In the UAE, you can use your company shares as collateral for loans. This involves temporarily transferring share ownership to the lender, who gains a security interest in the shares, which can be sold if you fail to repay the loan. Both mainland and free zone areas allow share pledging, but rules can differ, especially in free zones that attract foreign investors due to business ease and a favorable legal framework. Understanding the prerequisites is crucial before considering share pledging.
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What is a Share Pledge?
Share pledge refers to a legal agreement in which the owner of shares in a company (the “pledgor”) transfers the temporary ownership of the shares to a lender (the “pledgee”) as collateral for a loan or other financial transaction. The lender holds a security interest in the shares, meaning they can sell them if the borrower defaults on the loan. The pledge agreement is usually recorded in the company’s register of shareholders, and the lender is often given the right to vote on the shares while they are pledged. This way, the company can raise capital or secure financing without issuing new shares or taking on debt, but it also gives the lender security against the loan.
Benefits and Risks of Share Pledging
When considering whether to pledge your shares, it’s essential to carefully evaluate the potential benefits and risks of doing so. Here are a few factors to consider:
- Pledging Purpose: Understand why you’re pledging shares and if it aligns with your financial goals.
- Alternatives: Consider other capital-raising or financing options and their benefits/risks.
- Collateral Value: Evaluate the value of shares to be pledged for desired loan or credit.
- Pledge Agreement Terms: Review agreement terms like interest rate, repayment, and default penalties.
- Ownership Impact: Understand possible ownership dilution and the lender’s potential voting rights.
- Legal Framework: Know the country’s legal and regulatory setup where shares are pledged.
- Financial Standing: Assess if you can fulfill the pledge agreement and have a default plan.
Share pledging involves several potential risks as well: default risk, where borrowers risk forfeiture of pledged shares if they default on the loan; dilution of ownership if lenders seize and sell the shares; restrictions on shareholder rights due to possible voting power by the lender; the risk of share price decline decreasing the pledged shares’ value and loan security; legal risks from binding contracts and potential penalties on default; and the risk of losing shares and loan money if the lender becomes insolvent. Therefore, borrowers should scrutinize share pledge agreements’ terms and conditions and seek expert advice before agreeing.
Share Pledging in the UAE
The Dubai Development Authority allows companies to manage to share pledges in the UAE, with the Dubai Economic Department (DED) accepting notarised pledges for UAE Central Bank-regulated entities. A share pledge is an agreement where a shareholder temporarily transfers ownership of shares to a lender as collateral. The lender can sell the shares if the borrower defaults. This is a popular way for companies to raise capital without issuing new shares or debt but carries risks, such as lender takeover in case of default. The terms vary by company and circumstance, and it’s advised to consult experts for guidance.
Federal Law No. 18 of 1983 (Commercial Code) recognizes a commercial pledge as a security for commercial debt and categorizes UAE LLC shares as “movable property” which can be pledged. The UAE Commercial Companies Law 2015 permits shareholders to pledge their LLC shares in line with the company’s memorandum of association (MoA). Any pledge must be notarised and registered with the DED in the relevant emirate.
The Conditions for Pledging Shares
According to the Amendment Law for Commercial Companies, the following conditions must be met for a pledge over shares of a limited liability company:
Pledge Compliance Mandatory with Company’s MoA Terms: The Amendment Law stipulates that it is necessary for free zone companies to expressly authorise the pledging of shares by the partners in their Memorandum of Association (similar to the provisions of limited liability companies).
A pledge must be under an official document: An “official document” implies a share pledge agreement executed before an authorized authority, like a UAE notary public, prior to its registration in the Commercial Register. This aligns with the standard practice of the Dubai Economic Department and various free zone authorities in the UAE.
Pledge per the Commercial Companies Law amended by the Amendment Law: Under the proposed Amendment Law to register a pledge over shares in the UAE, a pledge cannot breach any clause of the Commercial Companies Law or any UAE law. In addition, parties to the share pledge are required to ensure that the pledge does not infringe on any statute nullifying security and preventing enforcement.
Enforceability of a Share Pledge
Article 81 of the Amendment Law provides a mechanism of enforcement against a partner’s share, noting that a creditor may agree with the partner (the debtor) and the company on the method and terms of sale (i.e. by way of private arrangement); else, the subject shares shall be offered for sale at a public auction. Article 81 further states that the company may, within 15 days from the date on which the auction is awarded, recover the shares on the same terms as awarded at the auction (effectively giving the company a pre-emptive right).
Can a Share Pledge Be Withdrawn?
Before withdrawing, review the pledge agreement to understand any penalties for early withdrawal. Withdrawal from a share pledge can be through:
- Full loan repayment, releasing pledged shares.
- Offering alternative collateral to release pledged shares.
- Mutual agreement between lender and borrower.
- Pledge agreement expiration, automatically releasing shares.
Ensure adherence to the agreement terms and relevant free zone laws. Professional consultation is advised to ensure legality and accuracy of the process. Note that pledge agreements are governed by UAE laws, inseparable from free zone laws.
Share Pledging in Meydan Free Zone
Share pledging in Meydan Free Zone, as in other free zones in the UAE, is a means of securing financing or raising capital by temporarily transferring ownership of shares to lenders as collateral. The Meydan Free Zone Authority regulates the activities of the companies, and the regulations for share pledging may vary depending on the company and the specific circumstances. In general, the pledge agreement is governed by the laws of the UAE and the Free Zone Authority.