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Analysis & Insights

Spotlight on ADGM: Structural Advantages and Benefits for Investors

10 Jun 2020

While COVID-19 has created dislocation across financial markets, the Middle East remains a key centre for private equity and venture capital activity.  While some investors have shied away from the wider region due to concerns over perceived issues regarding the enforceability of structures and transaction terms, these risks can be mitigated by structuring transactions using vehicles domiciled in the Abu Dhabi Global Market ("ADGM").  By using this financial free zone in Abu Dhabi, United Arab Emirates ("UAE"), to enter markets in the Gulf Cooperation Council ("GCC"), particularly Saudi Arabia, enforceability can be improved for private equity and venture capital investors.  The Maples Group recently connected, via video conference, with Nabil A. Issa and James Stull, partners at King & Spalding LLP, to discuss the state of the market and the benefits of considering ADGM to host a regional fund, joint venture or holding company.  

Maples Group: Could you tell us about the ADGM and why it would appeal to an investor versus the numerous other free zones in the GCC for structuring deals and joint ventures?

King & Spalding: The ADGM is a financial free zone located in Abu Dhabi, that adopts the English Common Law of England and Wales and applies it to civil and commercial matters, similar to the approach taken by Singapore and Hong Kong.  It is the first jurisdiction in the Middle East to completely adopt such an approach and the legal regime gives comfort to foreign investors who are familiar with common law systems and instils confidence regarding the usage and enforceability of contract provisions. 

Companies incorporated in the ADGM are widely treated as being "GCC nationals" for purposes of investing in the GCC countries, particularly to the extent such are owned by GCC nationals.  This is important for tax and foreign ownership considerations.  

The ADGM introduced a particular type of limited liability company, a special purpose vehicle ("SPV"), that feels and operates like limited companies in typical offshore financial centres like the Cayman Islands or British Virgin Islands.  Unlike most companies in the UAE and the wider GCC, there is not a requirement to lease actual office space, and similar to other offshore jurisdictions you can appoint a corporate service provider, such as the Maples Group, to provide a registered address or to have signatories in the jurisdiction.  The SPVs are relatively low cost to establish and maintain and can be set up more quickly than most forms of corporate vehicles in the GCC.
In short, the primary draws of the ADGM are the English law regime with the treatment of a GCC company when investing, while also being time and cost effective. 

The Dubai International Financial Centre ("DIFC") also largely has an English environment, but does not yet permit the formation of special purpose vehicles that do not lease offices, unless such are part of a structured financing transaction or a subsidiary of an existing entity.  Ras Al Khaimah offers RAK ICC, which also fairly recently began permitting holding companies to operate under English law and form low cost SPVs, but does not have a regime to allow the formation of funds and is relatively untested.  

Similar to other offshore jurisdictions, parties need to carefully consider the substance rules when using an ADGM SPV entity for investments.  Nevertheless, we find many clients already have some level of operations in the UAE and can partially use such to evidence substance in the jurisdiction.  Parties can also work with the Maples Group to take the minimum necessary steps to ensure they meet the relevant substance rules. 

Maples Group: As the largest economy in the Middle East, Saudi business assets are attractive both to GCC and non-GCC investors with its burgeoning venture capital scene, dynamic young population and active IPO market.  The potentially transformative Vision 2030 program to diversify the economy away from oil and engineer a dramatic increase in private sector investment has been reflected in the flexible approach taken by Saudi authorities to encourage foreign investment, while efforts to modernise Saudi society have bolstered the attractiveness of a number of key sectors in the economy.  We understand that the current leadership in Saudi Arabia is easing certain restrictions. Is this correct and what sectors are being impacted?

King & Spalding: Yes. We have seen a dramatic opening in Saudi Arabia over the past 18-24 months in general and in many previously closed or prohibited sectors.  

One of the most obvious sectors has been cinemas, which historically were not permitted.  We are aware of at least six issued licenses to operators including: iPiC, AMC, VOX, Empire, Cinépolis, and Next Generation (Muvi).  The success of the entertainment / food festivals - Jeddah Season and Riyadh Season - demonstrated that Saudi nationals are keen to have the latest top-end restaurants with the successful launch of Cipriani and Black Tap in Riyadh and Scalini and Fogo de Chao in Jeddah, in addition to the excitement of the upcoming Nobu Hotel and Samba Sushi.  We are currently working with various parties to establish ADGM funds and holding companies to create entities focused on these sectors.  

The healthcare system is another sector specifically primed for foreign investment under Vision 2030, where recent legislative changes now permit 100% foreign ownership of most private healthcare institutions, previously restricted to ownership by Saudi nationals.  The government is working to allow private participation in government owned healthcare facilities.  We recently worked with Soliman Fakeeh to acquire a substantial stake in Saudi Arabian Airlines' medical center in Jeddah.  This was the first privatisation under Vision 2030 and we expect a number of high profile transactions to follow.

We also continue to see growth and investment in e-commerce companies such as Deliveroo, Talabat, and Mumzworld, among others.  Moreover, there are various Saudi governmental entities, such as the Jada Fund of Funds and Saudi Venture Capital, that have shown a willingness to not only invest in Saudi Arabian CMA funds, but also ADGM funds and ADGM vehicles.  

Maples Group: Acquisitions through a joint venture with a local player makes it much easier to penetrate the GCC market, typically dominated in places like Saudi by tightly held family businesses insulated from significant competition.  While full foreign ownership is permitted in key sectors in Saudi, foreign investors typically find it preferable to approach the acquisition through a joint venture, bringing a local partner for their expertise and experience, to marry with their own funds for expansion and business plan.  How can the ADGM be helpful in creating a joint venture targeting Saudi Arabia or even elsewhere in the GCC?

King & Spalding: Joint ventures are a great way to help parties penetrate the GCC, but we often find partners become frustrated when they cannot readily enforce their joint venture agreements.  Certain complex matters are not necessarily addressed under the relevant companies laws in most of the GCC and may not be familiar to judges in a court in the GCC.  Such provisions provide valuable protection to a shareholder, as well as valuable exit rights, and therefore it is important that there is no ambiguity or uncertainty around enforceability.  For example, the articles of Saudi LLCs are generally standardised and are based on a relatively simple and generic drop down list of authorisations with limited flexibility for adjustments.  As a result, any detailed matters which the parties agree in the joint venture agreement cannot be reflected in the articles and, therefore, may not always be enforceable, particularly if the action objected to involves a third party.

English law is applied by judges in the ADGM and therefore English statute and hundreds of years of case law is considered and applied which provides comfort on the enforceability of contractual protections that are agreed in the joint venture agreement.  The ADGM's common law environment will also allow future investors to isolate financial and legal risks associated with any investment by ring-fencing assets and liabilities held by the ADGM SPV.  By moving the joint venture to the ADGM, the parties can have the joint venture agreement under English law and any dispute heard by a common law trained judge.  Moreover, the parties do not have to appear in person and usually participate electronically, via Skype or Zoom.  

We have also found foreign lenders are much more willing to lend at the ADGM level rather than a company onshore in the GCC, including in Saudi Arabia.  Security interests that may be sought in relation to future financing by third party lenders, or even the shareholders can be registered in the ADGM.  In relation to third party lenders, this will provide comfort on the ability to enforce security and will therefore widen the pool of lenders that are available and should reduce the cost of funding.  In relation to security provided by the shareholders, the ability to register and enforce the security should also provide comfort.

Lastly, we are also seeing a growing trend of parties wanting to create enforceable employee stock option plans ("ESOP") to encourage their best employees to make long term commitments to jurisdictions such as Saudi Arabia or Kuwait.  The English law environment makes the ADGM ideal to create an ESOP that gives employees comfort they have an enforceable ESOP, while providing employers the ease of taking those rights away in the event the employee is a "bad leaver" and joins a direct competitor.  

Difficulties can arise from incorporating a limited liability company either in Saudi or the UAE to make such investment, particularly due to the rigid corporate legislative frameworks in these onshore jurisdictions. Due to this inflexibility, when acquiring less than 100% of a target company, joint venture participants will tend to establish a shareholders agreement, which will detail provisions relating to how shareholder disputes will be settled, alongside the treatment of options and what restrictive covenants will be in place.  Additionally, where private equity firms are involved it will be essential to map out the strategy in advance to exit the investment. Investors looking to the Saudi market will be well advised to enter through a strong and stable jurisdiction which can provide them with the requisite security from a well-respected legal and court system. This requirement is underlined by the fact that Saudi or UAE courts usually veer away from taking specific performance in a shareholder dispute, in favour of financial compensation where one party has breached a provision of the agreement.

Maples Group: In addition to its regarded legal system and highly developed company law framework, we understand the ADGM is recognised by many GCC countries as being "GCC national".  That means that the entity is treated as a GCC acquirer in Saudi Arabia, Kuwait, Dubai and others, opening the door to more efficient tax treatment and the opportunity to invest in a wider range of sectors.  Looking specifically at taxation, is the ADGM useful in maximising efficiency?

King & Spalding: In general, the position in the UAE is that companies formed in the ADGM, or the DIFC or RAK ICC for that matter, should be treated as UAE companies.  This is not always true as certain jurisdictions or regulators sometimes take the position that these companies should be treated as offshore, but that generally is not the case.  It is important to note that the shareholding of the ADGM entity would matter. For example, an ADGM entity that is 100% owned by non-GCC foreigners would not be treated as a GCC national, but an ADGM entity that is majority or 100% GCC owned potentially will be.

Last year a new tax treaty was announced between the UAE and Saudi Arabia, which introduced some interesting new possibilities for ADGM entities.  Under the new treaty it is now possible to deem an ADGM entity as a Saudi Arabian resident for tax purposes.  This means that if an ADGM entity owns a Saudi company, the 5% withholding tax on amounts leaving Saudi Arabia such as dividends and the 20% capital gains tax on exits at the Saudi level can be eliminated by demonstrating that decisions will be made in Saudi Arabia and registering such properly with the General Authority on Zakat & Taxation with the assistance of an experienced accounting firm.

Further, if a Saudi Arabian shareholder in an ADGM entity could potentially be in the same tax position as it would be in if it invested into a Saudi Arabian vehicle, the shareholder would continue paying zakat at the rate of 2.5%, while any non-GCC investor would pay tax at the rate of 20% of profits.  

For these reasons it makes locating the acquisition structure in either ADGM, or the DIFC, where similar advantages exist, highly optimal.  Among the other taxation benefits applicable to ADGM companies, are the absence of corporation tax, transfer or capital gains tax, or withholding, inheritance or any other taxes, with no stamp duty on the transfer of shares.  

Maples Group: How can the ADGM legal environment assist with enforcement of provisions not normally recognised in the GCC?

King & Spalding: Deadlocks arising from major disputes between shareholders can be generally resolved through a buy-sell mechanism, which would allow one party to buy the other's interest at a named price.  Saudi courts, however, will normally not enforce these provisions, nor will they recognise the concept of dilution, which can remedy a situation where one partner will not put up the required capital call.  This again reinforces the need for a jurisdiction that has flexibility within its regulatory and legal framework.
When joint venture partners run into litigation, more of which can potentially be expected at this current phase in the cycle, it tends to be related to the wording in the joint venture agreement.  Central to the suitability of the ADGM's legal system for international investment into Saudi Arabia and elsewhere in the GCC is the adoption of English law for its legislation and the enforceability of such provisions for entities in ADGM.  The ADGM is a highly suitable venue for joint ventures as its court system recognises the joint venture agreement as an enforceable obligation of the parties and has judges more experienced with such matters and essentially more trustworthy in dealing with what most leading international financial centres would consider basic tenets of international corporate law.  

For example, a party could legally agree to disproportionate profits for a UAE LLC.  The UAE national partner could own 51% or more of the shares of the ADGM SPV, while agreeing to Class B shareholder with fewer rights and to disproportionate profits.  Thus, if the UAE national partner agrees to give the Class A shareholders all rights to appoint management and receive over 90% of profits, such can be legally documented in an ADGM SPV under English law.  One can also agree on put and call option mechanisms to deal with situations where a partner may wish to exit the joint venture.

Furthermore, as will be apparent in the current climate of uncertainty, with investment markets still waiting for the effects of the COVID-19 related volatility to work their way through the financial system, it will be important for acquirers to maximise the exit options available within the structure, such as coming to an initial agreement how an exit will take place.  Greater efficiencies can also be introduced.  For example, it is possible to reduce or eliminate the 20% capital gains tax on exit that must otherwise be paid by a party outside of Saudi Arabia through use of an intermediate SPV which can be domiciled in ADGM. 

Maples Group: It is clear that there are advantages to establishing a holding company in the ADGM rather than directly in a GCC jurisdiction, but why establish a fund in the ADGM rather than other popular jurisdictions or onshore in Saudi Arabia, the UAE, or elsewhere?

King & Spalding: First of all, a regional fund can acquire GCC nationality.  Investors in an offshore fund, however, when investing in a jurisdiction such as Saudi Arabia will normally not be able to invest in sectors not open to non-GCC nationals and will be subject to the higher 20% tax on profits, rather than zakat levels of 2.5%.  Also, an offshore fund cannot acquire real estate outside designated areas in the UAE. 
While an ADGM fund certainly takes more time and effort than in many offshore jurisdictions, it is often simpler than forming an onshore fund in the GCC.  Moreover, the English law environment of the ADGM provides a high degree of legal certainty as to enforceability of side letters, capital call structures, etc.  Therefore, we are seeing a surge in the formation of funds domiciled in both the ADGM and DIFC to ultimately invest throughout the UAE, Oman, Kuwait and Saudi Arabia in a wide range of sectors.

Further, ADGM funds operate under the purview of the ADGM Financial Services Regulatory Authority ("FSRA").  The FSRA is a pragmatic but legitimate regulator that gives investors comfort that the fund managers will be subject to a certain level of oversight. 

Central to ensuring a successful transaction will be taking direction by counsel and fiduciary service providers with experience and a good understanding of the regional considerations in the Middle East, ideally combining knowledge of local laws with international best practice.  With long standing expertise in supporting acquisitions in the Middle East, the Maples Group is highly experienced in the fiduciary aspects of establishing the relevant structures, keeping all entities in good legal standing and in full compliance with global regulatory requirements.

For further legal information, please contact Nabil Issa at [email protected] or James Stull at [email protected].  You can also obtain further information on King & Spalding, LLP at www.kslaw.com. 


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