Dubai Announces Special Insolvency Regime for Dubai World - Implications

No doubt you've seen the announcements today that HH Shaykh Mohammed Bin Rashid Al Maktoum issued a decree setting up special legal arrangements to adjudicate "Disputes Related to the Settlement of the Financial Position of Dubai World and its Subsidiaries".

Here is the official announcement from WAM.

Why was this step taken?

The press release advises that:

"The decree is based on the keen interest of Dubai Government in preserving the rights of Dubai World creditors, on its commitment to further strengthen the position of the emirate of Dubai in global economy as well as on its pledge to make sure financing establishments will get all their financial rights in view of the strength of its economy that is based on dynamism of the UAE economy which is capable of assimilating the consequences of the global financial crisis as well as on Dubai's big and diverse infrastructure and structural assets."

More importantly what does it mean?  No, not the press release. The decision on the legal framework.

The big picture answer is that it means a better legal regime for settling Dubai World and its subsidiaries' debts.  The DIFC legal regime is largely based on Western practice with a strong does of English law and practice at its core.

Is the DIFC legal structure better because it's Western?  No!.   Nor is it infallible. But its "foundation" structure has been repeatedly used, tested and refined over the years.  It is also one which is more institutionalized and less personal.  Something particularly useful in such cases - particularly when the amounts involved are large and there are large numbers of creditors. 

But at a practical level what are the implications?  And how does the process differ from that under local law?

Let's take a closer look.

First to set the stage, a focus on Section 4 of Decree 57 of 14 December 2009 which establishes these new procedures:  "The decisions and orders of the Tribunal shall be final, irrevocable and not subject to any appeal or review."  The parties to any court action get "one bite at the apple".  No appeals, though perhaps the Ruler might have a final word if there were a real controversy over the Court's decision.

Here are links to the Insolvency Law  ("IL") and the Insolvency Regulations  ("IR") so you can follow along.

And, as usual, before we begin the caveat that I am not a lawyer.

1. Insolvency Law ("IL") Part 2 Section 9 - When a company proposes a voluntary scheme of arrangement, it may petition the Court to impose a moratorium.  As per the Insolvency Regulations ("IR") Section 3, the Court decides if a moratorium is justified.   
2. What is the legal effect of a moratorium?  IR 3.5 stays any creditor legal action.  No steps may be taken to enforce rights. This includes secured creditors as per IR 3.6.   AA:  To the extent that foreign jurisdictions recognize the proceedings in Dubai as taking place under a reasonable law and process, they may honor the moratorium in their own jurisdictions.  I suspect they will given the ultimate origin of the law, the identities of the judges and presumed competence/impartiality in the matter at hand, etc. 
   
3. IL Part 2 Sections 10 and 11 provide for creditors to vote on the company's proposed scheme of arrangement.  As per IR Section 2.5,  passage requires the affirmative vote of more than 75% of creditors.   
4. IL Part 2 Section13 (3) - Provides that all creditors are bound by the vote of the meeting. AA:  This eliminates a major problem in GCC reschedulings:  the need for 100% creditor agreement to bind all creditors.  The DIFC Law in effect results in a legally sanctioned "cramdown". of any dissenting creditor.  To the extent I am right about other jurisdictions' views of these proceedings, a settlement will be an effective cramdown overseas as well.
   
5. IL Part 5 Section 68 (2)  provides that during a liquidation the liquidator may "disclaim onerous property" which includes unprofitable contracts, but only if it is not a members voluntary winding up.  AA: If creditors force a wind-up, some debt obligations might wind-up being voided.  As I've posted before, the requirements of sukuks often result in non market or potentially onerous contractual obligations.  Other contractual arrangements with non financial firms - contractors, suppliers, etc. - might be snared as well.  The occurrence of hardball legal tactics like these  are directly related to the assumed shortfall in recovery by the parties.  It's not likely that there will be a formal legal wind up or bankruptcy in this case.   If there is an economic need for one, it will be handled through a disguised liquidation portrayed as a restructuring/asset realization.
   
6. IL Part 10 Sections 96-100 deals with undervalue transactions, preferences etc..  The look back is two years prior to insolvency for transactions with a related party and six months for an unrelated party.  IL Part 5 Sections 73-79 also cover various transactions made in anticipation of a winding up.  AA: As outlined in an earlier post, since 30 June 2008, Nakheel has extended net credit to the Group of at least AED 12 billion.  On the other hand, the Nakheel Sukuk repayment will be exposed for six months from repayment.  However, all this is theoretical.  It is not likely that such claims will be made.  And perhaps not entertained if made.

To recap, what are the differences and does one party or another gain from them?

1. Moratorium:  Advantage to debtors versus the existing UAE law. The moratorium stops legal action in Dubai where the bulk of debtor assets are.  Since I think that other jurisdictions will recognize the Dubai proceedings and therefore stay legal action in their countries, it will effect a moratorium in other jurisdictions.  Thus, removing a significant legal weapon from the hands of creditors.  This is a common feature of "advanced" insolvency regimes. The test will be the creditors ability to end a moratorium if there is no consensual agreement to the borrower's plan which is the way I suspect any settlement will be structured.  At least initially.
   
2. Cramdown:  This is a major benefit to both parties by eliminating the power of minority creditors to hold up a deal. Additionally, if local banks - who are a significant portion of the debt - take  a more understanding view of the debtor's situation, they have the votes to block any amendment of the debtor's proposal for voluntary restructuring.  On the other hand local creditors do not have the votes to secure approval.  Foreign banks will have enough votes to prevent adoption. 
   
3. "Disclaim" of Onerous Contract and Obligations:  Depends on the situation and the sharpness with which the parties want to deal.  That usually is a function of the gap between assets and liabilities.  The lower the ultimate recovery the more likely that creditors will fight among themselves over the carcass.  But recall that this applies only  is in the context of an involuntary wind-up.  Probably not relevant here.  Unlikely that there will be a forced bankruptcy.  And as mentioned above if one is necessary, it will be disguised as a "restructuring".
   
4. Preferences:  Allows creditors to put pressure on the Emirate and fight among themselves.  Again usually motivated by fear of less than 100% recovery.  It's hard to imagine the Court entertaining such motions.  Or creditors raising them except under the most extreme situations.
   

On balance both sides are better served by a DIFC proceeding than one in local courts.  The law is better and the judges probably more familiar with commercial matters.  How this all turns out will ultimately depend on the estimated recovery for creditors.