UAE. GCC nations have attempted to modernise and standardise their legal frameworks in the past 30 years to encourage foreign investment in this rapidly growing region.
But how much investment can be expected when foreigners can’t own their businesses outright and business debts are secured by a cheque?
The nations that constitute the Gulf Co-operation Council (GCC) - Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates (UAE) - have deep-rooted and complex legal traditions.
Laws within these countries include elements of Quranic jurisprudence, Ottoman legal scholarship and European codes of law introduced during the colonial period.
But this rich fabric is being pulled apart by the various strains of modern business, which needs an impersonal, ubiquitously applicable legal framework that is complex in the more modern sense, and wherein the business itself replaces the handshake and personal commitment. And then there’s the problem of the inability of foreigners to own their business outright.
Across the GCC, legal frameworks are generally consistent. They are all civil law jurisdictions, which are based on Egyptian laws, and all of them follow Sharia law. However, Ludmila Yamalova, a partner at the Dubai-based law consultancy Yamalova & Plewka, told INSEAD Knowledge that while the legal systems are similar on paper, there are major discrepancies in the way that laws are practiced.
“The biggest differences among these countries are their implementation and interpretation of various laws,” she says. “For instance, Saudi Arabia emphasises Islamic Sharia law, while the UAE has focused on developing legislation that will attract foreign investment.”
These inconsistencies make the GCC a confusing place to do business at times. Samer Qudah, Partner and Head of Corporate Structuring from Al Tamimi and Company, the biggest law firm in the Middle East, describes how expatriates can sometimes fall foul of the laws in the GCC. “...some [expatriates] come to the market and just assume that it’s similar to their own jurisdiction, and … run into trouble, because it’s a completely different culture.” Yamalova adds that this confusion is made worse because there is a “lack of transparency in the workings of (GCC) legal systems and an absence of a centralised database of relevant information, such as court precedents and copies of the laws”.
Restrictions on foreign ownership
While the legal roadblocks vary from country to country, a major complaint throughout the GCC is that foreign investors are often not allowed to own real estate or companies. Abdul Aziz Al-Yaqout, Regional Managing Partner Middle East at DLA Piper, says: “The principle hurdle for foreign investors is that laws in the GCC are very protective of local nationals and local economic interests, as is often manifested in legal barriers to the full participation of foreigners ... in GCC economies.” In many countries, there is a federal requirement that a local business partner must own at least 51% of the company.
According to Al-Yaqout, these restrictions force foreign investors to change their business practices to establish themselves in the GCC – essentially, finding a local business partner who will own more than half the business.
Alternatively, they can run their business offshore so that they can retain full ownership, but in doing so they will face many constraints on business activities that they may conduct within the GCC. Both scenarios, Al-Yaqout argues, come at a cost to the foreign investor, and in some instances it may not be worth it.
Dubai has attempted to do away with these restrictions on foreign ownership. It has fashioned itself as the most welcoming emirate by establishing a large number of free zones in which foreigners can own 100 percent of the business and land. These zones are governed by modern legislative frameworks that are mostly based on common law principles, rather than civil laws.
These legal reforms resulted in the exponential growth of the Dubai real estate market, attracting thousands of foreign investors and billions of funds, and contributing to the subsequent seven-year economic “bubble”. Yamalova says with this phenomenon, “many legal issues arose, which are symptomatic of any rapid and unregulated growth ... Often, laws and regulations are not enforced as efficiently as the market demands them.”
Lack of credit rating system
In addition to the problematic ownership laws in the GCC, foreign businesses also struggle with the lack of a credit rating system within the GCC. Without an established system of measuring creditworthiness, debts in the GCC are secured by cheques. If a borrower becomes unable to honour payments, the cheque is cashed as security and if it should bounce because of insufficient funds, it is considered a criminal offence that could result in a jail sentence.
Yamalova says that this system is “archaic because jailing someone who is otherwise a productive member of society with earning power, albeit reduced, does not benefit anyone”. She believes that it is imperative to develop a credit rating system and to modernise bankruptcy laws to allow borrowers another chance to restructure their loans without being subject to criminal sanctions.
Continuing appeal of GCC region
Despite these roadblocks, the GCC region continues to be seen as a generally safe and reliable market for foreign investors from around the world. “This is a very rich region and still attracts lots of foreign investors,” Qudah says. Compared to many other regions, countries in the GCC are lucrative investment hubs. The largest draw is undoubtedly that many countries within the GCC offer investors a tax-free environment. Al-Yaqout says that “tax-free revenues, consumer willingness to embrace new products, high per capita income and a growing 'upwardly mobile' population are all characteristics of this rapidly developing market.”
The recent uprisings throughout the Middle East - now known as the Arab Spring - have not shaken the confidence of foreign businesses in GCC countries. Yamalova says this has only “confirmed and re-established the UAE’s supremacy as a hub for foreign investment, including for many GCC countries such as Oman and Bahrain”.
This interest in the region is likely to continue, especially if the GCC countries continue in their efforts to modernise their legal systems to keep pace with the rapid changes in the global economy.
Still, much has yet to be done to ensure that the various jurisdictions in the GCC are up to the standards of developed countries. When Al-Yaqout is asked to comment on what he feels are the most urgent reforms needed to attract and protect foreign investors in the region, he says that it will take “a comprehensive overhaul of the civil, commercial and company codes, which form the basis of business law.
Furthermore, there will have to be a far reaching overhaul of the court systems, in order to make them more efficient, transparent and ultimately trustworthy.” However, if the creation of the free zones in Dubai is a sign of things to come, he believes the legal codes in the GCC can modernise rapidly, making the region an even more enticing site for foreign investment.
This article is republished courtesy of INSEAD Knowledge
Copyright INSEAD 2011.