Security Law In The UAE (Overview)
Husan Hourani (Partner in Law Firm Banking & Finance)
The United Arab Emirates is a civil law country and therefore its laws are generally completely codified. The UAE legal system is based to a large extent on the French and Roman law systems with a mix of some Sharia (Islamic) principles. The Sharia principles have been modernized and embodied in the UAE Civil Code. Although the United Arab Emirates was established as a Federation in 1971, the UAE Commercial Code was not adopted until 1993. Prior to 1993, matters involving commercial issues were based on commercial principles of other Arab countries such as Egypt and Iraq, largely depending on the national origin of the judge presiding over the matter (most Judges were foreign). Until the adoption of the Commercial Code, the banking industry was dominated by lack of control and loose regulatory guidelines. The lack of comprehensive guidelines and supervision became an issue of vital interest to the UAE federation due to its impact on the local and international business communities.
Security law is predominantly governed by the UAE Commercial Code and the UAE Civil Code (Federal Law No. 5 of 1985, as amended), together with law and practice developed from several sources, including Islamic Law and the French/Egyptian legal models. Since the Commercial Code was adopted fairly recently, there is little case law in this area of the law. In many ways the UAE is still a developing jurisdiction and enforcement of rights and obligations arising from legal relationships under the commercial code is still being tested in the courts. This paper focuses on security law as set out in the Commercial Code. The establishment, enforcement and other rights and obligations under various types of security interests are also addressed.
I. Types of Mortgages/Pledges
Under the Commercial Code, mortgages or pledges are divided into six (6) categories based on the type of property to be mortgaged or pledged, and each is addressed separately thereunder. The Commercial Code clearly distinguishes movable property from immovable property based on the context of the manner in which a mortgage can be created over such property. The Civil Code defines immovable property as a thing, which has a permanent fixed nature and may not be removed without damaging or altering its structure (physical appearance or surroundings). Everything else is regarded as movable. Immovable property specifically refers to real property and any structural improvements thereon. Although fixtures, which cannot be removed without damaging the structure, fall within the legal description in the Civil Code, they are not considered immovable property. Movable property is further subcategorized into tangible and intangible property. Tangible elements include goods, tools, machinery, equipment and cash. Intangible elements include trade name, goodwill, intellectual property rights, licenses, and the right to enter into contracts. Negotiable instruments, debts, if accompanied by documents evidencing the same, and shares are also considered tangible property.
The rights, obligations, registration and enforcement of pledges securing movables, immovables, commercial business, negotiable instruments, debts and shares issued by UAE registered companies will each be addressed separately.
II. Mortgage Over Immovable Property
Pursuant to Article 1399 of the Civil Code, a mortgage over real property is defined as a contract whereby the mortgagee acquires a security interest over the real property mortgaged for the mortgagor’s debt. The mortgagee is given a priority right above ordinary creditors and creditors subsequent in rank to that of the mortgagee. In addition, the mortgagee is entitled to have its debt satisfied out of the proceeds of the real property mortgaged. Any person or entity may grant a mortgage to a mortgagor.
A mortgage over immovable property in the UAE can be achieved by a simple application, which, in effect, becomes the mortgage deed. The mortgage must be registered at the Mortgage Registrar at the Land Department or Municipality in order to be recognized. Registration can be conducted on a specified form at the Land Department or Municipality detailing the land, amount secured, interest on the loan, period of the mortgage and the signature of both parties. The Land Department or Municipality records the information contained in the application and retains one copy of the mortgage deed on file. The mortgagor and mortgagee are also each given an original copy of the mortgage deed. The procedure and specimen of the application varies from one Emirate to another, though they are similar in form and substance. Special terms and conditions of the mortgage may be added to the forms in any of the Emirates.
Once the mortgage is registered and recorded at the Land Department or Municipality it will not be lifted unless the mortgagor makes a formal application to deregister the mortgage. Even if the mortgage expires or is satisfied prior to expiration, it will not be automatically deregistered until a formal application is made to the Mortgage Registrar to delete the mortgage from its register. A mortgage over real property only becomes effective against third parties from the date of registration. Assignment of the mortgage by the mortgagee is permitted under the Code, provided that the mortgagor consents to the assignment. The assignment deed must be registered at the Land Department in order to become effective.
If the mortgagor fails to satisfy the debt in the mortgage deed by the expiration of the instrument, the mortgagee may satisfy the debt owed out of the mortgaged immovable. This is accomplished by filing a civil action in the courts. The courts will order the sale of the mortgaged immovable property by way of public auction directly. The mortgagor may challenge this order of sale by obtaining a court order to stop or stay the sale. During this time period granted to the mortgagor under the stay, he has an opportunity to satisfy the debt to the mortgagee. If he fails to do so, the immovable is sold with the proceeds of the sale used to satisfy the debt owed to the mortgagee and any balance thereon paid to the mortgagor. If the proceeds of the sale are insufficient to satisfy the debt, the mortgagee may have recourse for the balance against the debtor’s other assets. In this case, however, the mortgagee will lose its priority as a creditor and be ranked as an ordinary creditor in relation to such balance. It should be noted that pursuant to the UAE Civil Procedures Code only UAE nationals may purchase property through a public auction.
Finally, it should also be noted that all lands in the Jebel Ali Free Zone are leased land and thus mortgage over land in Jebel Ali Free Zone is not available as a security.
III. Pledge Over Movables
The general rule pursuant to Article 165 of the Commercial Code is that a pledge over movables may not be effective against the debtor and/or any third party except by transferring possession of the pledged property to the pledgee or to a third party appointed by both parties. Further, in order to be valid, the pledged property must remain in the hands of the pledgee or the appointed third party until the debt is satisfied. This rule does not apply to pledges over commercial business, which is discussed separately below.
In some jurisdictions, mortgages over movable property is achieved by a recording system within the Courts or other Departments, which allows the filing of financing documents. The filing system protects the financier/mortgagee against third parties or subsequent mortgages against the same movable property. There is no such recording system for immovable pledges in the UAE. In this regard the area of the law regarding movables is underdeveloped.
A pledge for movable property may be established by a written or oral agreement of the parties. However, without a written instrument, evidence of the movable pledge is difficult. Once the parties enter into the agreement, the pledged property is transferred to the pledgee or appointed third party. During this time period, the pledgee or appointed third party is responsible and liable to the debtor for any damage or theft thereof. Once the debt is satisfied, the pledgee must return the pledged property to the debtor in its original condition. If the debtor fails to re-pay his debt on the due date, the pledgee or mortgagee may after 7 days of requesting the debtor to pay the debt, apply to the court for permission to sell the pledged assets through a public auction.
IV. Pledge Over Commercial Business
Article 39 of the Commercial Code defines a commercial business or unit as “all kinds of tangible and intangible property allocated for commercial trading.” Article 40 further identifies the tangible and intangible elements of a commercial business or unit. Tangible elements include goods, tools, machinery and equipment. Intangible elements include trade name, goodwill, intellectual property rights, and contracts with clients, the right to let and licenses. Although tangible elements are not required to a unit to be described as a commercial business, at least one intangible element must be present. Real property is expressly excluded from the definition of a commercial business or unit. Further, if the pledge agreement does not specify the assets pledged, the pledge will not be effective except in relation to the trade name, right to let, client contracts and goodwill.
Although the pledge over commercial business involves the pledge of movable property, it is distinguishable in several ways from the general rule regarding movable property described in the preceding section.
The Commercial Code distinguishes pledges over commercial business from other types of pledges by providing in Article 49 that only banks and financial institutions may grant pledges to a commercial business.
Another distinguishing factor is that the mortgagor may continue to maintain possession of the commercial business or unit even after pledging the commercial business or unit. The crucial question is whether goods are excluded. Under Egyptian Law, upon which much of the UAE law is based, goods are expressly excluded. Goods are meant to be sold, and the merchant cannot operate unless he is able to dispose of his goods in such a way as to give bona fide purchasers good title to the goods. However, the merchant will not be able to grant good title to the goods if they were pledged. Therefore, if the goods are not excluded from the materials elements that can be pledged, trading will be impossible, thus defeating the whole purpose of having a special type of pledge that does not require possession. Moreover, goods could be pledged under Articles 164 to 177 of the Commercial Code by actual delivery of possession of the goods.
Based on this, it can also be argued that a pledge on commercial business is somewhat different from the “floating charge” concept recognized in a number of jurisdictions, including U.S. and U.K. Since the pledge over commercial property, by definition, relates to the concept of the “floating charge”, it is often the source of confusion by foreign attorneys familiar with the “floating charge.” Under the UAE Civil Law System the floating charge concept does not expressly exist. In the UK, such a charge was held to exist if it had three main characteristics: (1) it is a charge on a class of assets of a company present and future; (2) that class is one which in the ordinary course of the business of the company would be changing from time to time; and (3) it is contemplated that, until some future step is taken by or on behalf of those interested in the charge, the company may carry on its business in the ordinary way so far as concerns the particular class of assets. Based on this definition of a “floating charge”, the commercial pledge can be distinguished from the “floating charge” since the material elements of a commercial business are not constantly changing, and the creditor has priority over all unsecured claims and secured creditors, if they rank junior to him.
The Commercial Code provides that a pledge over a commercial business “must be made in writing, notarised before a Notary Public and registered at the Commercial Registry.” Until now, there are only three established Commercial Registries in the UAE in the Emirates of Dubai, Abu Dhabi and Sharjah. Thus, the pledge of commercial business may only be effected in these three Emirates. Jebel Ali Free Zone Authority is in the process of setting up a Commercial Register. Therefore, until a Commercial Register is set up in Jebel Ali Free Zone, this type of security is not fully available for Jebel Ali Free Zone entities.
Registration in the Commercial Register provides protection for a period of five (5) years from the date of registration, bearing in mind that such registration will be automatically cancelled if not renewed prior to the expiry of the five (5) years. The registration of a pledge at the Commercial Registry may not be cancelled except by the consent of both parties or pursuant to a final court order.
In the event that the debtor fails to re-pay his debts when due, the lender may 8 days after notifying the debtor, apply to the court for permission for the assets included in the pledge agreement to be sold at a public auction.
V. Mortgages over immovable property erected at Jebel Ali Free Zone
Dubai Government issued Law No. 1 of 2002 in relation to mortgages over immovable property at Jebel Ali Free Zone (“JAFZ”). Before the issue of this Law, banks tended to provide secured financing to establishments in JAFZ against a pledge over their movable assets and/or an assignment of the lease over the JAFZ land. Practically, many problems were encountered by banks: firstly, a pledge over the movable assets of an establishment in JAFZ cannot be registered at any registry in the UAE and hence the rights arising out of the pledge may not be protected against third parties; secondly, the assignment of the lease was in the form of an assignment in which the bank only had the right to request that the lease is assigned to its own name or the name of a third party, after the consent of the Jebel Ali Free Zone Authority (the “JAFZA”) had been obtained. In practice however, JAFZA promptly consented to such assignments.
Under this Law, only structures erected at JAFZ may be mortgaged and this does not include land leased by JAFZA, which remains under the ownership of Dubai Government. Banks and other creditors may be the mortgagee under this Law and, therefore, the scope of application of this Law is wider than former security laws in the UAE. The mortgagor and the mortgagee have to provide their mutual consent to the mortgage over the immovable property before the Registrar at JAFZ. Once the Registrar has obtained receipt of an application to register the mortgage, he must ascertain the competence of the contracting parties to perform the mortgage and ensure that there is no previous attachment court order over the immovable property. In addition, the Registrar has to ensure that the immovable property is owned by the mortgagor after reviewing evidence submitted to him regarding the same, this may be in the form of different invoices, the lease and any bank accounts. Finally, the Registrar ensures that the amount of the mortgage debt is not higher than the value of the immovable property mortgaged.
Under this Law, a registered mortgage constitutes conclusive evidence vis-à-vis third parties and, therefore, registration is essential for the preservation of the security for the debt. Any alteration or cancellation will not be effective vis-à-vis third parties unless the same is made in the Registrar. Priority among registered mortgages is according to the date of the registration of such mortgages. Under Section 13 of this Law, a deed of mortgage made pursuant to its provisions will be deemed an executable deed. Accordingly, if the mortgagor fails on repayment of the debt, the mortgagee may approach the Dubai Execution Court immediately without having to resort to filing a civil action before the courts.
Under Section 14 of this Law, it is provided that a mortgage shall expire at the end of the lease of the land on which the Immovable Property has been erected or by agreement of the contracting parties or by a final judgment of a competent court. In practice, the first circumstance may cause problems in the event that the lessee has defaulted on rent. JAFZA may then terminate the lease and – if one applies the section as is worded – the mortgage shall accordingly expire. In effect, the mortgagor may upon his own will, be able to free the Immovable Property of all mortgages by simply defaulting on the rent.
Under Section 17 of this Law, it is stipulated that the buyer of the mortgaged property may personally benefit from it or rent the land from JAFZA for the remaining period of the lease concluded between JAFZA and the lessee (mortgagor). Further, the fees for registration of a mortgage is 1.2% of the amount of the debt, and this is also applicable in the event of an amendment to the conditions of the mortgage.
In conclusion, we feel that the Dubai Government has by issuing this Law, eased the legal mechanism for credit financing in the JAFZ. The Law overcomes previous difficulties encountered by JAFZ entities when requesting credit financing from banks and other creditors. However, there are some ambiguous sections that may prove difficult to enforce in practice. It should be noted that JAFZA has stated that it shall refrain from registering a mortgage over Immovable Property when the lease of the related land has already been assigned, thereby removing one possible conflict in enforcing this Law.
VI. Pledging Certain Instruments and Debts
The Commercial Code provides for the pledging of the rights contained in certain instruments such as promissory notes and bills of exchange by delivering such instruments to the pledgee. If such instruments are bearer instruments, the pledge will be affected by a written document specifying that the delivery of such instruments is by way of security. Moreover, such documents must be registered with the entity that issued such instrument.
The pledging of debts due to the pledgor is also permissible under the Commercial Code provided that (1) an instrument representing the debt is delivered to the mortgagee; and (2) the pledgor’s debtor has been notified of the pledge or has accepted the pledge. Such pledge will not be valid against any third party unless the pledgee maintains possession of the instrument representing the debt.
VII. Pledges over quoted and unquoted shares issued by companies registered in the UAE
A pledge is effected by a written agreement in which all the details of the pledge are stated. Such details include the amount, period, event of default and the terms and conditions of the pledge. A pledge can be created in favour of banks and financial institutions.
Any agreement seeking to authorize a creditor to acquire ownership of the pledged items without adhering to the prescribed enforcement procedures is void. If the pledgor breaches any term or condition of the pledge agreement, the creditor has the right, after giving seven days notice to the pledgor, to petition the court for permission to sell all or part of the pledged items. Such a sale must be by public auction, for which the court determines the date, time, place and method of sale. The public auction must be advertised at least 10 days before it takes place.
The pledge may not be enforced against the debtor or a third party except if the pledged asset is transferred from the pledgor to the pledgee and held in possession by the lender or third party until the expiry of the pledge or if it is placed in a manner that makes the pledgor unable to dispose of it without the knowledge of the pledgee.
Also, the pledgee is considered to be in possession of the pledged asset once it is placed under his disposal in a manner that leads other to believe that the pledged asset is in his custody or if he receives a deed that represents the pledged asset and gives its possessor exclusive right to receive it.
Three types of companies may issue shares in the UAE: private joint stock companies, public joint stock companies and partnerships limited by shares. This includes Free Zone companies.
Shares in joint stock companies, Free Zone companies and participating shareholders’ shares in a partnership limited by shares are nominal and not in bearer form. Also, the shares are negotiable. Such shares, therefore, may be pledged by delivering them to the pledgee. In order to effect the pledge, the pledgor should undertake to request the company to register the pledge in the register of shares of the company to secure the full payment of the facility or loan. The pledgor should also deliver the share certificate to the pledgee. The pledgor shall have the right to receive the dividends and utilize the rights related to the shares unless otherwise agreed in the pledge agreement.
The pledgee’s rights over the pledged shares can be protected by registering the pledge at company’s register or JAFZA and by marking the share certificate. This will give the pledgee a priority right over other creditors of the pledgor in relation to the pledged shares.
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