Certainty for commercial lending practices in the United Arab Emirates – new UAE Pledge Law takes effect

With Federal Law 20/2016 on the Pledge of Movables as Security for Debt (Law), which came into force in mid-March 2017, the United Arab Emirates (UAE) passed a law that garnered little attention but which will substantially alter commercial lending practices in the UAE. For lack of regulatory certainty, the UAE lending market was traditionally quite difficult to navigate where debt was secured with movable property. As a result, the market was dominated by name- and family-based lending rather than internationally accepted standards of risk analysis. An individual’s or family’s reputation and what the market – justifiably or unjustifiably – perceived as such was much more important than financial realities. This was in part due to the fact that under UAE law borrowers could not be effectively prevented from pledging movable property to multiple lenders as security for different loans. The Law now seeks to encourage the adoption of more prudent lending practices by providing protections against the multiple pledges of assets.

The existing lending regime

Traditionally, security for lending by non-institutional lenders in the UAE has largely been supported by possessory liens. These remain valid under the Law. In fact, it appears that they may even be registered under the Law. Still, despite the Law recognizing possessory liens, its provisions are almost entirely limited to non-possessory pledges over assets to secure lending or support other secured transactions.

While their application has been significantly modified by the Law, non-possessory pledges were available in UAE prior to the implementation of the Law. Federal Law 18/1993 on Commercial Transactions (Commercial Transaction Law) contains provision on non-possessory liens that may be utilized to encumber several types of physical and intangible assets. Where movable assets are to be used as security the Commercial Transaction Law differentiates between two forms of liens:

• business or commercial mortgages that can only be granted to financial organizations; and
• commercial pledges – commonly referred to as chattel mortgages – that may be granted to non-institutional lenders.

Under the existing lending regime pledge agreements have to contain very specific language as to which assets are covered by the agreement for it to be effective. Ambiguity constitutes grounds for voiding the charge. Furthermore, certain formal requirements have to be observed. Pledges have to be:

• executed before a competent notary public;
• registered with the mortgage register maintained by the relevant commercial register;
• and the issuance of the pledge has to be published in at least one Arabic-language newspaper two weeks prior to its registration being effected.

Thus, since the UAE notary publics only execute documents in Arabic language, mortgage agreements subject to the existing lending regime have to be drafted in Arabic language; or at least bilingual with the Arabic version being the legally decisive one. Furthermore, while federal legislation compelled all Emirates to establish a mortgage register at their commercial register, only the Emirates of Abu Dhabi and Dubai set up such registers. Moreover, the existing mortgage registers are extremely difficult to search. Remote access is effectively not available and even on location searches for existing liens remain difficult and time consuming.

In addition, the existing lending regime does not regulate priority among pledges. The only relevant provision in this respect is article 1130(1) Federal Law 5/1985 on Civil Transactions (Civil Code), which provides that where there are several assignments of one right, only the first assignment shall be enforceable. This provision is generally interpreted as including the right to receivables. Priority of security, however, is not specifically addressed under the existing UAE lending regime.

Enforcement has also been somewhat problematic under the existing regime. The existing regime does not include any self-help remedies for creditors and heavily relies on courts throughout the enforcement process from notice through realization.

Changes under the new Law

The Law does not address business mortgages and pledges granted under the Commercial Transactions Law and fails to amend or suspend any provisions of the Commercial Transaction Law or the Civil Code. Thus, it stands to reason that even upon the Law entering into force, the existing lending regime remains in place. However, the Law introduces several new aspects to the UAE lending regime that will significantly impact lending practices in the market. Most importantly it provides for the establishment of a central mortgage register and allows for pledges without transfer of possession as well as pledges over future property rights.

Establishment of a central register

The Law provides for a register for pledges over moveable and other stipulated assets. The register contemplated by the Law appears to be somewhat similar to that established under the U.S. Uniform Commercial Code.

While the register shall be established by cabinet resolution, which is thus far still outstanding, the Law provides for some specification. According to the Law the register will be an electronic register, presumably searchable and likely administered by a federal authority at the national level. The Law is, however, silent as to which information will be included in the register and to what extent the information recorded will be publicly available.

Collateral available

A wide range of assets can be pledged as collateral security under the Law. These include – in particular – bank deposits, bonds and similar financial instruments, trade payables, equipment and other tangible commercial assets, goods on consignment and raw materials.

Pledges without transfer of possession

The Law allows for assets to be pledged without title or possession having to be transferred to the pledgee or a third party, provided that the pledge is duly registered. Moreover, it affords pledgees holding possessory liens the right to register such pledges under the Law, subject to certain conditions.

Form of pledge

It is thus far unclear whether pledges under the Law will require notarization by a competent notary public as do commercial or business pledges under the Commercial Transactions Law. Aside from the requirement of notarization, the Law provides for several formal requirements a pledge has to comply with to be valid and enforceable under the Law:

• the pledge agreements must be in writing and comply with the executive regulations, which are still forthcoming;
• the pledgor must have capacity to enter into the pledge agreement concerning the relevant property – thus the pledgor must have authority to dispose over the property by way of encumbrance;
• the assets encumbered must be described in general or specific terms consistent with commercial practice relevant to the type of asset(s) pledged;
• the pledge must contain a statement as to whether or not there are prior liens on the asset(s) encumbered; and
• the pledgee must in fact transfer to the pledgor the funds that are secured by the pledge.

Pledges over future property rights

Pursuant to the Law property not yet acquired may be provided as security for a loan. The introduction of this option is significant not only because such practice was previously not permissible under UAE law, but also because it contradicts principles of Islamic law. Islamic law, which is considered to be the principle source of UAE law, does not recognize dispositions over future rights. It remains to be seen how the competent authorities and the judiciary will treat such pledges in practice.

Priority

In line with international standards priority depends on the time of registration of a pledge. Thus, being first in registration grants priority to a creditor in a pledged asset against third parties. Such priority extends the proceeds derived through disposition over the pledged asset.

Enforcement

The Law provides for several self-help remedies of creditors such as seizure and sale of pledged assets. Thus, the involvement of the local courts in enforcement pledges is significantly limited by the Law.

Outlook

In the wider context of recent legislative reform amending the commercial and corporate law regime of the UAE, the new Law constitutes a positive step towards more sophisticated and professionalized lending practices in the UAE. The introduction of a centralized federal register and the – hopefully – resulting increase in transparency, in particular, are welcome. Still, for it to be effective the register will have to make publicly available information suitable to identify and evaluate existing pledges and be maintained and administrated by an effective authority. Furthermore, remaining ambiguities in the Law need to be addressed and clarified in implementing regulations for it to truly install positive change in lending practices.

Still, it is to be expected that traditional name- and family-based lending will continue in private-to-private lending. Such practices are well established within the Emirati and other Arab communities. Thus, financial institutions and other professional lenders will have to consider this duality of asset-based and name-based lending when evaluating the financial standing of customers from the UAE.