Charging interest on a loan between individuals in a non-commercial relationship is a criminal offence in the UAE. Apart from this, when the lender is a legal entity, lending on interest is illegal if the lender does not have an appropriate licence or does not comply with other regulatory requirements. An illegal loan agreement is unenforceable in respect of interest.

The DIFC Court of First Instance considered these principles of UAE law in two recent judgments: NS Investment Limited v Ajay Sethi [2020] DIFC CFI 055 of 27 September 2023 and Alexander Reuter and Ors v Wellness United INC and Ors [2021] DIFC CFI 107 and 108 of 27 October 2023. (The latter are in fact two cases, however the relevant facts and the relevant parts of the judgments in both cases are the same.) In both cases, the lender was a company, and the borrower was an individual.

In NS Investment, the Court ruled that the loan agreement was illegal on the basis that the lender did not have the legal capacity or competence to enter into the contract. This was for three reasons. First, the lender did not have the necessary approval to conduct commercial activity outside of the commercial zone where it was registered. Second, the lender’s memorandum of association prohibited it from dealing with residents of the UAE and carrying out banking business. Third, the lender was not licensed to provide banking or financial services in the UAE.

The Court also noted that the absence of a license for banking or financial services contravened articles 458 and 459 of the UAE Penal Code 2021 which criminalise lending money on interest to individuals. The Court held that it does not matter whether the lender is an individual or a company for purpose of article 458.

However, it appears that this conclusion was in error. Firstly, the Arabic text of article 458 refers both to the lender and the borrower as a “physical person”.  In line with this, the prevailing view among practitioners is that this article is applicable only when both the lender and the borrower are individuals. Further, article 459 refers to the lender as the “physical person” and it does not refer to the borrower. Accordingly, articles 458 and 459 of the UAE Penal Code are inapplicable when the lender is a legal entity.

Secondly, in Alexander Reuter and Ors v Wellness United INC and Ors [2021] DIFC CFI 107 and 108, the Court accepted that articles 409 and 412 of the UAE Penal Code 1987 (which are analogous to articles 458 and 459 of the UAE Penal Code 2021) apply only when the transaction is between individuals. In that case, the Court also confirmed that, while articles 710 and 714 of the UAE Civil Code prohibit interest-bearing loans in the context of a civil relationship, such loans are permitted in the context of a commercial relationship: article 72 of the Federal Commercial Transactions Law and Commercial Appeal in Cassation No 89 of 2021. The Court noted, however, that what amounts to a commercial relationship is a question of fact, on which clear guidance is difficult to find. Indeed, a transaction between two individuals may be commercial, just as between two companies or between an individual and a company.

It seems clear that the relationship between the lender and the borrower in NS Investment was of a commercial nature. On that basis, it appears that the loan agreement was indeed permitted, and therefore the lender’s conduct did not contravene the Penal Code.

It should be noted that the lender’s capacity (including licenses) is a separate issue which should not be conflated with the criminal conduct. The absence of capacity will have the effect of rendering the contract void but does not in itself constitute a criminal offence.

Foreign loan agreements

One may wonder what approach the UAE courts would adopt in a case involving a loan agreement between foreign individuals, governed by foreign law, and which is not intended to be performed in the UAE.

These were the facts in Alexander Reuter. The Court stated that even if it had found that the agreements were illegal under UAE law, that would not have amounted to a defence because they were valid under the governing law which applied to those agreements.  The same approach can be expected to be adopted by the ADGM Courts.

As far as onshore UAE courts are concerned, we are not aware of any decided case concerning a loan agreement between foreign parties governed by foreign law and not intended to be performed in the UAE. However, we expect that the onshore courts would likely determine that such a loan agreement is invalid in respect of interest if it is between individuals in a non-commercial relationship.

To conclude, below are some practical points to take into account by the lender charging interest on a loan in the UAE or in a UAE-related transaction.

Firstly, do not charge interest on a loan between individuals in non-commercial transactions.

Secondly, when the borrower is an individual:

1. It is advisable to lend funds from a legal entity rather than an individual. This does not mean, however, that a legal entity can be used merely as a sham to disguise a non-commercial relationship, as the court may look at the real substance of the transaction.
2. Although it will not be determinative, it is advisable to include an acknowledgment in the loan agreement that the relationship between the parties is of commercial nature and the loan is provided for a commercial purpose.
3. Additional protection may potentially be provided by selecting a governing law that does not prohibit lending on interest and by opting for the jurisdiction of either the DIFC or ADGM Courts, foreign courts, or an arbitral tribunal. Again, however, this cannot be guaranteed to have effect if either or both the lender and borrow are located in the UAE such that the loan agreement may be considered to be performed in the UAE.

Finally, for lenders that are corporate entities, they must be appropriately licensed and comply with all applicable regulations, as well as ensuring that their constitutional documents and trade licences permit or at least do not specifically prohibit this activity.

Author: Arthur Dedels