Side Agreements

Different countries have varying laws when it comes to relationships among shareholders in a company. It is important to understand what constitutes an agreement that is legal between the shareholders who own a company. In this context, an analysis of the law is made in relation to UAE and whether side agreements are enforceable in the country, which will be done with consideration of the fact that different laws apply from one country to another and, therefore, it will be vital to determine such similarities and differences. When shareholders are coming together to form a company it is important to state how it will be run. It is important, thus, to determine exactly what is meant by the term a shareholder’s agreement. There are certain advantages as well as disadvantages that exist within the concept of a shareholder’s agreement, hence, it is important to have a look at them.

In the context of UAE, it is known that most of the limited liability companies are managed and owned by shareholders that are foreign yet the legal documentation of ownership does show something very different. This is a country in which it is common for the shareholder to carry out and execute what is known as “side agreements”. Side agreements usually take different forms and in most cases contain some provisions that are against the provisions created by the Company’s law and Memorandum of Association in UAE. One example involves a situation where a foreign owner may provide financing to a UAE shareholder who buys shares in a company and the foreign owner gets a pledge over the shares of the UAE national. In most instances, the UAE national has the ability to execute some deeds or arrangements that would favour the foreign shareholder, which would allow the foreigner to control the business as the loan is repaid in its full amount. It is vital that an analysis of some of the cases concerning such arrangements be done to determine whether they are against the UAE laws. 

Shareholders’ Agreement

Shareholder’s agreement is defined as a contract between the shareholders of a company defining how the company will be run. Ahmed and Kothari (2015) affirm that in such a set up all the shareholders agree to make use of their voting power to ensure that the agreements are complied with as per the interest of the shareholders. In most situations,  arrangements are made to protect minority shareholders in the organization. In most instances, starting a business with a friend or a family member requires trust, but it is important to come up with an accord that would guide relations in the organization that is being formed. It is to safeguard the fact that something could go wrong in future and therefore such an agreement will come in handy.

Terterov (2006) points out that in many situations, the articles of association are utilised effectively, but there is need for a well drafted shareholder’s agreement which will act as a safeguard and provide an individual protection against a scenario of disagreement. There are many cases, though, where people have these sorts of arrangements, but never do they rely upon them. That should not stand to mean that they are inessential - it is important that for benefit of doubt such agreements are put in place.

Advantages

A shareholder’s agreement has numerous advantages:

1. It provides an opportunity through which shareholders are able to obtain additional rights or to expand on the rights that they already have. Comyn, Elaraby, and Fabian (2015) opine that the arrangements are usually created in such a manner that they are suitable to different circumstances that shareholders might face.
2. It is highly beneficial to a minority shareholder and one can be able to derive extra benefits attributed to their access to important information related to the company, the right to be nominated or appointed to be a director, and the privilege of a pre-emption if the company decides to increase the number of shares.
3. The third advantage is that such documents can be tailored to suit individual needs of the parties involved.  According to IBP, Inc. (2015), there are majority shareholders who can benefit from this provision in the sense that some default provisions can be included. It also comes about with the drag along the provision. It means that in any case, the majority shareholder receives better terms to sell his shares and he/she can pull the other shareholders to sell their shares too.
4. It is also advantageous to the potential investors, who usually consider how a company is run before they become willing to invest their capital into such businesses. The investors also in some instances are concerned about their ability to get their capital investment back as well as come up with a strategy for exit.

Disadvantages

Generally, it can be stated that there have not been any proven cases where the creation of shareholders’ agreement has negatively affected operations in an organization. One aspect which can be said to have a negative effect is when a family business is being operated using article of association and some members of the board propose that such an agreement is created, there could be loss of trust and familial relations between the members, which may have a greater long term negative effect.

UAU Company Law in General

Vallander (2013) asserts that the UAE federal law no. 8 (1984) as was amended does provide that foreigners are not eligible to own more than 49% of any joint venture in UAE outside those areas regarded as being free zone. In most situations, there are people who have found it effective to have ‘side arrangements’ in which UAE nationals who own more than 51% of shares in a joint venture only do so in trust of the foreign individual or party.

In most cases in UAE, people have contented the fact that highest courts in Emirates of Dubai as well as Abu Dhabi have upheld situations of side agreements, and while making such rulings they have relied on upon economic provisions and ignored the statutory provisions. The major feeling among most legal experts in the country is that in any case the side agreements are declared illegal in the country; it will have an adverse impact on the foreign investments that are made into the country.  Terterov (2006) emphasises that this will be against the notion being sent by the UAE administration that they are encouraging foreign investment.

The Company Law in UAE

The company law in UAE does recognize various forms of corporate ownership, but for most joint venture entities in the state, limited liability companies are the most popular. Martelli (2014) explains that the other option which is actively utilised is the joint stock company that must have a minimum of five shareholders, has tougher capital requirements and is highly time consuming when it comes to its establishment. This is the reason why the discussion about side agreements tends to be restricted to limited liability companies.

The UAE law provides that an LLC must have a minimum of two shareholders and a generally lower need for capitalization.  Vallander (2013) opines that foreign companies can operate in UAE only after they have acquired a license which is registered in compliance with the provisions of article 314 and 315 in the companies’ law. One important step that is legally provided in creation of an LLC is the filing of a draft article of association. This article is required to follow standard forms provided for any article. There are only few instances where the document form may vary on some smaller aspects. Varrenti, de las Cuevas, and Hurlock (2011) reiterate that notary Public is vested with the role of reviewing documents of such nature and in most cases does not allow some instances of dramatic changes. It is advisable that any individual who wishes to establish a partnership in a future LLC must first enter a formal shareholding agreement before entering any joint venture enterprise in the UAE.  The agreements that are being made have to be consistent with the law of UAE and the articles that have been registered a forehand.

Supreme Court Judgment on Issue of Side Agreement

To understand what the courts have ruled when it comes to side agreement, it is vital to remember the fact that the court has to consider the true intent of the parties while entering into the side agreement contract.  Terterov (2006) underlines that the actual agreement must have a contract that reflects the true intent of the parties that enter into the contract. It must come in a written form in order to ensure the validity and priority in times of litigations. This is a confirmation which states that side agreements are agreed with if they are written and indicate the true intent of the parties.

According to IBP, Inc. (2015), the first instance of a case that is analysed here is Case No. 2009/211 in Dubai Court of Cassation. In this situation, an important statement was provided in relation to actual agreement. The principle, who was the foreign shareholder, got the favour of the court, where he was given the right to financial interest associated with the shares of the nominee. The court reflected on the true intent of the parties that entered into the contract in relation to the registered agreement. It was in this ruling that a difference was provided between an economic and a registered ownership, while at the same time it also created a ground through which side agreements could be honoured. It is even when it is known that a side agreement is not part of the UAE Civil Transactions Code. The other paramount element that was learnt through this case is the fact that side agreements have to be written in order to conform with the evidence law.

IBP, Inc. (2015) opines that another case under the Dubai Court of Cassation that is significant in understanding a side agreement is the Case No. 2008/121 in January 2009. The court stated that the agreement must be documented before it can fully be accepted. It was a judgment that is in line with the Article 10 under the CCL. The article 10 does provide that testimonies that are unwritten are prohibited when disputes arise and one of the partners wants to show an agreement that is outside what was originally agreed in the Article of Association. In light of this provision, it does indicate that at one point through the discretion of the court it is possible for the side agreement to be upheld as long as the parties can demonstrate through the formal documentation that this was the intention of the contract at the time of entering into a joint venture relationship.

There is a third court case, which can be used to elaborate the manner in which courts in UAE have handled the case of side agreements. Varrenti, de las Cuevas, and Hurlock (2011) indicate that Case No. 2009/17 was created and ruled out of the provisions of the first two cases. This is a judgment that emphasised the provisions under article 322 and 232 under the CCL and belongs to “restriction fronting regime” (Vallander, 2013). The most relevant parts of 322 and 323 does offer sanctions on parties found to be intentionally providing misleading information when it comes to the articles.

This is the provision which indicates that the law does not allow people to enter into a memorandum of association with the information that is false. One is not allowed to sign and distribute such documents, and in a situation when they do so – it will be contravening the law. It is further stated that companies should never violate the set provisions concerning the proportion of the UAE nationals who are in the company capital structure.

On the basis of the above-written paragraph, the law is very clear in terms of what should not be violated while entering into a joint venture. What is seen in most of the above rulings is that the courts seemingly do not have any reservations when it comes to side agreements as long as the contracts that provide such creations that are contrary to the memorandum of association is documented and that there was specific intent when such contract was being entered.  Vallander (2013) asserts that despite the set implications above in Articles 322 and 323, the judgments made honoured the existence of side agreements. The Dubai Court of Cassation ordered that the relationship between the partners in the company should be governed under the side agreement set as de facto company.

What is to be understood is that, despite the above three cases indicating that Dubai Court of Cassation agree with side agreement, the Supreme Court has a different contrary understanding of this matter. The cases mentioned above have acknowledged the existence of side agreements in United Arab Emirates. In one of the latest ruling by the Supreme Court there was an indication that they did not agree with the Court of Cassation.

The Current Situation

A recent judgment that was handed down by the Supreme Court has indicated that there is a unique position when it comes to the concept of a side agreement and partner removal in a company. According to Ahmed and Kothari (2015), most of the judgments have been drawn in effort to offer more information in terms of validity and enforcement of the side agreement context to 49/51 UAE LLC. Even though the general environment and belief in UAE is that the government and the judiciary are pro side agreement, there are reasons to make foreign investors weary. The foreign investors are required to take into consideration two important elements;

1. The UAE Federal law 17 of 2004, which is in respect of Commercial Concealment i.e. the UAE harbouring law.
2. Union Supreme Court case in which a side agreement in a UAE joint venture was invalidated.

Martelli (2014) highlights the view that the the Harbouring Law in UAE was enacted in 2004 and the actual implementation was deferred up to the November of 2007. It was again deferred to November of 2009 through a cabinet resolution of 2007. It, therefore, means that the Harbouring Law is actually in force and it does not enable the local national to allow a foreigner to carry out an economic or professional activity that is not permitted by the law of United Arab Emirates whether by doing so he/she will be enabling him/her to evade a certain form of liability.

There are some penalties when one violates the harbouring law and therefore it is important for foreigners to consider such laws before entering into an agreement with a local concerning side agreement. Evidence suggests that UAE is not doing much in terms of implementation of the harbouring laws, but it, being a law in the constitution of the country, cannot be ignored unless one wants to get into trouble in future. Ahmed and Kothari (2015) opine that in 2012, Union Supreme court situated in Abu Dhabi made a decision which suggested that side agreements are not legal. The decision stated that the agreements made to vary the economic rights or any other form of rights in UAE joint venture should be provided in the registered article and be recognized through a local notary public and go through normal authorization and licensing in the Emirates. It is understandable that such a case does not hold any precedential value which can create binding precedent in the common jurisdiction, yet it is of a great significance that foreign entities are mindful of the fact that there are examples of the courts making invalid such agreements.

Supreme Court against Side Agreement

This case, which generally is named Case X, was ruled in 2013. It shows a unique position taken by the Supreme Court on issue of proof in terms of side agreements.  Comyn, Elaraby, and Fabian (2015) explain that there was a conflict that arose in the Abu Dhabi based LLC between a UAE shareholder who owned 51% of the shares and an Omani shareholder who owned 24% and a US company that owned 25% of the shares. The UAE shareholder wanted to effect his right to 51% of the profits as was provided in the registered contract. There was a counter from the Omani Shareholder, who claimed that there was a side agreement in which both of the parties owned 37.5% of the shares and United States Company owned the rest (Martelli, 2014).

The first instance saw the court rule in favour of the UAE shareholder based on the provisions of the MOA which is the official document. The same case was taken to the Federal Court of appeal, which upheld the prior judgment. It was at the Supreme Court that one important issue arose. Evidence law in UAE states that written contracts can only be contradicted through evidences that are provided in a written form (Case No. 2008/212). There are some instances where certain exceptions are provided. The first is if the opponent ignored the right to documentary evidence, and the second instance it is an agreement to defraud the law. In case the exceptions are activated, it means that the individual offended can make use of any means of evidence to prove that the official agreement is not an honest justification of the side agreement. It is based on this that the Supreme Court overruled the previous decisions and referred the case back to the Court of Appeal.

The Court of Appeal still did not see the evidence and ruled in favour of the UAE shareholder. The Supreme Court still rejected this judgment as the Supreme Court believed that the lower court had not considered side agreement clause under Article 20. This had each of the partners acknowledge that they own equal shares in the company.