Tuesday, February 16, 2016

Foreign ownership restrictions in the GCC – time for change?

Curtis Partner Taimur Malik discussed foreign ownership restrictions in the GCC for the International Bar Association's latest newsletter. The full text is reproduced here, with the kind permission of the IBA.

During the last decade we have seen the Gulf Cooperation Council (GCC) countries taking initiatives to diversify their income and reduce dependence on the oil and gas sector. Such initiatives often involve foreign direct investment in projects that can create jobs, result in local supplier development, create in-country value and increase the host country’s export base.

In many cases, foreign investors collaborate with the host government or a local business group to implement the desired project. In some cases, the host GCC government would grant a 100 per cent foreign ownership approvals to foreign investors to establish a 100 per cent foreign-owned company for a given project. Moreover, in most GCC countries, if a foreign company has a contract with the government then it is often allowed to establish a branch office of its parent company in the host country in order to perform the contract.

However, such exemption approvals and foreign investor-host government partnerships are the exceptions and the majority of foreign investors need to find and work with a national or private sector entity of the host country as a shareholder in the company being established.
Foreign investors often do not know either individuals or corporate entities that might be suitable partners for such joint ventures, and the risks of dealing with an unknown partner in an unfamiliar territory often deter foreign investors. Moreover, often local partners are unable or unwilling to commit their share of the capital required for a project and prefer to limit their participation to local support only. Consequently, foreign investors are often required to stump up all the financial resources necessary for the investment. If foreign investors still feel comfortable in taking such risks, they nevertheless derive what comfort they can from entering into side agreements (such as a loan agreement to cover the capital contribution made by a local partner) despite the uncertain enforceability of such arrangements.

As a general rule, in UAE and Qatar, a foreign investor can hold up to 49 per cent shareholding in a company. In the Sultanate of Oman, a foreign investor can own up to 70 per cent of the registered share capital of a limited liability company.

In Saudi Arabia, a foreign investor can have up to 100 per cent control of its investment by establishing a branch office or by forming a limited liability company (unless the desired activity or sector is on a list of activities or sectors restricted by the Supreme Economic Council, or if the desired activities relate to a sector (such as trading, telecom or real estate) in which a certain level of participation by a local shareholder is mandatory).

Exceptions to the general foreign ownership restriction rules are increasing across the region, either by way of special approvals granted pursuant to free trade agreements or the establishment of free trade zones in these countries. For example, special zones and industrial estates such as Salalah Free Zone, Sohar Free Zone and Knowledge Oasis Muscat in the Sultanate of Oman allow 100 per cent foreign ownership of companies (with reduced minimum capital requirements and various other incentives). Similarly, UAE has more than two dozen special zones (such as Jebel Ali Free Zone, DIFC, Khalifa Industrial Zone Abu Dhabi and RAK Free Trade Zone) where such incentives exist for foreign investors. In terms of free trade agreements, US citizens and entities are allowed to establish 100 per cent US owned companies (with the exception of certain sectors) in the Sultanate of Oman pursuant to the free trade agreement between the two countries.

That more such exceptions are being made reflects an acknowledgment by the GCC countries that foreign investors prefer to invest in an environment where they can own up to 100 per cent of their local enterprise. In circumstances where foreign investors feel the genuine need for local participation, we see examples of partnership with local parties – even where that is not a mandatory legal requirement.

In view of the above, it is perhaps worthwhile to consider whether the GCC countries would benefit from further relaxing foreign ownership restrictions and allowing up to 100 per cent foreign ownership across the board, with the exception of a limited number of activities and sectors which are deemed critical for reasons of national security, religion or for the protection of local industry. If there are concerns relating to shell companies being established by foreign investors solely to obtain investment-based residence visas, governments can revise and increase the minimum capital requirements for 100 per cent foreign-owned companies and place additional obligations on foreign investment companies to show regular evidence of real business activity by submitting annual audited statements.

Relaxing foreign investment restrictions will lessen the problem of liability risks faced by local shareholders, who are often held liable in their capacity as shareholders, authorised signatories and/or directors of companies despite having no real investment stake in or control over the business activities – and the associated risks – of the companies with which they are involved.

The benefits of increased foreign investment and enhanced legal protection for foreign investors, coupled with genuine need-based partnership and collaboration with local parties, could outweigh the benefits of the existing foreign investment restriction rules.

This article first appeared in the February 2016 issue of the Newsletter of the Arab Regional Forum of the Legal Practice Division of the International Bar Association, and is reproduced by kind permission of the International Bar Association, London, UK. © International Bar Association.