Leading the charge (pun intended): international security transactions in the Middle East

The Law of Security: striving for perfection

The Dubai International Financial Centre (DIFC), one of the Middle East’s leading financial centers, recently passed a new law in respect of secured transactions, the DIFC Law of Security No. 4 of 2024, which came into force on March 8, 2024 (the Law of Security). The revised regime set out in the Law of Security is modelled, subject to important additions and modifications, on the UNCITRAL Model Law on Secured Transactions 2016 (the Model Law) such that, in interpreting this new law, users are told that “regard is to be had to its international origin and the need to promote uniformity in its application and the observance of good faith” (Art 12(1) of the Law of Security).

In this article, we explore: the policy objectives underpinning the Law of Security, some of the new concepts, most notably in relation to Digital Assets (which include assets that can be created using blockchain technology) and Electronic Trade Documents (i.e. paper trade documents such as bills of exchange or promissory notes which are in electronic form and which satisfy certain other requirements), and the inclusion of a regime governing Acquisition Security Rights.

Capitalized terms defined in the Law of Security, the Digital Assets Law (as defined below) and Law of Obligations (as defined below) have the same meaning in this article unless expressly defined in this article.

Registering the Law of Security's key objectives

A democratic pledge

One of the driving forces behind the Law of Security is intended to be democratization; establishing a law that legislates for diversified and novel sources of credit for all types of lenders. For example, the Law of Security does not discriminate between different methods of financings such as lender financing and vendor financing.^[1] By creating this simpler, more accessible regime for secured lending, DIFCA’s aim is to increase the number of secured transactions in the region.

The DIFC is an international financial hub and “due to the nature of such transactions, lawyers advising parties […] require straightforward, modern terminology to facilitate their understanding of the relevant law. The UML’s use of neutral, modern terminology and avoidance of unfamiliar legal terms drawn from other jurisdictions are of particular assistance in this respect”.^[2] Basing the Law of Security on the Model Law allows for a balance between a law that follows international best practice and a law that feels familiar to multi-jurisdictional practitioners and which is appropriate for cross-border transactions.

Another advantage of basing the Law of Security on the Model Law is that the Model Law is accompanied by existing guidance on practice^[3] and enactment.^[4] Moreover, as is clear from the Model Law’s enactment guidance, the Model Law largely derives from UNCITRAL’s earlier legislative guide,^[5] which has been described as “a splendid and massive opus of legal art and intelligence”.^[6] DIFCA’s Consultation Paper on the Law of Security, provides commentary regarding the Law of Security’s derivations from the Model Law.^[7] Having this information immediately available to users, in plain English, is crucial to assist debtors, grantors and secured creditors (experienced or unexperienced) to structure their transactions with a higher degree of certainty and, importantly, lower cost implications.

Charging forward: confirming the international trajectory of DIFC legislation

It should also be noted that DIFCA is proposing to amend an existing DIFC statute which sets out certain principles of statutory interpretation, the DIFC Law No. 3 of 2004 on the Application of Civil and Commercial Laws in the DIFC (DIFC Application Law).^[8]

While the final version of the amendments to the DIFC Application Law is not yet available, pending the outcome of the consultations with stakeholders, the proposed amendments will confirm that “if the relevant DIFC Statute is based on an international model law, its interpretation may also be guided by international jurisprudence interpreting and applying the international model law, as well as interpretative aids and commentary published by international bodies regarding the international model law”.^[9]

New kids on the blockchain: digital assets and electronic trade documents

DIFCA is keen to ensure that the DIFC’s statutory framework can keep pace with the rapid developments in international trade and finance.

It is therefore not a coincidence that, around the same time as enacting the Law of Security, DIFCA enacted a new law governing digital assets (DIFC Law No. 2 of 2024, the DAL) and related amendments to other DIFC laws including DIFC Law No. 5 of 2005, as amended, (the Law of Obligations), to introduce, among other things, a new concept of “Electronic Trade Document”. As DIFCA notes:

“Digital Assets represent a trillion- dollar asset class and the scope for future innovation and market opportunities within it are considerable.”^[10]

The DAL sets out (among other things) the definitions of Digital Assets and Control (noting that these definitions are cross-referred to in the Law of Security), as well as the general rules governing title and the transfer of title over Digital Assets. The amendments to the Law of Obligations set out the definition of an Electronic Trade Document and the rules governing this type of asset. As for the Law of Security, it sets out the regime governing the creation, third- party effectiveness, priority and enforceability of security rights over both types of assets.

Digital Assets

A Security Right in a Digital Asset can be made effective against third parties by registration or by the Secured Creditor having Control of that Digital Asset (see Arts 26 and 34 of the Law of Security). Additionally, certain types of Digital Assets may fall within the definition of Financial Collateral (e.g. a Digital Asset may include “Money which is credited to a Bank Account”, or, where a Digital Asset is functionally equivalent to, for example, a debt instrument, and is held in an account with an Account Provider, it may also constitute “Financial Property”). Where this is the case, a Security Right in such Digital Assets would be made effective against third parties by Control, and not by registration (see Pt 8 of the Law of Security, which is also discussed below).

A Security Right in a Digital Asset which is made effective by Control has priority over a competing Security Right which is made effective by any other method such as registration (see Art 59(1) of the Law of Security). This reflects an objective of mirroring the “fast-moving and international nature of markets in many types of Digital Assets”.^[11] Rightly, DIFCA states in its consultation paper on the Law of Security that it would be “unrealistic in most cases to expect a person who is considering taking a Security Right in a Digital Asset to search the Security Registry”, noting that this approach aligns with Principle 16 of the UNIDROIT Principles on Digital Assets and Private Law.^[12]

Electronic Trade Documents

The new legal regime for Electronic Trade Documents in the DIFC is largely modelled on the UK’s Electronic Trade Documents Act 2023 (ETD Act).^[13]In both jurisdictions, prior to the entry into force of the ETD Act and the amendments to the Law of Obligations and issuance of the Law of Security (in relation to England and Wales and the DIFC, respectively), “the legal rules governing paper trade documents, including, bills of lading, bills of exchange and warehouse receipts, [were] premised on the idea that they can be physically held or ’possessed’. The […] law [did] not recognize the possibility of possessing electronic documents”.^[14] Looking at the value of the foreign trade of goods and services to the UAE (non-oil) which surpassed AED3.5trn in 2023,^[15] it was important to enact functional legislation to try and capture some of that value.

Article 153A of the Law of Obligations defines a “paper trade document” as: (a) a document in paper form; (b) that is commonly used in connection with: (i) trade in or transport of goods; or (ii) financing such trade or transport; and (c) where possession of that document is required as a matter of law or commercial custom, usage or practice for a person to claim performance of an obligation. Article 153B of the Law of Obligations provides that an Electronic Trade Document consists of information in electronic form which, if it were contained in a document in paper form, would have led to that document being a paper trade document (together with any other information with which it is logically associated that is also in electronic form), provided that the other requirements in Art 153B are also satisfied.

The amendments to the Law of Obligations provide that a person can “possess” an Electronic Trade Document and that an Electronic Trade Document has the same effect as an equivalent paper trade document (see Art 153D of the Law of Obligations); “possession”, in relation to an Electronic Trade Document, being “control” of that Electronic Trade Document within the meaning of Art 153C of the Law of Obligations.^[16]

Enforcing its position as a leading financial center

The Law of Security also has a broader scope than the Model Law, in that Pt 8 of the Law of Security governs security rights in intermediated securities and financial contracts governed by netting agreements.^[17] Part 8 replaces the previous financial collateral regulations which had been issued pursuant to the Law of Security’s predecessor law in 2019 (FCR). The DIFC remains one of the only jurisdictions in the Middle East which has comprehensive legislation governing financial collateral. DIFCA notes that “the ultimate inspiration for the FCR was the EU Financial Collateral Directive, which became part of UK law as the Financial Collateral Arrangements (No. 2) Regulations 2003”.^[18]

Part 8 replaces the FCR and introduces certain changes to the previous FCR regime. For example, Pt 8 now includes an FCR Receivable as a category of Financial Collateral (along with “Money credited to a Bank Account” and “Financial Property held in an account with an Account Provider”). The third category of FCR Receivable mainly covers: (a) a money claim by an Account Provider against its customer; or (b) a money claim that is due or payable and arises in connection with a Close-Out Netting Arrangement (i.e. what is otherwise not covered under the category of “Money credited to a Bank Account”).^[19] Further, Pt 8 provides for priority as between competing Security Rights made effective against third parties by different types of “Control” (for the different types of “Control”, see its definition in Sch 2 of the Law of Security).

Acquisition financing

The Law of Security includes provisions governing Acquisition Security Rights (ASRs) in the context of acquisition financing transactions, i.e. transactions that permit buyers to acquire assets on credit. Broadly speaking, an ASR refers to the security right taken by the seller to secure the unpaid purchase price or by a lender that advances the purchase price.

It is worth highlighting that DIFCA made some important amendments to the Model Law in this respect (e.g. in relation to leases, commercial consignments, cross-collateralization), which are described in paras 54-84 of DIFCA’s consultation paper on the Law of Security. These amendments to the Model Law were based on international best practice, some of which emerged after the publication of the Model Law. In making these amendments, DIFCA considered approaches adopted by the legislatures in Canada, Australia and New Zealand.

Summary

With the enactment of the Law of Security and the DAL and associated amendments to DIFC Laws, DIFCA’s desire to create a legal regime that is consistent with international best practice and is fit for purpose now and in the future has been made clear. The methodology of basing the Law of Security on solid legal foundations whilst supplementing it with top tier legislation and thinking from different jurisdictions and international bodies has generally been welcomed by the market.

Footnotes 

[1] Consultation Paper No. 5 dated September 2023 on “the Law of Security and Financial Collateral Regulations” issued by the Dubai International Financial Centre Authority, para 20 (Key features of the Proposed Law), last bullet, p 8.

[2] Consultation Paper No. 5 dated September 2023 on “the Law of Security and Financial Collateral Regulations” issued by the Dubai International Financial Centre Authority, para 21 (Key features of the Proposed Law), first bullet, p 9.

[3] https://uncitral.un.org/sites/uncitral.un.org/files/media-documents/uncitral/en/19-10910_e.pdf UNCITRAL Practice Guide to the Model Law on Secured Transactions

[4] https://uncitral.un.org/sites/uncitral.un.org/files/media-documents/uncitral/en/mlst_guide_to_ enactment_e.pdf UNCITRAL Model Law on Secured Transactions: Guide to Enactment.

[5] https://uncitral.un.org/sites/uncitral.un.org/files/media-documents/uncitral/en/09-82670_ebook- guide_09-04-10english.pdf UNCITRAL Legislative Guide on Secured Transactions.

[6] Wood P (2019), Comparative Law of Security Interests of Title Finance (3rd ed). Sweet & Maxwell, section 54-002.

[7] Consultation Paper No. 5 dated September 2023 on “the Law of Security and Financial Collateral Regulations” issued by the Dubai International Financial Centre Authority, paras 28 and 29 (Derivation Table) and Appendix 2. Note that, following consultation, some of the numbering of articles in the enacted Law of Security has changed (as has some of the final wording of some articles).

[8] Consultation Paper No. 1 dated May 2024 on “Proposed amendments to the Law on the Application of Civil and Commercial Laws in the DIFC” issued by the Dubai International Financial Centre Authority.

[9] Consultation Paper No. 1 dated May 2024 on “Proposed amendments to the Law on the Application of Civil and Commercial Laws in the DIFC” issued by the Dubai International Financial Centre Authority, paragraph 36 (Explanation of Proposed Legislation – the Interpretation Issue).

[10] Consultation Paper No. 4 dated September 2023 on “DAL” issued by the Dubai International Financial Centre Authority, para 16 (Background).

[11] Consultation Paper No. 5 dated September 2023 on “the Law of Security and Financial Collateral Regulations” issued by the Dubai International Financial Centre Authority, para 155 (Q30. Do you agree that it should also be possible to make a Security Right in a Digital Asset effective against third parties by Control of the Digital Asset?).

[12] Consultation Paper No. 5 dated September 2023 on “the Law of Security and Financial Collateral Regulations” issued by the Dubai International Financial Centre Authority, paras 155 and 156 (Q30. Do you agree that it should also be possible to make a Security Right in a Digital Asset effective against third parties by Control of the Digital Asset?).

[13] Consultation Paper No. 4 dated September 2023 on “DAL” issued by the Dubai International Financial Centre Authority, paras 16 to 21 (Background).

[14] Electronic Trade Documents – summary, The Law Commission, https://cloud-platform-e218f50a4812967ba1215eaecede923f.s3.amazonaws.com/uploads/sites/30/2022/03/Electronic-Trade-Documents-summary-of-final-report-.pdf and Consultation Paper No. 5 dated September 2023 on “the Law of Security and Financial Collateral Regulations” issued by the Dubai International Financial Centre Authority, paras 88-90 (Negotiable Instruments/ Documents and Electronic Trade Documents).

[15] Mohammed bin Rashid: UAE non-oil foreign trade surpassed AED3.5 trillion in 2023, 18th February 2024, Government of Dubai Medial Office https://mediaoffice.ae/en/news/2024/February/18-02/Mohammed-bin-Rashid-said-UAE-non-oil-foreign-trade-of-goods-and-services-surpassed-AED3-trillion 

[16] See also Consultation Paper No. 5 dated September 2023 on “the Law of Security and Financial Collateral Regulations” issued by the Dubai International Financial Centre Authority, para 94 (Negotiable Instruments/ Documents and Electronic Trade Documents).

[17] Consultation Paper No. 5 dated September 2023 on “the Law of Security and Financial Collateral Regulations” issued by the Dubai International Financial Centre Authority, para 18 (Background).

[18] Consultation Paper No. 5 dated September 2023 on “the Law of Security and Financial Collateral Regulations” issued by the Dubai International Financial Centre Authority, para 125 (Q21. Do you agree with our proposed asset classes for an “FCR Receivable”? If not, what types of asset classes should be removed or added?).

[19] Consultation Paper No. 5 dated September 2023 on “the Law of Security and Financial Collateral Regulations” issued by the Dubai International Financial Centre Authority, para 122 (Financial Collateral Arrangements).