past few weeks, we have received various queries on these provisions from clients, broadly revolving around a central theme – namely, a concern that, on plain reading of these provisions, one possible interpretation is that unsecured financing is now prohibited by UAE law, with particular focus on the switch made from "may" (يجوز) to "banks must" (على المصارف) under Article 409(2) of the New Commercial Code. In the context of financing facilities provided to "natural persons and private sole proprietorships" (as opposed to, for instance, joint stock companies and limited liability companies (the position of single shareholder limited liability companies is less clear, although potentially the intention is for those to be captured)), that interpretation is supported further as a result of the Banking Law Amendment requiring that "all" (جميع) such facilities are to be backed by "sufficient guarantees" (الضمانات الكافية), noting that "guarantees" here seems to be used in the broader sense of referring to credit support generally (i.e. both guarantees and security, as opposed to strictly referring to guarantees only). Failure to satisfy this means a licensed financial institution could be running the dual risk under Article 121 (bis) of not only potentially being unable to file a claim against the relevant creditor to enforce that financier's debt claim, but also of receiving an administrative and/or financial penalty from the Central Bank. The combination of these provisions (and an interesting recent case in the UAE courts which touched upon some of the uncertainties raised by these recent developments, but in the context of relying on a personal cheque as a guarantee) is causing some consternation in the UAE financing community and is likely to do so until clarified further.

Official guidance is yet to be published on a number of other key provisions of the pertinent articles which have the potential to give financiers comfort that such an unlikely interpretation is definitely not what the UAE legislators intended. For instance, to name a few:

• What does "sufficient" (الكافية) mean under Article 409(2)? Arguably nothing could be sufficient in certain circumstances.
• What does "as determined by the Central Bank" mean under Article 121 (bis)? One potential interpretation is that this is referring to determination by the Central Bank on a piecemeal basis following an application, thereby importing some kind of consent regime, but this would be impractical to administer and arguably makes this interpretation unlikely. A more plausible interpretation is that this is referring to a later determination by the Central Bank by way of separate regulations, in which case Article 121 (bis) would not be capable of being fully understood or enforced until such additional regulations had been issued.

Market participants will be left second guessing the precise meaning of such provisions, pending official clarification.

Taking a step back from looking at these provisions in isolation and looking at them instead in the context of commercial reality and common market practice, unsecured financing is, and remains, very common practice under UAE law notwithstanding these developments. On first principles, whether or not a financier determines it needs security in any particular situation is a credit assessment for that financier to make and price as it deems fit. Unsecured financings being completely prohibited would pull UAE law outside standard international practice. It would also not sit well with multiple provisions under UAE law, including various provisions in the New Commercial Code itself (including within Article 409 of the New Commercial Code) which expressly provide financiers with a right to: provide loans; charge interest; agree the terms that govern repayment; impose an obligation on borrowers to repay loans; and provide a right for financiers to charge default interest in the event of late payment. In that context, the interpretation that unsecured financing under UAE law is now prohibited and unenforceable would seem fanciful at best.

These provisions would appear to be a codification of what has previously been reported in the UAE press as early as 2021 regarding guidance issued by the Abu Dhabi Judicial Department to UAE banks. Such guidance cautioned UAE banks against providing loans to individuals and companies without "sufficient guarantees", noting that a failure to do so would be deemed to be a violation of UAE law, which might result in non-acceptance of cases filed by such banks before the Abu Dhabi courts. According to such reports, a statement issued by judicial officials noted further that "considering a large number of these cases, the Abu Dhabi Judicial Department courts have found that the guarantee provided by a borrower is not equal or proportional to the value of the loan and, in some cases, banks disburse money against the borrower’s personal guarantee or his identification papers only". The Abu Dhabi Judicial Department reminded UAE banks at that time of the need to adhere to such requirements when granting loans and to obtain "adequate guarantees, thereby helping to ensure that borrowers have the financial ability to settle their loans".

In our view, on balance taking into account various factors, including our analysis of the legislation, the court case and previous UAE court guidance referred to above, it appears that perhaps, as opposed to seeking to prohibit unsecured lending altogether, the overarching policy objective here, which is to be applauded, is one of trying to ensure responsible lending and reduce potential insolvencies caused by corporates borrowing more than their businesses can support on a standalone basis. In other words, a bank should ensure it first looks to take "sufficient" security from an obligor in the context of the financing which is being provided to that obligor, as opposed to perhaps seeking to rely on a personal guarantee from a high net worth individual associated with that obligor which is not backed by liquid assets. This would just create an additional unsecured debt claim against that guarantor which, in practice, a bank is unlikely to have much appetite to seek to enforce, thus providing limited real additional credit support for that financing.

It seems that the UAE courts do not want their time taken up considering claims relating to loans provided irresponsibly in the first place. The UAE courts will not step in to save claims relating to such loans, but will seek to strike them out. As reported on previously and as now appears to be enshrined in UAE law, lending in the UAE (as elsewhere) should be based on a thorough credit assessment of a borrower's actual credit standing and that borrower's ability to repay its loan which is properly documented and supported by "sufficient" security. A personal guarantee (regardless of the standing of the guarantor) will not automatically be deemed by the UAE courts to be sufficient to make a loan responsible (in particular in the context of a loan made by a company owned solely by an individual). By contrast, the UAE court's assessment may well be different in the context of a loan provided to a special purpose company incorporated by a well-established company for structuring purposes, where the initial credit assessment shows that that special purpose company should have a clear income stream in the future sufficient to repay its loan, whether or not that loan is unsecured or a guarantee has been provided as additional credit support. As always, the devil will be in the detail as to where the UAE courts ultimately determine the line should be drawn on precisely what constitutes responsible lending, but it seems that the key takeaway for now is that the onus of proof here is being put firmly onto UAE banks to demonstrate that they have undertaken a thorough credit assessment of an entity to which they have lent when later seeking to file a claim against that entity for failing to repay its loan.

Going forwards, these developments are likely to significantly curtail the practice of "named lending" in the UAE under which perhaps such credit assessments have historically not been as thorough as the UAE courts would have liked. To date, this practice has seen banks lend to groups of companies on the basis of personal guarantees of their ultimate high net worth shareholders, where the credit standing of the corporate group would not clearly support the incurrence of such debt if assessed on a standalone basis. In this regard, there are limited checks and balances that credit committees can carry out to assess a personal guarantor's ability to repay guaranteed debts from liquid assets (for instance, there is no practice of personal guarantors needing to prepare statutory accounts). Furthermore, given the standing of those likely to grant personal guarantees in such contexts, banks have historically been quite reluctant to enforce such guarantees when enforceable as a matter of contract.

In any case, given the plain reading of these new laws, financial institutions would be well advised to tread carefully until clarifications are available and to ensure they structure their financings (and their unsecured financings in particular) under UAE law in line with considered advice, taking the requirements summarised above into account.

Conclusion

As is now clear, unfortunately there is no definitive answer to the question posed above. Rather, this soundbite is issued with the primary goal of raising awareness of a legal wrinkle recently introduced into UAE law to which all financiers need to be alive. Hopefully, it will soon be clarified what precisely is intended in respect of the regulation of UAE law unsecured financings, thereby removing the uncertainty that recent developments have now introduced. There are a number of practical steps a financier could take in the meantime to mitigate the risk of possibly ending up in a UAE court struggling to enforce its debt claim or facing a fine because it contravened UAE law. We allude to some of these steps above and have been helping a number of our clients with the same. Until such time as clarifications are available, there is a risk that the UAE courts might be called upon to adjudicate issues arising from these recent developments. Thankfully, in our view, there seems to be sufficient flexibility in the new laws to mean that well-advised financiers should be able to chart a path through their unsecured financings to ensure that they fall on the right side of the line and that the risk arising from these new laws is not material enough to warrant halting unsecured financings altogether.

If you have any queries on the above or require assistance from our Banking and Finance team, please contact us.

This article is also available in Arabic, click here to download.