Many issues that arise after the business is established a year or two in UAE are the result of a decision made at the inception of the company and may have been a seemingly unimportant one. Getting a company up and running in the UAE has becomes swift and digital, a great advantage, but the process can hide in plain sight legal decisions that may prove costly and difficult to recoup further down the road. Out of the many things that can go wrong in the process of company formation, it is better to know what they are to avoid a costly correction down the road if a founder chooses to hire a company formation lawyer in UAE. This article examines some of the most common errors and what to do to avoid them.
Two Layers of Company Formation
The company formation process has two stages which founders can easily mix up. The first one is administrative: Identification of licence, premises, visas. The other is legal, which involves choosing the right entity, specifying who will be the owners of the entity, establishing how the entity will be owned and how profits will be distributed, protecting the business name and assets, and ensuring compliance. Government setups and portals have simplified the administration procedures. Mistakes tend to be overlooked in the legal layer as a licence could be issued to perfection and the arrangements of which it is under could be weak.
The issue lies in the timing of it. Later on, nearly anything in the administrative level can be modified cheaply: a phone number, a manager, an additional visa. The legal aspects are entirely different: a jurisdiction, a company structure or no shareholders agreement can be very complex and expensive to unwind once the business is operating and, in the worst of cases, once owners have fallen out. Some errors are worth mention as they are the least expensive to avoid at the outset.
The Legal Framework Behind the Mistakes
Laws apply both to the UAE mainland and to each of the individual free zones, and there are distinctive common law regimes in both the DIFC and ADGM. On top of this, there are some cross-cutting regulatory obligations for all businesses: the obligation to register the ultimate beneficial owners, the anti-money laundering requirements applicable to certain businesses, the economic substance requirements applicable to certain types of income-generating activities, corporate tax, and data protection. Many of the errors are those that result from ignoring one of these layers or when a rule from one jurisdiction is thought to apply to another. Not any of these obligations is exclusive to large companies. A two person consultancy might be set up in a free zone, but beneficial owners must still be declared and depending on the activities of the consultancy, a corporate tax registration may be necessary for the supervision of anti-money laundering as well. One of the more customary first mistakes is considering compliance to be an issue that only large companies need to be concerned with and it often rears its head at the worst possible time: when a bank, investor, or auditor requests proof of the filing.
Common Mistakes
Choosing the wrong jurisdiction: One of the most common and impactful mistakes is registering in a free zone if the business will be trading directly with the local UAE market. The reverse is also true: paying for the setup in the mainland when the free zone would have cost the business less to set up an export or online business. The solution is to do a customer mapping first, and then choose.
Problems with choosing the appropriate legal form: There are differences between a sole establishment and a civil company and limited liability company in terms of liability and ownership. If founders choose the form, which does not match the number of owners or risk profile, they could end up personally liable, or may have problems attracting investors later on.
Weak or even non-existing shareholder mechanism: If there are more than one shareholders and no shareholders agreement, there is no one that answers the following questions: How and when they make decisions, how they can resolve a deadlock, how a shareholder can exit, how the value of the shares is determined and what restrictions can be placed on a shareholder to prevent them from transferring their shares. These are easily fixed at the beginning for very little cost, but are very expensive and painful once a dispute has started. The significance of proper documentation of the rights of shareholders has also been echoed by the DIFC Courts. In Dimension B+ Ltd v Saleh Abdelkarim Hussain Abdelrahman Almaazmi, the Court focused on competing claims and contractual rights which emanated from nominee shareholding arrangements and how conflicts can arise from problematic ownership structures, which could lead to costly litigations. This case came under the DIFC legal umbrella, and should serve as a reminder to the importance of having clear shareholder agreements and well-documented ownership structures.
Undocumented or informal documented ownership: Historically, some foreign founders resorted to arrangements in which the UAE nationals held their shares in their name. As foreign ownership has been made available for many of these activities their necessity has decreased, and if they are applied they must be done legally and documented accurately. Side agreements, which are not written, are a very real danger and anyone thinking of entering into such an agreement should seek legal advice about it to ensure it is needed and executed properly. The DIFC Courts have also ruled on nominee shareholding structures. The Court in Dimension B+ Ltd v Saleh Abdelkarim Hussain Abdelrahman Almaazmi, discussed the concepts of beneficial ownership and contractual rights in the context of nominee structures. The case illustrates the need to make sure that the ownership structure is legally binding and in proper writing
Activity which is not related to the operations: The more narrow or different the licensing activities are the more likely that contracts will be problematic and penalties will be due, and the more broad the list, the higher the cost and scrutiny. The business should be represented in the licence.
Ignoring sector approvals: In addition to the trade licence, the trade may need additional approvals on top of that (financial services, health, education, food, legal, media). It is illegal to run without them, even with a licence.
Overlooking ongoing compliance: New businesses often fail to submit desired NBO, AML, economic substance or corporate tax registrations when the business activity is declared. They are commitments that are made near or right after the birth of a business, and the repercussions for failing to meet them are tangible.
Neglecting intellectual property: The right to use a trade licence does not mean that the name is automatically a trademark. For a business to have a brand without having registered the trademark, they risk losing the trademark or infringing on another. Trademarking early in the right classes, prevents a rebrand at a later stage. A company name or a trade licence do not provide a trademark protection. Businesses with a business branding focus should think about protecting its trademarks at an early stage in accordance with UAE trademark laws in order to enhance its protection and enforcement possibilities for its intellectual property.
Employability and payroll issues: Any contract that is not compliant with UAE labour law or the Wages Protection System where applicable, will impose future obligations as soon as the employee is engaged.
A business dealing with personal data should think about the regime that applies, either the federal Personal Data Protection Law, or the data protection laws in the DIFC and the ADGM for entities based in these centres. It is easily forgotten when forming and is more and more enforced.
Corporate tax will now be applicable, and the free zone zero-rate will be subject to conditions. Not thinking about tax in the initial stages of structuring the business or its contracts can be an unnecessary burden or a scrambling to restructure.
Simply relying on verbal assurance. While helpful for administration, any statement of eligibility to own or tax treatment or what may be included in a licence shall be verified in writing with the assistance of a set-up agent and consultants with reference to any rules of the authority. Without understanding here, a business can be running within the parameters of its licence, and then suddenly find they are operating outside of it without knowing it.
Where a Company Formation Lawyer Adds Value
Many of the less complicated company formation setups do not need the services of a company formation lawyer, and not all one-owner businesses do. But if there is more than one owner, outside funding, a corporate group structure, cross-border aspects, regulated activities, valuable IP rights, or any other aspect that is not in the standard template, then legal advice will be a required addition. Company formation portals and agents do not explain this, but a UAE company formation lawyer can help with choosing the company structure, shareholders agreements, eligibility and approvals of ownership, and the compliance requirements.
Targeted, a review of the proposed structure and activities before registration, and a brief compliance checklist, relevant to the business, many times this is the most effective approach. That is why, when that concerted input is made, it is usually cheaper than what it would cost if it were done as a later step to settle a disagreement or restructure, and the typical steps of the licensing process are then followed.
What These Mistakes Cost
Cost of correction: It is much more expensive to correct a structural error than to get it right at formation.
Compliance penalties: The financial penalties and licence consequences for beneficial ownership, anti-money laundering, substance, and tax obligations are applicable.
Enforceability: Unwritten agreements can be hard or even impossible to police, especially side deals.
Banking and funding impact: If it is not done, it may result in problems in the banking process and in future investments.
Building on Solid Foundations
When it comes to company formation in the UAE, the errors that are crucial are almost never administrative. These involve selecting the wrong jurisdiction (and/or structure), failing to record the cooperation between owners, and not being aware of compliance requirements and the neglect of intellectual property and tax. Each of these can be dealt with in an easy manner at the start and are very costly to rectify later.
For businesses that are easy and have one owner, careful consideration of the jurisdiction, activity and early compliance filings may be enough. But, if there are several owners, investors, group structure or regulated activity, it is not so hard to establish, it is just hard to get it right, so hiring the services of a company formation lawyer in the UAE at the planning stage is a worthwhile investment.
