The UAE continues to pursue a proactive law reform agenda to promote the financial services industry whilst carefully balancing the needs of lenders and borrowers. The need for a careful balance to be struck between lenders and borrowers has been notably stark in the major restructuring situations that we have seen in the UAE over the last 3 years (including for example with respect to NMC Health plc, KBBO Group and Finablr plc). There is no doubt that the underpinning financial and bankruptcy legislation in the UAE has been stretched in dealing with these situations and we have seen numerous instances where the UAE legislature has amended legislation in order to address unintended consequences of these laws. Two recent amendments to the UAE's banking laws are a continuation of this theme.

UAE Banking Law (as amended)

UAE Federal Law No. 23 of 2022 came into force on 2 January 2023, amending certain provisions of UAE Federal Law No. 14 of 2018 on the Central Bank and the Organisation of Financial Institutions and Activities (the UAE Banking Law (As Amended)). By virtue of Article 121, the UAE Banking Law (As Amended), now obliges Licensed Financial Institutions (LFIs) [1]  to obtain "sufficient guarantees" when lending to natural persons and sole proprietorships.  When obtaining such guarantees (which has been interpreted to mean 'security'), the LFIs must take into account factors such as the customer's income and the size of the requested facility.

The UAE Banking Law (As Amended) does not offer a definition for "sufficient guarantees", nor does it provide guidance on what types of guarantees are 'sufficient'. Failing to obtain "sufficient guarantees" will result in the rejection of any application, claim or defence filed by LFIs – in relation to the validity of credit facilities provided to natural persons or sole proprietorships – before competent judicial authorities or arbitral tribunals. A failure by LFIs to obtain "sufficient guarantees" may also result in administrative and financial sanctions being imposed by the UAE Central Bank (for example, fines or restrictions on the LFIs' license)[2].  Importantly, the UAE Banking Law (As Amended) has retrospective effect. Therefore, despite the general prohibition on retroactivity in the UAE Constitution , the obligation to obtain "sufficient guarantees" in support of lending activity applies to loans that have already been sanctioned and advanced.

The New Commercial Law

UAE Federal Law No. 50 of 2022 also came into force on 2 January 2023 (the New Commercial Law), replacing UAE Federal Law No. 18 of 1993 (the Old Commercial Law). Article 409(2) of the New Commercial Law similarly requires that "banks shall have sufficient securities or guarantees against loans they provide" (emphasis added). The inclusion of "shall" is of particular note and is a more robust obligation compared to the predecessor provision under the Old Commercial Law which provided that banks "may" have such securities and guarantees in place.

The Assistant Governor for Monetary Policy and Financial Stability at the UAE Central Bank, H.E. Ebrahim Al Zaabi, has offered an insight into the policy objective behind these reforms. Local media reported that His Excellency stated that Article 121 of the Banking Law (As Amended) was introduced to mitigate the uptick in defaults  among natural persons and sole proprietorships in the UAE due to burdensome instalment payments that are disproportionate to their income levels and are beyond their repayment capacity. We suspect that these insights were driven by an overwhelming number of claims arising under personal guarantees given by individuals in the context of distressed situations on the major restructurings which have been prevalent in the UAE in recent years. Hence, Article 121 aims to enhance the effectiveness of the measures taken by the UAE Central Bank in regulating financial facilities granted to natural persons and sole proprietorships, and to reduce the rates of default [5]. 

Following the introduction of Article 121, and in response to a request for clarification by the Abu Dhabi Courts, the UAE Central Bank Governor issued a clarification letter confirming that a 'personal guarantee' on its own (i.e., not backed by a tangible collateral) shall no longer be considered as a 'sufficient' form of guarantee for the purposes of Article 121. We suspect this guidance also applies to the interpretation of "sufficient guarantees" pursuant to Article 409(2) of the New Commercial Law (the CB Clarification)[6].   

The legislative changes re-emphasise the importance of responsible lending by the financial institutions in the UAE (particularly if lending is to natural persons or sole proprietorships (or indeed being guaranteed by those persons)). The changes also perhaps signal a move away from the practice of "name-only" lending, a reduction in reliance on personal guarantees (only) as a form of security and a reminder to financial institutions to conduct thorough financial due diligence (particularly on natural persons) as part of any transaction credit assessment. This can only have positive implications given what the UAE restructuring and insolvency community witnessed as a result of the collapse NMC Health Plc and related group companies in addition to the financial fallout as a result of the COVID-19 pandemic.

The Abu Dhabi Courts have recently grappled with the interpretation of "sufficient guarantees" pursuant to Article 121 of the UAE Banking Law (As amended) in a host of cases brought by banks seeking to file claims or commence execution actions against customers and/or personal guarantors following a default by the debtor. The Abu Dhabi Courts have reportedly suspended litigation and execution actions in these circumstances for two contrasting reasons.

(a) Where banks are under-collateralised: In circumstances where the banks had only obtained a personal guarantee – without collateral – prior to lending to natural persons or sole proprietorships, the Abu Dhabi Courts have reportedly held (presumably in adherence to the CB Clarification) that such personal guarantees were not considered 'sufficient' for the purposes of Article 121.  In such cases, it has been reported that the Courts proceeded to reject claims/suspend execution actions commenced by banks against customers and/or personal guarantors. The personal guarantees are therefore effectively void leaving the banks with no recourse to the guarantors as was intended (by all parties) at the time of lending.

(b) Where banks are over-collateralised: In contrast, in a recent execution action brought by a bank against its customer (an individual) before the Abu Dhabi Courts, the Courts held that a mortgage over property was to be considered a 'sufficient' guarantee for the purposes of Article 121 but that a security cheque was not. The facts surrounding this execution action were such that the bank had collected two forms of 'guarantees' from its customer as security for a loan facility. The two forms of 'guarantee' were a mortgage over property and a security cheque.  Upon the customer's default, the bank commenced an action to execute against the security cheque.  Whilst stating that a property mortgage is considered a 'sufficient' form of guarantee (for the purposes Article 121), the Courts also held that by obtaining an additional form of guarantee (i.e. the security cheque) the bank had exceeded the 'sufficient guarantees' requirement under Article 121. As such, the Courts rejected the bank's execution action against the security cheque. The Court explained that by allowing the bank to over-collateralise in this way, it would risk exposing the customer to unnecessary financial distress – which would go against the intended rationale underpinning Article 121.  The Courts held in such case that enforcement action would be limited to enforcement of the 'sufficient' guarantee provided by the customer i.e., the mortgage over property only [7].  
          
It is unclear at present whether such interpretation by the Abu Dhabi Courts was envisaged by the UAE Banking Law (As Amended), particularly with respect to what constitutes as a 'sufficient' guarantee for the purposes of Article 121.  

Until clear parameters are issued on what specific forms of guarantees are considered 'sufficient' (and it is noted that regulations are envisaged to be issued by the UAE Banking Law), it is foreseeable that UAE Courts in other Emirates may also move to apply their own interpretations to Article 121, which will undoubtedly impact the outcome of current and future claims and actions brought by LFIs before courts and arbitral tribunals in the UAE. Such interpretations, that could potentially range from broad to narrow, are likely to also affect how LFIs approach lending to natural persons and sole proprietorships in the future and the risk rating (and therefore pricing) of such lending.

The requirement for financial institutions to obtain "sufficient" guarantees and securities for the loans they provide (as required by Article 121 of the UAE Banking Law (As amended) and Article 409(2) of the New Commercial Law) has significant implications for those financial institutions in respect of current distressed situations, in respect of new credit transactions and in respect of their existing loan books as a whole. We consider each of these in turn:

(a) Impact on current distressed situations / enforcement proceedings: Given the jurisprudence arising from the Abu Dhabi Courts we expect this is likely to be used as a tool by current defaulting borrowers (particularly those where the ultimate sponsor has granted a personal guarantee (which is not an uncommon practice in the UAE)) to attempt to disrupt enforcement proceedings taken by financial institutions by attempting to have guarantees (and potentially also securities) set aside as not being "sufficient". There is optimism that more detailed guidance on what amounts to "sufficient" will be forthcoming from the UAE legislature or indeed from the appellate courts in Abu Dhabi shortly. However, in the interim financial institutions should proceed with caution before taking enforcement proceedings (particularly in the Abu Dhabi Courts). It seems that the Abu Dhabi Courts are taking a particularly restrictive and onerous approach to the interpretation of "sufficient". Consideration should therefore be given to (i) whether there is scope to commence enforcement action in courts of other Emirates (for example Dubai) where the courts may apply a different interpretation[8]; and (ii) whether there is an ability to recalibrate the financial institution's guarantee or security position with the relevant customer prior to enforcement action being taken, for example by increasing the secured position if it is under-collateralised or decreasing the secured position if it is over-collateralised. This approach would obviously not come without its own challenges [9].  

(b) Impact on new credit transactions: Similarly, relationship teams within UAE financial institutions will be left scratching their heads when writing credit papers for new transactions. What now amounts to "sufficient" guarantees and security? What if this is an investment grade borrower with no guarantees or security proposed to be taken? How can the bank protect itself against being under-collateralised when borrowers often attempt to reduce the security and guarantee position proposed at term sheet stage? These are all legitimate questions which, in absence of any guidance as to what amounts to "sufficient", are difficult to answer at this stage.

We do not believe the purpose of the legislation is to curtail the investment grade lending market in the UAE. Financial institutions can take some comfort from the fact that borrowers of this nature do not often default. However, for all other lending activity there is no doubt that financial institutions will have to carefully consider the security and guarantee pool the borrower is proposing. In terms of practical guidance, we would suggest financial institutions consider the following: (i) thoroughly consider (including in light of all the transaction's circumstances, the level of debt and the customer's income/assets) the implications of the new legislation at the credit stage, create an audit trail for evidentiary purposes and record any decisions taken in the relevant credit papers that the security and guarantees proposed are, in the bank's view, "sufficient"[10]; (ii) giving effect to any asset cover/loan to value ratios it is proposing in its loan agreements and ensure the proposed security and guarantee package being taken falls within a reasonable range of these parameters; and (iii) relying on different governing law and jurisdiction clauses in their loan agreements moving forward (for example DIFC law/DIFC Courts, in order to allow for enforcement proceedings in jurisdictions that might take a less onerous approach to the interpretation of these provisions.

Whilst tailoring the jurisdiction/governing law clause might help, this approach is still not without risk. It is possible that a debtor would still raise arguments regarding the sufficiency of security either during the course of proceedings (on the basis that these are mandatory UAE law provisions that cannot be contracted out of by the parties) or at the enforcement stage, which may require the judgment to be recognised in the onshore UAE Courts (on the basis that there are public policy reasons why the judgment should not be recognised).  That said, the scope for successfully invoking public policy arguments at the enforcement stage (in respect of a DIFC Court judgment in the onshore courts) is quite narrow and generally these sorts of arguments do not succeed.

(c) Impact on existing loan books as a whole: Given the retrospective nature of Article 121 of the UAE Banking Law (As Amended) and the jurisprudence arising from the Abu Dhabi Courts which has penalised banks for having both under-collateralised and over-collateralised secured positions, there would be value in in banks conducting a thorough assessment of each of their existing UAE loan books (particularly targeting loans made to individuals or sole proprietorships or guaranteed by the same) to decipher whether the security or guarantees taken in respect of any individual positions would likely fall foul of any of the new legislation. A loan book review of this nature would be no small undertaking on the part of financial institutions, so perhaps the prudent steps would be to (i) ensure such a review takes place when loans are passed to the restructuring and non-performing teams within the institutions themselves; and (ii) conduct the thorough assessment (as outlined at 4(b)(i) above) at this stage, including an assessment as to whether the financial institution would have the ability to recalibrate its secured position (as outlined in 4(a)(i) above)).

[1] Defined under Article (1) of the UAE Banking Law (As Amended) as 'Banks and other financial institutions licensed under the provisions of this Decree by Law to perform one or more of the Licensed Financial Activities, including those performing all or part of its activities in accordance with the provisions of Islamic Law, provided that said institutions are incorporated inside the UAE or other Jurisdictions, or have branches, subsidiaries or representative offices thereto inside the UAE.' (translation by Westlaw Middle East)

[2] Article 137 of the UAE Banking Law (As Amended).

[3] Article 11

[4] Translated literally as "phenomenon of defaults".

[5] https://www.argaam.com/ar/article/articledetail/id/1614763

[6] Clarification letter issued by the UAE Central Bank Governor, 22 February 2023.

[7] Abu Dhabi Execution Action 143 of 2022

[8] The process for enforcing a Dubai Court judgment in Abu Dhabi is a relatively straightforward one and, at this stage, we do not consider that there is scope for the Abu Dhabi Courts to refuse to enforce such a judgment on the basis of inadequate security.

[9] Consideration would, for example and without limitation, have to be given to any potential hardening periods or antecedent transactions if new security is purported to be taken.

[10] Given the CB Clarification and the jurisprudence arising from the Abu Dhabi Courts financial institutions should not rely on personal guarantees only moving forward.