Issues affecting mergers and acquisitions in Arabian Gulf

The Gulf Cooperation Council (GCC) countries continue to offer favourable environments for foreign investments despite the slide in oil prices over the past year. The member countries of the GCC are Saudi Arabia, the United Arab Emirates (UAE), Kuwait, Qatar, Bahrain and Oman.

Despite political divisions and conflicts in neighbouring countries, the GCC remains attractive to investors, offering a wealth of opportunities in a favourable business environment. The rapidly growing GCC economies are stimulated by population growth. Native and expatriate populations experience high levels of employment, investment in social services and infrastructure and zero or low tax. These factors, coupled with business-friendly regulations allowing free recruitment and movement of labour, contribute to making GCC countries attractive to foreign investment.

Foreign investors must take a number of items into consideration when transacting in the GCC. The region’s practices have been influenced by Western ways of doing business and carrying out transactions. However, the fundamentals of the legal frameworks of most Middle Eastern countries remain deeply rooted in civil law principles, namely the French civil code as adopted and developed in Egypt. M&A activity is expected to continue increasing in the GCC, but new entrants are advised to familiarize themselves with the primary legal concepts and the practice of the same.

Foreign ownership

All GCC countries impose foreign ownership and control restrictions in local businesses in an attempt to protect their national entrepreneurs and limit foreigners to minority ownership positions. Foreign investors must consider the local ownership restrictions under the laws of the relevant jurisdiction, which are set out below.

1. Foreign ownership of companies in particular industries (e.g. oil and gas, construction) or ownership of real estate outside designated areas is not allowed; and

2. There are limitations on the shares percentage in other local companies that are available for foreign ownership, e.g. 51% local ownership restriction in the UAE, Kuwait and Qatar; 30% in Oman, excluding US purchasers; 25% in respect of trading and professional companies in Saudi Arabia. These may not apply in economic free zones sprinkled across GCC countries.

To comply with the local restrictions, foreign investors usually have two options. The first is to pursue a joint venture. The investor will need to identify a local company which will contribute to the business, share any financial risks and facilitate business development and operations on the ground.

The second option is to conclude arrangements with a local businessman (or company) who will be a partner in name only. Even where a local partner owns 51% of the company, the foreign investor will put in place side agreements allowing the foreign partner to retain almost all profits, carry all risks and exercise full control over the business.

Although the side arrangement seems simple enough from a common law standpoint, Middle Eastern countries, being civil law jurisdictions, do not recognize trust concepts. This failure to recognize separate beneficial title, particularly in the context of shares, is a grey area, leaving investors exposed to changes in regulatory practice and interpretation.

A foreign investor should keep the above in mind before entering into a side arrangement. They should also consult local experts to find out how side arrangements are viewed in the country concerned, as some GCC countries, e.g. UAE, are more liberal than others, e.g. Qatar.

Recent UAE developments

The new Emirati Commercial Companies Law took force on 1 July after a decade-long gestation. It permits listed public companies to make “strategic” share placements without running the gauntlet of their shareholders’ pre-emptive rights, facilitating the formation of important strategic alliances by public companies. It also permits sole shareholder companies and enables public joint stock company shareholders to sell their pre-emption rights. The law allows more than five individuals to serve as board members of limited liability companies, enabling large, closely held companies to broaden their director skill base and business network. These improvements further encourage foreign investment.

Things to keep in mind

Deal structure. Business acquisitions in the GCC are usually done by way of shares rather than assets. This is because the type of assets owned depends on where the business has been registered and what activities it is licensed to carry out. As a result a business licence is attached to the target company, so asset deals cannot be undertaken without a potentially problematic relicensing process. Further, the assets often are not suitable for transfer to the purchaser.

In order to benefit from the assets, a purchaser – regardless of their interest in buying a target company’s asset (e.g. a facility plant) – may have no choice other than to purchase the shares in the target company and deal with the actual or potential limitation of the target.

Licensing. Business licensing plays an important part in the GCC. Any business must obtain a gateway licence from the government to carry on business. This is a substantive process and applicants must demonstrate that they have available staff with appropriate skills and experience and track record to operate the business in that country. Some commercial (professional) licences can only be held by individuals who are nationals of the country in question, e.g. pharmacies and real estate brokerage firms in the UAE;, restaurants in Oman;, and law firms in Qatar, and highly regulated types of business, e.g. healthcare and education, require additional approval and licences. Investors must carry out careful due diligence on target companies to ensure that they can lawfully own the investment.

Due diligence. In GCC countries not much information is recorded on public registers. Only Bahrain has an accessible credit reporting system. Most of the information maintained is not available to the public or any third party, so a buyer usually has to rely on information furnished by the seller. So investors should be cautious, especially when making an offer in a contractual context. They may not be able to revoke an offer freely or at all – under civil law principles any offer has a binding character and cannot necessarily be revoked.

Conclusion

The GCC offers a wealth of opportunities in a business-friendly environment which has continued to be an attractive part of the world for the making investments, starting or growing a business. We expect M&A activity to continue to increase, but it is vital that new entrants do their homework carefully to avoid the pitfalls.

Gary Watts is a partner and regional head of corporate commercial and Sarah Hasnani is an associate in the corporate commercial department of Al Tamimi & Company