Therefore, a typical transaction involves a share sale for cash consideration paid on completion. Where shares are used as consideration, there is often also an element of cash consideration. Price adjustment mechanisms are generally used in determining the consideration to be paid, with completion accounts and locked box the most frequently used mechanisms. The authors anticipate that price adjustment mechanisms will become more frequently used as parties try to account for the potential consequences of the 2019 novel coronavirus disease (COVID-19) pandemic, particularly in ongoing transactions where initial valuations and non-binding offers have been based on pre-COVID-19 activity levels.
The use of warranty and indemnity insurance is not as common as it is in other jurisdictions, as the market is less mature than for example Europe. However, the authors are seeing greater interest from sellers in this regard, particularly in the context of auction sales and from private equity sellers.
Share purchase agreements often contain restrictive covenants, with the most common seller restrictions relating to the solicitation of employees and customers and the conducting of a similar business. Material adverse change is not always defined. However, this is likely to change and more precise definitions of material adverse change will be used, as parties seek to include/exclude consequences stemming from the COVID-19 pandemic.
5. What are the current trends in how private M&A transactions are conducted?
In the authors' experience, a number of transactions that were underway before the restrictions imposed as a result of the COVID-19 pandemic are continuing. However, parties are taking their time to revisit previous assumptions as to valuation and pre-closing conditions, and assess the possible trading impacts and capital expenditure requirements going forward. In particular, buyers are adapting their acquisition strategy and investment criteria to better suit the current market conditions. The authors expect that a key trend for M&A in 2020 will be that deals will take longer to complete as a result of a greater emphasis being placed on valuation and due diligence, and many may fail. A number of transactions will have failed or will have been postponed as a result of a failure by the parties to bridge any valuation gap or uncertainty relating to transaction execution and integration.
Large corporates are continuing to dispose of non-core business lines and other non-core assets to generate liquidity and satisfy leverage concerns. There is also significant opportunity for well-funded financial buyers and sovereign wealth funds to generate value for their investors by acquiring distressed assets and undervalued companies.
In the UAE, sovereign wealth funds and significant family offices emerge as key participants in M&A activity. The UAE is heavily dependent on imports in critical industries such as health care, pharmaceuticals, energy, and food production. A number of sovereign wealth funds and family offices pursue targets in these sectors in support of the UAE Government's localisation efforts.
Based on market observations and the authors' experience, the majority of transactions are conducted as negotiated sales rather than auction sales (with some auction sales, in the authors' experience, quickly becoming bilateral deals).
The combination of legal, financial and commercial/technical due diligence is becoming increasingly common in lower mid-market transactions and above. Owing to costs involved, red flag rather than full narrative diligence reports are typically commissioned by buyers when undertaking transactions at the lower end of the market. Bespoke tax due diligence is also becoming more common due to the recent introduction of VAT in the majority of GCC countries and as a result of many UAE-headquartered enterprises having significant foreign holdings.
It is market standard for a virtual data room to be prepared by the seller, with the review of legal, financial and commercial documents conducted via an online portal. This is more efficient, in relation to both cost and time, than using a physical data room. However, the authors note that physical data rooms and clean team agreements are still being used in transactions that are being negotiated between competitors, but physical data rooms may be increasingly replaced by clean team only sections of virtual data rooms.
The current situation with regards to COVID-19 gives rise to questions surrounding the management of practical requirements of a transaction. For example, if there are any restrictions in place for entry into or out of individual Emirates, or the UAE, parties will need to handle such restrictions effectively so as to minimise disruption to transaction execution, particularly if there is any intention to hold in person management meetings or undertake site visits.
Cross-border litigation and arbitration
6. Is it common market practice for a share purchase agreement to provide for a foreign governing law and/or jurisdiction? If so, in what circumstances does this occur and which governing law and/or jurisdiction are common choices?
It is common market practice in the UAE for share purchase agreements to provide for a foreign governing law. Generally, choice of law provisions are valid under UAE law. In the authors' experience, the law of England and Wales is the most common choice of foreign governing law. However, where a party to the contract is a state-owned entity, it is more difficult to agree a foreign governing law without first assessing the status of the parties to the transaction. This is because Federal Law No. 5 of 1985 regarding Civil Transactions provides that contracts entered into with UAE government bodies must be governed by local law. Dubai also has a specific law that prohibits the Dubai Government or its departments, institutions, bodies or authorities from entering into foreign law-governed agreements. If UAE law applies, the forum for resolving disputes must also be in Dubai. For this reason, it is not uncommon to see local law, such as the federal law of the UAE, as the governing law of agreements entered into with state entities.
7. Is it market practice for an arbitration provision to be included in private M&A documents? Are arbitration clauses enforceable in your jurisdiction? Do local courts respect the choice of jurisdiction in an arbitration clause?
It is common market practice in the UAE for arbitration provisions to be included in private M&A documents. The UAE has been a signatory to the UN Convention on the Recognition and Enforcement of Foreign Arbitral Awards of 1958 (New York Convention) since 2006 and is generally considered an arbitration-friendly jurisdiction, especially since the enactment of the new arbitration law in 2018 (Federal Law No. 6 of 2018).
Arbitration clauses in commercial agreements are generally enforceable under UAE law, including arbitration agreements that provide for international arbitration (that is, arbitration agreements that specify a seat outside the UAE). However, when contracting with a UAE government entity, the commercial counterparty should ensure that the requisite approvals have been granted before entering into the arbitration agreement. Under UAE federal law, government departments cannot enter into arbitration agreements unless the agreement has been approved by the Ministry of Justice before the contract is executed. In addition, Dubai has specific laws requiring government departments, institutions, bodies and authorities to obtain approval from the Ruler of Dubai before entering into arbitration clauses that specify a seat outside Dubai. Without such approval, the arbitration clause will be null and void.
Recent developments and proposals for reform
8. Have there been any significant recent or proposed legal developments affecting the market that could impact on transactions?
In September 2018, the UAE issued Federal Law No. 19 of 2018 on Foreign Direct Investment (FDI Law). The FDI Law provides a framework under which foreign investors can own up to 100% of the shares in companies incorporated onshore in the UAE. Typically, companies incorporated onshore in the UAE must be at least 51% owned by UAE nationals or an entity wholly owned by UAE nationals (Federal Law No. 2 of 2015 on Commercial Companies). The FDI Law therefore provides for a relaxation of these restrictions.
In March 2020, the UAE Cabinet issued Cabinet Resolution No. 16 of 2020, which sets out a list of 122 economic activities in which 100% foreign ownership is permitted (Positive List), subject to certain requirements such as a minimum capital investment and a minimum percentage of Emirati employees. The Positive List includes certain activities in sectors such as:
Various services industries (including health care, construction, education, hospitality and entertainment).
Article 7 of the FDI Law sets out a list of 13 sectors in which more than 49% foreign ownership is not permitted (Negative List). The Negative List includes sectors such as:
Water and electricity services.
Commercial agents' services.
With the introduction of the FDI Law and the Positive List, the UAE may begin to see an increase in foreign direct investment from investors who had previously been deterred by the foreign ownership restrictions.
The UAE also introduced a new bankruptcy law in 2016, Federal Law No. 9 of 2016 concerning Bankruptcy (Bankruptcy Law), which will need to be considered in the context of distressed M&A deals. The Bankruptcy Law provides that certain transactions (such as security granted for existing debt or disposals at an undervalue) may be invalid and unwound where they have been entered into by a company during the two years prior to it entering into bankruptcy proceedings. Bankruptcy proceedings can be initiated by creditors with an aggregate debt of least AED100,000 in cases where the company has failed to pay its debts for more than 30 consecutive working days. Buyers will therefore need to consider this when purchasing companies with significant losses or debts if there is a risk that the target or seller may become insolvent following completion.
9. What will be the main factors affecting the market next year, and how do you expect the market to develop?
The COVID-19 pandemic is likely to be the most significant factor affecting the UAE M&A market over the next year. The pandemic has already had an impact on the practicalities of completing M&A deals in the UAE, as most transactions require documents that need to be signed before a UAE notary public. While this has initially delayed completion of transactions, parties and local authorities have had to adapt. For example, there has been an increase in the use of electronic signatures rather than a physical exchange of documents. The Dubai Notary Public has also launched an online notarisation service for certain documents, such as powers of attorney. The notary will verify the identity of authorised signatories by way of a video call. A similar approach has also been taken by the Notary Public in Abu Dhabi. The economic departments in certain Emirates and free zone authorities are also processing share transfer applications online. If the use of these electronic processes proves to be efficient from a time and cost perspective, they may remain in place and be used more frequently by parties in the future.
The parties to ongoing and new transactions will need to consider the impact of COVID-19 on target businesses and agree risk allocation between the buyer and seller. As part of their due diligence, they will need to determine the degree of contractual counterparty risk, supplier disruption, customer slowdown and employment issues, each of which may have an impact on the valuation of the target. In terms of transaction documents, the parties will need to consider any conduct of business and pre-closing covenants relating to the implementation of COVID-19 measures, including additional warranties and disclosures, material adverse change and termination provisions, and deferred payment of consideration as a result of the uncertainty created by the pandemic. On leveraged deals, it will also be important to identify if the lending banks have any ability to pull the financing, and parties may need to find other solutions where there are new financing gaps. For example, some sellers may need to consider offering vendor financing to buyers to ensure that deals can be completed.
Expo 2020 was expected to cause an increase in activity in the facilities management industry. According to reports at the end of 2019, Emrill Services, a Dubai-based facilities management company, had been in discussions with a number of specialist services companies in the Middle East regarding one or more acquisitions. Emaar Properties was also reportedly in talks with potential buyers for the sale of its district cooling business. Now that Expo 2020 has been postponed to 2021, these types of deals may be pushed back to next year.
While many buyers may choose to postpone their potential acquisitions until there is greater certainty in the market, the impact of COVID-19 on many businesses in the UAE may potentially provide buyers with greater opportunities in stressed and distressed M&A deals. There may also be increased activity in certain sectors such as e-commerce and technology, as traditional businesses seek to adapt to the significant changes to consumer trends brought about by COVID-19. Sellers may also seek to accelerate anticipated disposals of non-core or underperforming businesses to raise cash.
This article was first published Thomson Reuters Practical Law