The UAE's foreign investment regime

Out-Law Guide | 26 Nov 2020 | 2:14 pm | 9 min. read

Foreign investment restrictions do exist in the United Arab Emirates (UAE). However, the regime is undergoing gradual change following the introduction of the new Federal Decree-Law No. 19 of 2018 on Foreign Direct Investment (FDI Law).

Background to the existing regime

Prior to the introduction of the FDI law, UAE law provided that foreign investors could only own up to 49% in a UAE mainland company, subject to limited exceptions. At least 51% of the shares in a UAE mainland company had to have been owned by one or more UAE nationals, or a company which is itself wholly owned by one or more UAE nationals. This meant that the constitutional documents of a UAE mainland company would state both the name of the local shareholder, as the legal owner of not less than 51%, and the foreign shareholder, as the legal owner of not more than 49%, making the foreign shareholder a minority shareholder.

In addition, the conduct of certain commercial activities such as oil and gas exploration and production, banking, insurance, military and defence, water, electricity, broadcasting, publishing, telecoms, freight services and labour supply was reserved exclusively for UAE nationals or companies owned exclusively by UAE nationals. Accordingly, foreign investors were restricted from carrying out such activities and from investing in companies that carry out such activities.

The new FDI law increases the chances of a more streamlined approach to foreign investments in the UAE with a reduction in need for side agreements.

As an exception to the foreign ownership restriction, UAE companies could be owned entirely by nationals of Gulf Cooperation Council (GCC) countries or companies owned by nationals of GCC countries. However, any direct or indirect non-GCC shareholding in the UAE company would mean that the principle described in the first paragraph would again apply and at least 51% of the shares would have to be held directly or indirectly by UAE nationals. In these circumstances all non-UAE shareholders, including GCC individuals and companies, would be deemed to be foreign investors.

A further exception to the foreign ownership restriction applied within Free Zones. Free Zones are specially designated areas within the UAE established to attract foreign investment by encouraging companies to set up businesses and locate their operations within a Free Zone. Each Free Zone has its own administration and licensing authority responsible for issuing Free Zone licences and registering companies. The key difference between a Free Zone and mainland entity is that a Free Zone entity may be wholly owned by non-UAE nationals, meaning that foreign investors can own up to 100% of the shares in Free Zone companies.

Use of 'side agreements' under the existing regime

To overcome the disadvantages associated with the foreign ownership restrictions in the UAE, many foreign investors carry out business in the UAE mainland by engaging a UAE national to hold 51% of the share capital of the UAE company, effectively as a nominee shareholder, on behalf of the foreign investor (UAE Nominee), with the foreign investor holding the remaining 49%. Typically, a separate set of private 'side agreements', which are not subject to registration and the usual formalities of a company's constitutional documents, are put in place between the foreign shareholder and the UAE Nominee.  

Collectively these side agreements seek to transfer the beneficial ownership, meaning the benefits and rights associated with holding the shares, from the UAE shareholder to the foreign shareholder in return for a fixed annual fee. This transfer of beneficial ownership tends to:

  • place the control of the company in the hands of the foreign shareholder;
  • distort the distribution of profit share and dividends in favour of the foreign shareholder; and
  • limit the UAE shareholder's involvement in operational matters, meaning that the UAE shareholder effectively becomes a silent shareholder.

As the UAE is a civil law jurisdiction, there have been historical concerns in the UAE regarding the legal validity of these side agreements and their enforceability in the case of a dispute, creating risks such as an enforceability risk in light of the UAE Anti-Fronting Law. Parties to such agreements may put in place sophisticated corporate structures involving Free Zone holding companies - such as special purpose vehicles (SPVs) in the Abu Dhabi Global Markets Free Zone (ADGM) or prescribed companies in the Dubai International Financial Centre Free Zone (DIFC) - to take advantage of the common law regimes which allow for more sophisticated contractual structures and trust/beneficial ownership arrangements to be put in place. However, the validity of side agreements has not, to date, been properly tested in a court of law in the UAE so, despite the risk mitigation efforts of various companies, their true enforceability has never been an absolute certainty.

The introduction of the new FDI law has come as a welcome development for foreign investors. With its introduction, for companies that are able to avail of its benefits, a more streamlined approach to investment in the UAE, with a reduction in the need for side agreements, is likely to become more prevalent.

UAE Anti-Fronting Law

In November 2004 the UAE enacted a law aimed at preventing arrangements which seek to circumvent the restrictions surrounding foreign ownership of UAE companies ('Anti-Fronting Law'). One of the rationales behind introducing the Anti-Fronting Law is to prevent the use of side agreements /arrangements with UAE nationals similar to the ones described above.

The Anti-Fronting Law provides that "it is prohibited to act as a front for any foreigner - whether a natural person or a body corporate - by using the name, license or commercial register of the front…". The Anti-Fronting Law defines the term 'front' as "any natural or body corporate enabling a foreigner - whether a natural person or a body corporate - to practice any economic or professional activity he is prohibited to do inside the UAE".

The Anti-Fronting Law not only renders such arrangements invalid, but also imposes sanctions for breach of the law. Sanctions can be imposed on both the local partner and the foreign investor and include fines of up to AED100,000 (US$27,000) and possible imprisonment for a period of up to two years. In addition, any 'condemnation judgment' issued following a breach of the Anti-Fronting Law will provide that the name of the 'front' be deleted from the commercial register, effectively requiring the foreign company to close its business or make alternative arrangements in strict compliance with the regulations. A company involved in a 'fronting' arrangement will be deregistered from the commercial registry with respect to the activity involved and its licence may be revoked.

Although the Anti-Fronting Law is technically in force and effect, there has been no indication that the relevant authorities would take a proactive role in enforcing it. In addition, we are not aware of any instance whereby the Anti-Fronting Law was enforced despite foreign investors becoming more open about their side arrangements with UAE Nominees. We are also aware that the UAE authorities have, in the past, been supported by corporate service providers (who offer nominee shareholder services to foreign investors) as part of their foreign investment drive in other countries.

The new UAE FDI Law

The much-anticipated FDI Law came into force on 23 September 2018. The FDI Law now lays the framework for up to 100% direct foreign, meaning non-UAE, investment in the UAE.

The FDI Law classifies activities into three different categories:

  • activities falling on the 'negative list' - these will continue to be subject to their own laws and regulations and will fall outside of the foreign direct investment regime;
  • activities falling on the 'positive list' - these are activities in which up to 100% foreign direct investment will be permitted; and
  • activities not falling on either list – these are activities which are not expressly permitted or restricted and the authorities will have the discretion to determine whether up to 100% foreign direct investment will be allowed on a case by case basis.
Classification of activities – the negative and the positive list

The negative list includes the activities that will fall outside of the new regime, meaning that the existing regime - which restricts foreign ownership to 49% - will still apply. The industries in the negative list include:

  • oil and gas;
  • exploration and production;
  • banking;
  • insurance;
  • military and defence;
  • water and electricity;
  • broadcasting and publishing;
  • telecommunications;
  • commercial agencies; and
  • freight services.

The positive list has been issued following consultation with the Foreign Direct Investment Committee and includes 122 commercial activities. These activities will fall under the new regime, thus potentially allowing for 100% foreign ownership. The industries in the positive list include certain business activities in the fields of:

  • agriculture;
  • arts and entertainment;
  • construction and engineering;
  • education;
  • healthcare;
  • hospitality and food services;
  • information and communication;
  • manufacturing;
  • professional, scientific and technical activities;
  • shipping, transport and storage.

The UAE Cabinet has further confirmed that it will be left to the discretion of the local governments at an Emirate level to decide on the percentage of foreign ownership for each sector/activity. Notably, the FDI Law leaves room for each of the seven Emirates to permit up to 100% foreign investment for different activities, subject to the Federal authority's approval.

Activities not falling on either the positive list or the negative list (i.e. activities which are not expressly permitted or restricted) will be subject to the discretion of the authorities to determine whether up to 100% foreign direct investment will be allowed on a case by case basis.

Foreign investment companies

Companies incorporated under the new FDI Law (FDI companies) will be registered in a special FIC register held with the Ministry of Economy and will be treated as UAE companies. The process for registering as an FDI company will be largely similar to registering a mainland company in the UAE, with the application first being submitted to the local licensing authority, then to the relevant authority in the Emirate for approval. However, the issuance of an FDI licence may be subject to conditions, which can be wide-ranging and include prescribed levels of capital investment, additional reporting obligations or a requirement to employ UAE nationals. FDI companies will also need to appoint a UAE national or a company wholly owned by UAE nationals as a 'local service agent'.

In the event an application for FDI company registration is rejected, the FDI Law also allows the foreign investor to appeal this decision.

Existing UAE on-shore companies can be converted to FDI companies after obtaining the relevant approvals and meeting all the requirements for that. In any event, we expect to see an increase in M&A/corporate restructuring activity in the UAE as a result of the FDI Law.

Legal consequences

The UAE government is taking foreign investment seriously and encouraging diversification in the economy. The FDI Law is evidence of this and is a positive step towards increasing diversification across various sectors and promoting the UAE's ambition to become a global leader in attracting foreign investment.

In light of the new FDI Law, companies are advised to take future-proofing actions in anticipation of the changes ahead. For example, companies should:

  • consider whether existing UAE on-shore companies should be converted to FDI companies – noting that any conversion from a limited liability company to an FDI company could open the doors for further negotiations between shareholders, particularly where a conversion may result in a buy-out of existing shareholders. Companies should undertake contract audits to consider the impact on key trading relationships and any change of control provisions that may be triggered in key business contracts as a result of any conversion;
  • consider utilisation of corporate service providers for new investments – noting that such corporate service providers are familiar with the existing regime and understand the desire for foreign investors to seek contractual protections through side agreements; and
  • consider including future-proofed provisions in shareholder agreements – we would typically expected to see provisions in side agreements that would require the local shareholder to transfer its shares to the foreign shareholder in the event of a change in law that would allow the foreign shareholder to become the 100% owner of the company. Depending on the bargaining position of the parties, some agreements also include provisions that would entitle the foreign shareholder to a pro-rata refund of any service fees paid to the local shareholder if the arrangement were to be terminated as a result of a change in law.