I OVERVIEW OF M&A ACTIVITY
Despite a relatively strong start to the year, M&A activity appears to be facing strong headwinds in 2019. Geopolitical and regulatory developments appear to have encouraged both purchasers and sellers to delay or reconsider the particular value proposition that a deal presents. With the advent of ever-increasing regulation (including in the UAE), M&A transactions are becoming more complex to structure and to implement, and consequently have also become significantly more expensive.
In the UAE, headline M&A transactions continue to be driven by government-owned or controlled businesses, in particular the banking and finance industry. Of note, the much-rumoured three-way merger between Abu Dhabi Commercial Bank, Union National Bank and Al Hilal Bank was completed in the second quarter of 2019. The merged entity has an asset base exceeding 420 billion dirhams and is the third-largest lender in the UAE. The merger follows a trend of consolidation in the banking sector and represents the desire of the UAE authorities to see consolidation in sectors where cost-saving synergies can be made. On a similar note, media reports suggest that Dubai Islamic Bank and Noor Bank are currently engaged in merger talks. Talks are said to be ongoing and it is not yet certain whether a deal will materialise.
II GENERAL INTRODUCTION TO THE LEGAL FRAMEWORK FOR M&A
The UAE is a federation of seven emirates that was formed on 2 December 1971 by Abu Dhabi, Ajman, Dubai, Fujairah, Sharjah and Umm Al Qaiwain following the end of the British protectorate over the 'Trucial States'. The Emirate of Ras Al Khaimah joined the federation the following year.
The currency is the UAE dirham. The exchange rate is pegged at approximately 3.67 dirhams per US dollar since 1997. There are no currency import or export controls.
The UAE Federal Constitution apportions powers between the federal government (based in Abu Dhabi) and the governments of the constituent emirates. Some fields are regulated only at the federal level (e.g., immigration and labour relations) although local interpretations and practices sometimes differ from one emirate to another. Other matters are regulated only at the emirate level (e.g., each emirate retains sovereignty over its own natural resources, including its crude oil and natural gas reserves). Still other matters are regulated at both the emirate and federal levels (e.g., company formation and registration).
Any business operating in the UAE must hold a licence authorising its business activity in the UAE. These licences are issued by the concerned authorities in each emirate. A licence allows the licensed entity to carry on the business it is licensed to conduct within the emirate that issues the licence from the business premises identified in the licence. For example, a Dubai business licence authorises the conduct of business in the Emirate of Dubai. If the licence holder wishes to conduct business in the Emirate of Abu Dhabi (for example), then it must apply for and obtain a business licence in Abu Dhabi.
In addition to the licensing rules that are imposed in each emirate, there is a separate layer of federal regulation that a business must comply with. Business licences are available to foreign and local businesses, although there are restrictions that vary from emirate to emirate on the types of business activities that are available to foreign businesses and to local businesses with partial foreign ownership. A foreign business is required to appoint a UAE national shareholder as part of its application for a licence. Companies that are incorporated in the UAE (outside a free zone) must be at least majority-owned (51 per cent) by a UAE national or wholly Gulf Cooperation Council (GCC)-owned. Companies established in any of the UAE's many free zones may be wholly foreign-owned. No corporate or personal income tax is currently imposed anywhere in the UAE, except for the income taxes that are paid by foreign banks and foreign petroleum companies.
A business that wishes to operate in a free zone must obtain a licence from the authority for that free zone. The resulting licence authorises the conduct of the licensed activity within the geographical limits of the free zone. For example, a company licensed to trade certain goods in the free zone can import its goods into the free zone and re-export to destinations outside the free zone (and the wider UAE). However, the free zone licence does not authorise it to engage in any of these commercial activities in the UAE (outside the geographical limits of the free zone). No local ownership requirements are imposed in the free zones. An additional feature of most of the free zones is that they are not part of the customs territory of the UAE. The import of goods into a free zone from overseas does not attract customs duty. Instead, customs duty (5 per cent on most items) is paid when goods move from the free zone into the UAE proper. The free zones also observe a simplified process for hiring personnel. Shares in onshore and free zone entities can be freely transferred, but it is important to note that any transfers are subject to approval by the relevant authority of the incoming shareholder.
III DEVELOPMENTS IN CORPORATE AND TAKEOVER LAW AND
The government has recently introduced changes to the foreign ownership requirements under UAE law for companies that are registered outside a free zone.
Federal Decree-Law 19 of 2018 (FDI Law) was issued on 23 September 2018. The FDI Law adopts a similar approach to majority foreign ownership as the UAE Commercial Companies Law.2 An amendment to Article 10 of the UAE Commercial Companies Law adopted in September 2017 (pursuant to Federal Decree-Law 18 of 2017) stipulated that the Federal Cabinet may adopt resolutions permitting foreign nationals to hold in excess of 49 per cent of the share capital of UAE companies. The Federal Cabinet remains responsible for making key decisions with respect to the administration of the FDI Law. In addition to the Federal Cabinet, the Foreign Direct Investment Committee (to be presided over by the Ministry of Economy and appointed by the Federal Cabinet) has been made responsible for reviewing and making recommendations to the Federal Cabinet in respect of matters concerning foreign direct investment. Any recommendations made by the Foreign Direct Investment Committee shall continue to be subject to the approval of the Federal Cabinet. The FDI Law contains a negative list of 13 sectors that will not be subject to the proposed relaxation of the current foreign ownership restrictions. These sectors are the following:
- exploration and production of petroleum products;
- investigations, security, military sectors and manufacturing of weapons, explosives as well as military hardware, equipment and clothing;
- banking and financial activities and payment and cash handling systems;
- insurance services;
- hajj and umrah services3 and labour supply and recruitment services;
- water and electricity services;
- services related to fisheries;
- postal, communication and audiovisual services;
- land and air transport services;
- printing and publishing services;
- commercial agents services;
- retail medicine (such as private pharmacies); and
- poison centres, blood banks and quarantines.
The Federal Cabinet is empowered to add to or remove activities from the foregoing list. The FDI Law stipulates that the Federal Cabinet shall, in consultation with the Foreign Direct Investment Committee, propose a positive list of sectors in which foreign nationals shall be permitted an ownership interest of up to 100 per cent. On 2 July 2019, the Prime Minister issued a statement announcing the Federal Cabinet's approval of this positive list of 122 economic activities in sectors such as agriculture, manufacturing, renewable energy, electronic commerce, transportation, arts, construction and entertainment. The list of 122 economic activities is divided into 51 industrial activities, 52 service activities and 19 agricultural activities. While allowing up to 100 per cent foreign ownership, the positive list does not do this unconditionally. On the contrary, the list imposes additional requirements such as minimum capital requirements on some activities, obligations to employ advanced technology on other activities and requirements to contribute to the emiratisation of the workforce on others. For many business and service activities, existing restrictions and qualifications are expressly retained. Despite these requirements, this relaxation of the foreign ownership restrictions could act as trigger for a fresh wave of inbound M&A activity into, and also assist in the development of homegrown businesses in, the UAE. It is expected that the licensing authorities in each emirate will ultimately determine the permitted foreign ownership percentages for specific projects.
IV FOREIGN INVOLVEMENT IN M&A TRANSACTIONS
Despite recent headwinds, the year in review witnessed substantial M&A activity, with many transactions concerning foreign involvement. Reports indicate that 77 cross-border deals worth US$14.21 billion were completed in 2018 in the Middle East and North Africa region, making it the year with the highest volume of inbound M&A. Deals in the UAE more than doubled in 2018 to US$10.4 billion, with the energy sector being a key sector of interest for foreign acquirers. As noted above, substantial M&A activity (including transactions involving a foreign party) continues to be driven by businesses and sectors with significant government involvement or investment. Examples include the oil and gas and banking sectors.
In April 2019, it was announced that Emirates NBD (a commercial bank majority-owned by the government of Dubai) would be acquiring Denizbank for US$2.8 billion with combined assets of about US$180 billion. Denizbank is the fifth-largest bank in Turkey. Due to the depreciation of the Turkish lira and in light of the ongoing political and economic uncertainty in Turkey, the deal was ultimately revised and completed at a 20 per cent discount to a previously agreed price of US$3.2 billion.4
In the oil and gas sector, Italy's Eni and Austria's OMV have agreed to pay a combined US$5.8 billion to buy a stake in Abu Dhabi National Oil Company's (ADNOC) refining business and establish a new trading operation owned jointly by all three. Eni and OMV will acquire 20 and 15 per cent shares in ADNOC Refining.5 Similarly, KKR and BlackRock are reported to have formed a consortium to hold a 40 per cent stake in a new entity known as ADNOC Oil Pipelines, with ADNOC owning the remainder. The deal has been reported to have been completed at a value of US$ 4 billion.6
In March 2019, the much-anticipated deal between Uber Technologies Inc and Careem Networks FZ-LLC (Uber's key competitor in the Middle East) was announced. This transaction is discussed further in Section V.
V SIGNIFICANT TRANSACTIONS, KEY TRENDS AND HOT INDUSTRIES
As discussed further in Section VIII, the UAE, Saudi Arabia and Bahrain have introduced VAT to their respective local markets. In a first (at least for the UAE), vendors and purchasers must consider, seek advice on and address tax matters in their transaction documentation. Furthermore, the advent of VAT will no doubt put pressure on the cashflows of many small and medium-sized businesses, and it remains to be seen whether this will in turn have an effect on distressed M&A activity.
Furthermore, we have seen the Federal Ministry of Economy (the regulator in charge of administering the competition regime) become active in accepting and reviewing merger control notifications filed in connection with UAE transactions. Although still a developing area of law, the very fact that merger control notifications are now being submitted and reviewed indicates that the relevant authorities are serious about ensuring that those who are party to transactions concerning the UAE market consider and, where required, notify their transactions. It is also of note that the lack of publicly available decisions concerning such notifications creates a degree of uncertainty for transactions that are caught by the relevant filing requirements.
In terms of key trends and active industries, we continue to see transactions take place in the financial services sector, with the ongoing consolidation in the banking industry continuing to be a driver of M&A activity. The insurance industry also remains an industry of interest insofar as M&A transactions are concerned, with consolidation being a continuing trend.
In the technology sector, a number of UAE free zones (in particular the Dubai International Financial Centre (DIFC) in the Emirate of Dubai and the Abu Dhabi Global Market (ADGM) have made an effort to attract, support and grow technology-related business. The government of Dubai has also launched the Dubai future accelerators programme7 aimed at encourage young entrepreneurs to address the challenges we are currently facing. Similarly, the DIFC has introduced a fintech accelerator programme8 aimed at providing startups access to leading accelerator programmes and mentorship from leading financial institutions and insurance partners, along with a dedicated space to work alongside a community of like-minded individuals. In Abu Dhabi, the ADGM has introduced a licensing regime specifically catered towards tech startups that allows entrepreneurs to obtain an operational licence in the ADGM and that gives them access to a professional services support programme aimed at allowing entrepreneurs' entry to a community of businesses, financial services and professional advisers.9 Given these developments and the stated aim of the UAE government to encourage and support hi-tech businesses and startups, technology businesses will likely also continue to be a source of M&A activity in the UAE.
A transaction of note in the technology sector was the acquisition by Uber Technologies Inc of Careem Inc, with the result that Careem will (upon completion of the acquisition) operate as a wholly owned subsidiary of Uber, while at the same time maintaining its own brand and independent operations. The acquisition is reported to have been agreed for a price of US$3.1 billion, consisting of US$1.7 billion in convertible notes and US$1.4 billion in cash.10 Similarly, in May 2018, Dubai-based The Entertainer (a lifestyle and coupon application based in the UAE but operating across the Middle East, Europe, Asia and Africa) reported that GHF Financial Group, a Bahrain-based investment bank listed on the Dubai financial market, had acquired an 85 per cent stake in The Entertainer. Media reports suggest that the investment was agreed at a price of at least US$100 (although further details were not disclosed).11
VI FINANCING OF M&A: MAIN SOURCES AND DEVELOPMENTS
External financing for acquisitions continues to be less prevalent in the UAE in comparison to other jurisdictions, and a large majority of acquisitions continue to be financed in cash.
Where acquisition financing is made available on a transaction, it is usually structured as a long-term loan, which is almost always secured by personal or corporate guarantees, including securities over target assets. In addition to the primary facility documentation, borrowers may also issue a promissory note, a subordination agreement for any remaining debt and an assignment of certain identified assets depending on the nature of the acquisition.
Although most acquisitions that are financed are funded through conventional finance, various other Islamic finance structures are used as well, particularly the murabahah,12 musharakah,13 mudarabah14 and ijarah15 structures. However, note that the financial covenants of these Islamic structures are often more onerous than those found in conventional facilities.
In terms of the availability of private equity investment, the private equity market continues to feel the effects of global financial uncertainty, including the US and European sovereign debt crises. Regionally, the UAE continues to lead the market in terms of volume and value, partly due to the stability and availability of investable companies. However, gaps are still visible between company valuations and investors' expectations for returns, which hinder activity. A move away from traditional sectors such as oil and gas was witnessed in 2017, with an uptrend into consumer-driven sectors such as education, retail, food and beverages and healthcare, where added-value opportunities have arisen.
VII EMPLOYMENT LAW
The UAE Labour Law16 regulates most employment relationships in the UAE. The Labour Law imposes minimum standards on termination of employment, working hours, annual leave and safety standards, among other things, which cannot be contracted out of. In addition to the Labour Law, certain UAE free zones have implemented their own employment regulations, which apply to all companies licensed to operate in that free zone. In general, these employment regulations act as a supplement to the Labour Law, with the exception of the Dubai International Financial Centre free zone, where DIFC Law No. 4 of 2005 applies, and the Abu Dhabi Global Market, where the ADGM Employment Regulations 2015 apply.
On the sale of a business, there is nothing in the UAE that is akin to the Transfer of Undertakings (Protection of Employment) Regulations 2006 of the United Kingdom. Consequently, for employees to be transferred to a purchasing entity, the employees' employment contracts with the selling entity must be terminated and new employment contracts entered into with the purchasing entity.
On the termination of employment, transferring employees must be paid their share of service gratuity in accordance with the Labour Law, their salary for any accrued but unused annual leave, and any other entitlements as set out in their employment contracts.
End-of-service gratuity payments must be paid to any employee who completes one year or more in continuous service. If an employer has terminated his or her employment contract, the gratuity is 21 days' basic salary for each of the first five years of employment and 30 days' basic salary for each additional year over five years. The Labour Law caps the end-of-service gratuity to an amount equal to an employee's basic salary for two years. An employee will also be entitled to a gratuity payment for fractions of the year worked provided that the employee has completed one year in continuous service. The selling entity would therefore be required to make payment of the end-of-service gratuity and all other contractual payments to employees when they are transferred to the purchasing entity. Alternatively, the end-of-service gratuity and all other contractual payments due to employees could be paid by the purchasing entity and then deducted from the consideration payable for the business. However, one practical matter to consider with the latter approach is that the transferring employees will, on termination of their employment with the selling entity, be required to sign an undertaking confirming receipt of all amounts due by the employer. An employee will be reluctant to do so unless this is in fact the case, and it is unlikely that a prospective purchaser will want to make any payments in connection with the transferring employees until after the completion of the transfer of the business.
Transferring employees may also raise concerns about the termination of their current employment contracts and the payment of their end-of-service gratuity as this will result in the end of their period of continuous service, and they will therefore be required to work for the purchasing entity for a year before being entitled to an end-of-service gratuity payment. Generally there is no procedure for the transfer of the continuous service period from one employer to another. However, depending on where within the UAE the employee is employed, it may be possible for a period of continuous service to be acknowledged by the new employer and thereby preserve valuable end-of-service benefits for the employee.
As part of the sale of a business in the UAE and the transfer of employees, the amendment or cancellation and reissuance of UAE residence visas for each transferring employee will also need to be considered. As the number of employees that a company can sponsor for visa purposes is dependent on the space that it leases or owns, a purchasing entity will also need to ensure that it occupies sufficient space to sponsor all transferring employees.
In addition, the applicability of the Pensions Law17 (as amended) will also need to be considered in any transfer of a business in the UAE. The Pensions Law will have implications for any company that employs UAE or GCC nationals.
In a noteworthy development, the DIFC has recently initiated consultations on a proposed reform of the system of end-of-service gratuity payments in respect of employees that work in the DIFC. The DIFC has proposed that the current regime (which consists of a lump sum payment to employees at the termination of their employment relationship, and which is generally unfunded) be replaced with a DIFC employment workplace saving scheme into which DIFC employers contribute on a monthly basis. The proposed saving scheme shall be administered by the DIFC Authority. While the proposal is still at an early stage, the DIFC proposes implementing the new structure for end-of-service benefits by January 2020. As previously noted, changes to DIFC employment law will not have an effect on employers operating outside the DIFC (e.g., in other free zones or onshore in the UAE). It remains to be seen whether the UAE federal government will follow the DIFC in introducing similar reforms.
VIII TAX LAW
The UAE issued a substantive law on value added tax (VAT) in 2017. Pursuant to the VAT Law,18 the imposition of VAT in the UAE commenced on 1 January 2018 at a rate of 5 per cent.
Registration for VAT is mandatory for any taxable person or business if the total value of its taxable supplies made within the UAE exceeds the mandatory registration threshold of 375,000 dirhams during the previous 12 months, or if it is anticipated that the taxable supplies will exceed the threshold in the next 30 days.
A taxable supply refers to a supply of goods or services made by a business in the UAE that may be taxed at a rate of either 5 or zero per cent. Reversed charge supplies and imports are also taken into consideration for this purpose if a supply of such imported goods and services would be taxable if it were made in the UAE.
Entities that are not based in the UAE but that provide goods or services in the UAE are also required to apply for registration if they meet the threshold requirements.
The supply by a taxpayer of either exempt or zero-rated goods or services will not attract VAT; however, a supplier of zero-rated goods or services will be able to claim a refund on any VAT paid on their purchases, unlike a supplier of exempt goods or services who will be unable to recover any VAT paid on their purchases. The VAT Law sets out a list of zero-rated and exempt supplies.
The VAT Law also permits tax grouping, which allows group companies to be treated as one entity for the purposes of VAT. Each group company will be jointly and severally responsible for each other group company's VAT liabilities, and no VAT will be payable on transactions between entities within the group.
Generally a VAT-registered customer must account for VAT paid in respect of purchases; however, certain transactions between entities within the GCC will be subject to VAT by reverse charge. The concept of reverse-charging VAT allows the simplification of transactions within a single market (i.e., the GCC states). The reverse charge removes the obligation to account for VAT on a sale from a supplier and places it on the customer. It should be noted that for the purposes of a single market VAT treatment, only those countries that have implemented VAT at the relevant time will be taken into account; non-implementing countries would be treated like any foreign country.
Cabinet Decision No. 59 of 2017 specifies all designated zones for the purposes of implementing the designated zone provisions in the VAT Law. A designated zone is required to be a specific fenced area with security measures and customs controls in place to monitor the entry and exit of individuals and the movement of goods to and from the area. Concessional VAT treatment may be available for transactions involving the supply of physical goods within designated zones. No VAT concessions are available for transactions involving the supply of services within designated zones. The Cabinet has the authority to amend the list of designated zones as required.
With respect to the applicability of the VAT Law to M&A transactions, it provides that 'the transfer of the whole or independent part of a Business from a Person to a Taxable Person for the purposes of continuing the Business that was transferred'19 shall not be considered a supply, and therefore will not be subject to VAT. Consequently, in common with some European jurisdictions, the sale and purchase of a business in the UAE should not attract VAT. Note, however, that there is no clear guidance in the law as to what continuing a business involves; nor is there any detail on what constitutes the whole or independent part of a business.
Note also that pursuant to Article 42 of Cabinet Decision No. 52 of 2017, a transfer of title to equity securities is exempt from VAT.
It is noteworthy that in May 2019, the Minister for Justice issued a number of executive resolutions concerning the establishment of the requisite government machinery for the consideration and resolution of tax disputes. This includes the establishment of a specialised tax department in the Abu Dhabi Federal Court of First Instance and one in the Abu Dhabi Federal Court of Appeal. At present, these resolutions are limited to the Emirate of Abu Dhabi; accordingly, it is expected that similar specialised departments will be established in other emirates (the courts of the Emirates of Dubai and Ras al Khaimah are not a part of the UAE federal court system) to consider tax disputes.
IX COMPETITION LAW
The Competition Law20 was introduced into the United Arab Emirates as a means of regulating anticompetitive practices. The Competition Law deals with three key areas: a restriction on anticompetitive agreements, the regulation of dominant market positions and a requirement that acquisitions over a threshold combined market share obtain merger clearance from the UAE Ministry of Economy (Ministry).
Although the Competition Law was introduced in 23 February 2013, it initially had minimal impact as a result of it failing to establish the market share thresholds at which its restrictions became applicable. It also failed to define the small and medium-sized establishments that were stated to be outside the purview of the Law.
In 2016, two new Cabinet decisions were introduced that supplemented the Competition Law and provided guidance on these outstanding aspects: Cabinet Decision No. 13/2016 (Ratios Decision) in respect of market share thresholds and Cabinet Decision No. 22/2016 (SME Decision) in respect of small and medium-sized establishments.
As a result of the Competition Law and the two Cabinet Decisions, merger clearance will be required in advance of any proposed merger, acquisition or other consolidation of two or more entities that would result in a market share of 40 per cent or more. The concerned market is broadly defined in the Competition Law to comprise markets in which commodities or services are replaceable or may be substituted to meet specific needs according to price, properties and use. Although it is difficult to define the relevant market in legislation, and more often than not markets are only identifiable on a case-by-case basis, on a practical level the application of the Ratios Decision is somewhat difficult because the concerned market is not clearly defined.
In addition, as a result of the SME Decision, the Competition Law does not apply to certain small and medium-sized establishments as detailed in the SME Decision. The definition of small and medium-sized establishments varies according to whether the relevant entity operates in the trade, industry or services sector. Small and medium-sized establishments are also identified in the Ratios Decision according to turnover and number of employees.
Finally, note that the Ministry also has the power to investigate a potential violation of the Competition Law on its own initiative or following a complaint brought before it. Failure to notify a reportable economic concentration may result in a fine of between 2 and 5 per cent of turnover generated by the relevant undertaking in the UAE in the last financial year or, if data is not available, a fine of between 50,000 and 5 million dirhams.
The legal framework for corporate transactions with a UAE element has no doubt changed drastically over the past year. With the advent of the FDI Law, the implementation in earnest of VAT and the proposed introduction of key corporate governance and employment law reforms, those looking to buy, sell or invest in businesses that have a presence in the UAE would be well advised to consider the new regulatory landscape before concluding such transactions.
With more realistic valuations now being seen across the spectrum of M&A activity, potential purchasers may indeed find that deals that were not practicable in the past are now possible (and are potentially also more lucrative). There is therefore cautious optimism that M&A activity will remain buoyant through the next 12 months.
1 Danielle Lobo is a partner and Abdus Samad is an associate at Afridi & Angell.
2 UAE Commercial Companies Law (Federal Law 2 of 2015, as amended).
3 Hajj and umrah are forms of pilgrimage that Muslims undertake and that comprise visits to Mecca in the Kingdom of Saudi Arabia. While Hajj is considered obligatory to perform at least once in a lifetime of an adult and physically able Muslim, and must be performed at a prescribed time every year, Umrah is optional and can be performed at any time of the year.
12 A shariah-compliant form of financing that involves a sale contract in which the seller includes a profit margin in the sale price along with the actual cost of the subject matter of the contract.
13 A shariah-compliant joint venture or partnership.
14 A shariah-compliant form of financing in which two or more investors collaborate and pool their capital and appoint an agent to manage their investment in return for the payment of a fee.
15 A shariah-compliant lease, most commonly used to finance the acquisition of assets, for example in the context of a sale and leaseback arrangement.
16 The UAE Labour Law (Federal Law No. 8 of 1980 on Regulating Labour Relations (as amended)).
17 The Pensions Law (Federal Law No. 7 of 1999 concerning Pensions and Social Securities) (as amended).
18 The VAT Law (Federal Decree Law No. 8 of 2017).
19 Article 7 of Federal Decree Law No. 8 of 2017.
20 The Competition Law (Federal Law No. 4 of 2012 on the regulation of competition).