You Recovered Your Money from a Distressed Customer — Can You Be Made to Give It Back?

"You Recovered Your Money from a Distressed Customer — Can You Be Made to Give It Back?" Challenging Pre-Bankruptcy Transactions under the UAE Financial Restructuring and Bankruptcy Law

By Ahmed Yehia Hamdalla — Partner, SAT & Co. Advocates and Legal Consultants, Dubai

A supplier chases a customer that has been paying late for months, finally receives a transfer for the whole balance, closes the file and moves on. A bank, seeing the first bounced cheques, persuades the borrower to grant a mortgage over a warehouse to secure an overdraft that has existed for three years. A distributor accepts a consignment of stock in settlement of an overdue invoice because cash is not available. Eight months later the customer is placed in bankruptcy, and a letter arrives from the trustee asking for the money, the mortgage or the stock to be returned to the estate. Each of these creditors did what a diligent creditor is supposed to do; each of them has walked into the provisions of the Financial Restructuring and Bankruptcy Law, promulgated by Federal Decree-Law No. 51 of 2023 and in force since 1 May 2024, under which certain acts of a debtor in the period before it stopped paying are unenforceable against the general body of creditors. Collection, in other words, does not always end the risk. This article explains how the suspect period is now measured, which transactions are exposed automatically and which only where the creditor knew of the debtor's distress, why related parties are treated more severely, what defences and time limits apply, and how a creditor can recover from a shaky customer without creating a liability to give the recovery back.

1. The suspect period: shorter on paper, longer in practice

Under the previous law, Federal Decree-Law No. 9 of 2016, the transactions exposed to challenge were those made in the two years preceding the commencement of proceedings. The 2023 law re-drew the window in two ways. First, it shortened the general period: under Article 148 the listed acts are unenforceable if carried out during the six months preceding the cessation of payment date, and the period is extended to two years only where the act was executed between the debtor and an insider or a related party. Secondly, and less noticed, it anchored the period not to the date on which proceedings were opened but to the date on which the debtor ceased to pay, which is a date the court fixes. Under Article 31 the decision to initiate proceedings specifies a temporary cessation of payment date, and if it does not, the date of the decision itself is taken; under Article 32 the court may, of its own motion or on the application of the debtor, any creditor, the trustee or any interested party, amend that date at any time until the list of debts is approved, provided that it is not backdated more than two years before the decision to initiate proceedings. The practical consequence is that a creditor cannot know, when it collects, where the window will eventually fall. If the court later fixes the cessation date two years before the opening decision, a payment received two and a half years before the opening of proceedings is inside the six-month window, and a related-party transaction four years before it is inside the two-year window. The law's own definition of cessation of payment, the failure to pay a due debt within ten days of the deadline set in the creditor's notice, even where the debtor's assets or the security would suffice to pay it, means that the date is often earlier than the debtor's public difficulties would suggest.

2. Five acts that are unenforceable without proof of knowledge

Article 148(1) lists the acts that may not be invoked against the creditors if the debtor carried them out within the suspect period. The first two are the classic cases of dissipation: donations and gifts, other than the small customary gifts, and any transaction in which the debtor's obligations are significantly out of balance with those of the counterparty, whether the obligations are in cash or in kind. A sale of stock or equipment at a fraction of its value, a settlement that gives the counterparty far more than it was owed, or a "consultancy" or "management" fee that bears no relation to any service will fall here, and the creditor's good faith is not an ingredient of the test. The remaining three are the ones that catch ordinary creditors doing ordinary things. The third is the repayment of a debt before its maturity date, by whatever method, or in a manner different from the one usually followed for that type of debt; the law adds that providing cover for a negotiable instrument that has not yet matured is treated as premature repayment. The fourth is the repayment of a debt that is due, but with consideration other than that agreed: goods instead of money, the assignment of a receivable, the transfer of a vehicle or a plot of land in satisfaction of a cash debt. The law is careful to add that payment by negotiable instrument or bank transfer is treated as payment in cash, so a creditor who is paid the sum due, when due, by cheque or transfer is not exposed under this head. The fifth is the arrangement of any new security over the debtor's assets to guarantee a previous debt, which is precisely what a creditor is tempted to obtain when it first senses trouble.

For the third, fourth and fifth acts the law provides one escape: each is unenforceable "unless there are commercial considerations that justify the same". That phrase is the creditor's principal defence and it must be built at the time of the transaction, not reconstructed after the trustee's letter. An early settlement made in exchange for a discount under a pricing policy the debtor applied to all its suppliers, a payment in kind that was the mechanism the contract always contemplated, a new security granted in exchange for new money, a genuine extension of time or a real forbearance, are commercial considerations; a security taken because the creditor was worried, or a payment brought forward because the creditor pressed hardest, are not. It should also be noted that none of the five heads requires the trustee to prove that the creditor knew of the debtor's difficulties. The creditor who received an early payment in complete ignorance of the debtor's position is in the same position as the one who demanded it with full knowledge, subject only to the commercial-justification defence and to the court's general discretion under Article 150, discussed below.

3. The general clause:

Beyond the listed acts, Article 148(2) gives the Bankruptcy Court a general power to declare unenforceable any disposition made by the debtor during the suspect period if two conditions are met: the disposition was harmful to the creditors, and the counterparty knew, or should have known, at the time, that the debtor had ceased to pay its debts or was in a state of financial distress. This is the provision under which a payment made at maturity, in the agreed manner, can still be attacked, and it is the reason why the creditor's own file is so important. A creditor that had sent formal demands, received bounced cheques, been asked for extensions or seen the debtor's other creditors take enforcement action will find it difficult to deny that it should have known; a creditor that was paid in the ordinary course, on the ordinary terms, without any sign of difficulty, has a strong answer. The same emphasis on knowledge governs security. Under Article 149, the registration of a mortgage or lien over the debtor's assets after the cessation of payment date may be declared unenforceable if the creditor is proven to have known of the cessation of payment, unless the registration merely perfected an existing debt secured by the same rights over the same assets and registered before the cessation date, or was made in implementation of a contract concluded before that date; a later-ranking mortgagee takes the rank of the avoided mortgage but receives no more than it would have received had the avoided mortgage stood, the difference going to the creditors as a body. The rule is coupled with Article 134, under which a disposition that requires registration or another formality to be effective is not enforceable against the creditors unless the formality was completed before the decision to initiate bankruptcy proceedings. Knowledge also decides the position of those who receive payment on negotiable instruments: under Article 161, the holder of a bill or cheque paid by the debtor after the cessation date and before the opening of proceedings keeps the payment, and the refund obligation falls instead on the drawer, the person for whose benefit the instrument was drawn or, in the case of a promissory note, the first endorser, if that person knew of the cessation of payment when the instrument was issued or acquired. And at the far end of the spectrum the law adds a criminal sanction: under Article 275, a creditor who, after the cessation of payment and knowing of it, enters into a secret agreement with the debtor granting itself special advantages to the detriment of the other creditors is liable to imprisonment and/or a fine of up to AED 300,000, the agreement is declared void as against the debtor and everyone else, and the creditor must return what it received even if acquitted.

4. Related parties and insiders: a two-year window and a wider net

The two-year window applies where the act was executed between the debtor and an "insider" or a "related party", and both terms are defined widely in Article 1. An insider is any person who by virtue of his position has access to undisclosed information about the debtor's business, assets, financial position or management, and the members of the board and the administrative staff of the debtor, its subsidiaries and its parent company are deemed insiders. Where the debtor is a company, the related parties include its subsidiaries; the members of its board and senior executive management and those of its subsidiaries; any person holding five per cent or more of its shares or of a subsidiary's shares; the relatives to the third degree and the partners of all of those persons; the employees' savings funds; enterprises, joint ventures and partnerships between the company and any other entity; companies whose directors or senior executives, or their relatives to the third degree, can exert effective influence over the debtor; anyone who by virtue of his office has access to internal information on the debtor's financial position, including the chairman, the directors, the general manager, the chief financial officer, the internal and external auditors and the company's representative, together with their relatives; and any natural person charged with paying the debtor's debts. Where the debtor is an individual, the spouse, relatives by blood or marriage to the third degree and persons whose activity gives them access to the debtor's financial information are related parties, and the marital bond counts even if the marriage was contracted after the transaction or ended within the year preceding it. In practice this means that the repayment of a shareholder loan, the settlement of an intercompany balance, the grant of a guarantee or security to a group company, the transfer of an asset to a director's relative and the payment of a sister company's invoices ahead of third-party suppliers are all exposed for two years before the cessation date, and, by the operation of Article 32, potentially for up to four years before the opening of proceedings. Group treasurers and boards who "tidy up" intra-group positions when a subsidiary begins to struggle are creating exactly the record that a trustee will later use.

5. Defences, time limits and what "giving it back" means

The law tempers these rules in four ways. First, under Article 150(1) the Bankruptcy Court may dismiss an action under Articles 148 or 149 if it is satisfied that the debtor acted in good faith with the aim of carrying on its business and that, when it acted, there were reasons to believe that the act could be beneficial to the business. The defence is framed around the debtor's state of mind rather than the creditor's, so the creditor who wishes to rely on it must be able to show what the transaction did for the debtor: the supply that continued, the facility that was extended, the working capital that was preserved. Secondly, under Article 150(2) an action under Articles 148 or 149 may not be heard after one year from the date of service of the decision to initiate proceedings, a short period that creditors who have received notice of proceedings should calendar. Thirdly, the trustee retains, under Article 151, the general action for the non-enforceability of a debtor's acts that is provided by the Civil Transactions Law, the actio pauliana, which reaches acts done before the opening of proceedings to the detriment of creditors on the ordinary civil-law conditions; a judgment under it renders the act unenforceable against all creditors, whether their rights arose before or after the act. Fourthly, the law preserves contractual netting: under Article 224, while set-off of debts falling due after the opening decision requires the court's authorisation or the terms of the plan, a netting agreement within the meaning of Federal Decree-Law No. 10 of 2018 remains final and effective in accordance with its terms.

Article 152 describes what "giving it back" involves. Where an act is declared unenforceable, the counterparty must refund to the debtor or the trustee the amounts it received, or the value of the asset at the date of receipt if it cannot be returned in kind, together with the interest or benefits derived from it since receipt. In exchange the counterparty may recover the consideration it gave if that consideration can still be identified in the estate; if it cannot, the counterparty may claim from the debtor and the creditors the benefit the estate derived from the transaction and participates in the proceedings as an ordinary creditor for the excess. In the ordinary case of a supplier paid early, therefore, the supplier returns the money with interest and is restored to its position as an unsecured creditor for the invoice, sharing in whatever dividend the estate ultimately pays. The economic effect is that the recovery is reversed and the creditor is returned to the queue, which is exactly what the provisions are designed to achieve.

Two related provisions complete the picture from the debtor's side and explain why these transactions attract attention. Under Article 246, where a company is declared bankrupt the court may, on the application of the trustee or any creditor, order its directors, managers or de facto managers to contribute to the company's debts in proportion to their fault if, in the two years before the cessation of payment, they paid the debts of any creditor with the intention of harming the others, disposed of assets for no or inadequate consideration or engaged in reckless commercial methods, subject to a defence for those who took the precautions a reasonable person would have taken and an exemption for those who recorded their objection in writing; the action must be brought within two years of the bankruptcy judgment. And under Articles 270 and 271 a debtor or a company's managers who, after the cessation of payment, pay a creditor to the detriment of the others or grant a creditor security or special advantages commit an offence. A distressed customer that pays one creditor ahead of the rest is therefore exposing its own management, and its trustee will be looking for precisely those payments when it reconstructs the final months.

6. Collecting from a distressed customer without creating a clawback

The provisions do not make it unlawful to be paid by a customer in difficulty; they make it unwise to be paid in the wrong way. The safest recovery is the most ordinary one: the sum due, paid at or after maturity, in the manner the contract provides, by transfer or cheque, without any concession from the debtor that it was not already bound to give. Every departure from that pattern should be examined against Article 148 before it is accepted. A proposal to pay early should be declined unless there is a documented commercial reason that applies generally and not only to this creditor. A proposal to settle in goods, receivables, vehicles or property in place of cash is exposed under the fourth head and should be accepted, if at all, at a documented market value and with a contemporaneous record of why cash was not available and why the estate is no worse off. A request for new security over a previous debt should be met with new value: fresh credit, a formal extension of time, a reduction in rate, the release of another security or some other consideration that a court will recognise as commercial, recorded in the facility documentation rather than in a covering email. Security should be registered immediately, because an unregistered mortgage is exposed under Article 134 and a mortgage registered after the cessation date is exposed under Article 149 if the creditor knew of the cessation.

The creditor's own file matters as much as the transaction. Because the general clause in Article 148(2) and the mortgage rule in Article 149 turn on what the creditor knew or should have known, a creditor that is negotiating with a customer in difficulty should be conscious that its demand letters, its internal credit notes and its correspondence about bounced cheques will be read by the trustee; that is not a reason to stop recording the facts, but it is a reason to record at the same time the commercial justification for whatever is agreed. Side letters, undisclosed arrangements and informal preferences should be refused outright, since they engage Article 275 as well as Article 148. Dealings with related parties, where the creditor is itself a group company, a shareholder, a director's relative or anyone with access to internal information, should be approached on the assumption that they will be examined over a two-year window and should be supported by evidence that they were made on arm's-length terms. Once proceedings are opened, the creditor should note the date of service of the opening decision and the one-year period in Article 150(2), lodge its proof of debt, monitor any application to move the cessation of payment date under Article 32, and assemble the evidence of commercial justification and of the debtor's good faith before the trustee's letter arrives rather than after it.

Conclusion

The 2023 law rebalanced the treatment of pre-bankruptcy transactions in a way that is, on its face, more favourable to creditors than the 2016 regime: a six-month window rather than two years, a commercial-justification defence built into the text, a good-faith discretion and a one-year limitation period. But it anchored the window to a cessation of payment date that the court fixes and can move back by up to two years, it retained a two-year period for the widely defined class of related parties and insiders, it left the listed acts exposed without any requirement that the creditor knew of the debtor's distress, and it gave the trustee both the statutory action and the general civil-law action. For creditors the conclusion is a practical one. The question to ask when a distressed customer offers to pay is not only "will the money arrive?" but "will I be allowed to keep it?", and the answer depends on whether the payment was due, was made as agreed, was supported by a commercial reason and was received without a side arrangement.

Sources: Federal Decree-Law No. 51 of 2023 Promulgating the Financial Restructuring and Bankruptcy Law (in force 1 May 2024), in particular Article 1 (definitions of "Cessation of Payment", "Insider" and "Related Party"), Articles 31 and 32 (setting and amendment of the cessation of payment date), Article 134, Articles 148 to 152 (dispositions unenforceable against creditors, registration of mortgages and liens, dismissal and time bar, the action for non-enforceability and the effects of the judgment), Article 161, Article 224, Article 246 and Articles 270, 271 and 275, as published in English on the UAE Legislation portal (uaelegislation.gov.ae), reference being made to the Arabic text in case of conflict; Federal Decree-Law No. 9 of 2016 (the previous Bankruptcy Law), Articles 168 to 170, for comparison.

This article is general commentary and not legal advice on any specific transaction or proceeding.