In the dynamic landscape of business law in the UAE, recent legislative changes have introduced significant opportunities and considerations for family-owned businesses. Federal Decree-Law No. 37 of 2022 in relation to Family Companies provides new mechanisms and flexibility for managing family businesses (“Family Companies Law”). Understanding these changes is crucial for founders and family shareholders looking to navigate the complexities of business succession and governance.
The Structure and Challenges of Family Businesses
Family businesses, traditionally structured as Limited Liability Companies (LLCs) pursuant to Federal Decree-Law No. 32 of the Commercial Companies Law (“Commercial Companies Law”), face unique challenges. The general rules governing LLCs are designed for scenarios where shareholders might not be related, which can create issues for family-owned entities. Typically, family businesses start with a founder and may include other family members in management roles. However, after the founder's demise, the absence of clear succession planning can lead to disputes and loss of control.
Founders often face dilemmas when considering the distribution of shares during their lifetime. Two common scenarios highlight these concerns:
1. Single Founder with Potential Heirs: A founder who owns all shares might worry about the future management of the company after their death. Questions arise about who among the children will manage the business, the risk of third-party involvement, and the potential influence of in-laws.
2. Existing Family Business with Multiple Generations: When a family business has already passed through generations, the death of shareholders can lead to fragmentation of ownership and dilution of managerial control among grandchildren, which can destabilize the business.
Advantages of the Family Companies Law Over the Commercial Companies Law
The new Family Companies Law addresses these challenges by providing a structured voting mechanism that allows founders to distribute shares in a way that aligns with their vision for the company's future. This law empowers founders to create a system that maintains control and management within the family, even as shares are distributed.
Key benefits include:
· Control Over Distribution: Founders can allocate shares according to their preferences during their lifetime.
Previously under the Commercial Companies Law, founders’ concerns revolved around the distribution of their shares during their lifetime which ultimately meant that they either had to comply with inheritance principles or alternatively give up their shares which also meant their control in the company when trying to allocate shares to beneficiaries. Under the new Family Companies Law, this flexibility ensures that even those who have actively contributed to the business can be rewarded appropriately without being strictly bound by inheritance laws.
· No Limitation on the Number of shareholders: there is no restriction on the maximum number of individuals who can become shareholders in a family company.
Previously, the Companies Law restricted the number of shareholders in an LLC to a maximum of fifty (50) shareholders. This limitation is a point of concern for family businesses as the number of shareholders may be impacted by forced heirship rules under the UAE Personal Status Law at the time ownership is transferred from one generation to the next.
· Management Stability: By implementing clear governance structures and voting mechanisms, the law helps maintain stability and continuity in management across generations.
Family affairs related to the family business can be effectively governed by creating councils and committees, such as a family association, family council, or family office. These bodies can oversee family matters and manage relationships with the family business, ensuring a clear separation between the ownership and governance of personal family assets and those of the Family Business. They can also oversee family investments, coordinate charitable activities and community contributions, manage conflicts of interest, and resolve disputes among family members and shareholders.
· Dual Shares: a structure that allows families to separate voting rights from ownership, thereby maintaining control over the management and operation of the family business and mitigating risks associated with heirs becoming shareholders.
The Family Companies Law addresses the structure of dual shares by permitting shareholders to own (i) “A Shares” which provide both dividend rights and voting rights at the general assembly, and (ii) “B Shares” which offer dividend rights without voting rights. Whereas the Commercial Companies Law does not permit the issuance of preference shares or any other forms of equity instruments, including various classes of ordinary shares with different associated rights.
· Pre- emption Rights and Buy Back of Shares: introducing an exception to pre-emption rights and allowing family groups to rearrange their shareholding within the family company without the obligation to initially offer these shares to other extended family members.
The Family Companies Law includes a statutory pre-emption right on transfer, except for transfers to a family member’s spouse or first-degree relatives. For example, a partner selling his share is entitled to waive his share with or without compensation to his wife or any of his relatives up to the first degree, without offering it to the rest of the partners. Unlike the Commercial Companies Law whereby the partner wishing to sell his share will be required to offer such shares to the remaining partners prior to a third party buyer.
The Family Companies Law includes a buyback mechanism that allows the company to repurchase up to 30% of its shares in certain situations. These include (i) the desire to reduce the company's capital and/or (ii) the need to purchase or redeem shares from a partner who wishes to sell, is bankrupt, or insolvent, and there is no buyer for these shares among the partners. This buyback occurs following an offer made by a family member shareholder intending to sell their shares. This process aligns with pre-emption provisions, which are designed to support the family's system of pre-emption preferences.
· Neutral Dispute Resolution: The Family Companies Law offers mechanisms for resolving disputes, ensuring that conflicts are handled impartially and without disrupting the business.
Recognizing the potential for conflicts within family businesses, the Family Companies Law facilitates the formation of councils to mediate disputes among shareholders and family members. If these councils cannot resolve conflicts within three months, disputes are referred to a Committee established by the Ministry of Justice in each emirate, which has the authority to take preventive measures to ensure business continuity and prevent reputational or financial harm. Decisions made by the Committee are subject to appeal before the local courts.
Alternatively, parties may agree to resolve disputes through arbitration or the courts of the DIFC or ADGM.
Maintaining a business as a traditional LLC versus converting it to a family company involves several considerations. An LLC is subject to general commercial laws similar to those around the world, which may not be tailored to the nuances of family dynamics and succession planning. On the other hand, a family company, as defined under the new law, benefits from tailored provisions that address the specific needs of family-owned enterprises.
Conversion Process
The following steps are typically involved in convert an existing LLC into a family company:
Review and Compliance: Ensure that the company complies with all requirements set out in Federal Decree-Law No. 37 of 2022.
Resolution: Pass a resolution approving the registration of the company as a family company.
Amend Articles of Association: Modify the company’s articles of association to incorporate the new governance structures and voting mechanisms.
Register the Change: Officially register the company as a family company with the relevant authorities.
Implement Governance Structures: Establish the necessary governance bodies and mechanisms to ensure smooth management.
Conclusion
The introduction of Federal Decree-Law No. 37 of 2022 marks a transformative step for family-owned businesses in the UAE. This legislation provides innovative mechanisms that address the unique challenges faced by family enterprises, especially in terms of succession planning and governance. By offering flexibility in share distribution, management stability through structured governance, and mechanisms for dispute resolution, the Family Companies Law ensures that family businesses can thrive across generations.
Transitioning from a traditional LLC to a family company involves specific steps to ensure compliance with the new law. This process, though detailed, ultimately enables family businesses to benefit from tailored provisions that address their unique needs, ensuring longevity and stability.
The Family Companies Law represents a significant advancement for family businesses, aligning legal frameworks with the intricate dynamics of family-run enterprises. For founders and family shareholders, understanding and leveraging these new provisions is crucial for sustainable growth and successful succession planning
Haya Obaid
Associate - Advisory
NHB LEGAL