Sharia guidance offers a way through the inheritance maze

In the Gulf, Sharia forms the basis of the legal system. Sharia also directly governs intestate succession as a matter of UAE public policy for Muslims.

Intestate describes the estate of a person who has died without making a will.

The legal framework does not easily recognise some of the arrangements families may elect for their family-owned businesses. Whether you choose onshore or offshore jurisdictions to regulate your succession planning, expert legal guidance in the Sharia space can prove to be the difference between your family receiving what you wish, or not.

Under Sharia rules, inheritance is a complex issue. Sharia inheritance rules automatically apply a formula for the distribution of inherited assets. This would apply equally to commercial assets, like shares in the family business, as it would to personal assets.

In the UAE this is reflected in Federal Law No 28/2005 (the Personal Affairs Law). The principles of Sharia, to conserve and distribute wealth fairly across the generations, may actually conflict with a family’s desired succession arrangements.

In line with Sharia inheritance law, a will or testament will only be applied and be valid to a third of the total estate and to specific persons, provided that all outstanding debts are settled. If a will is contrary to Sharia law, it cannot be legally enforced. As a result, arrangements trying to interfere with the passing of shares between generations, and in particular to retain the shares within the bloodline of the family, are likely to be open to challenge. This creates uncertainty when considering the most appropriate legal structures.

For example, in the unfortunate event of the death of a second-generation family member and shareholder in the family business, some of their shares would pass by Sharia to their spouse, who would not be a bloodline family member and who could in turn remarry and have children of their own, creating more complicated scenarios.

As a result, the shares could quite realistically and quickly pass outside of the family. In these circumstances, and to avoid these scenarios, share buyback provisions can be introduced into the articles of the company, which would mean the shares would have to be sold back to the bloodline family members at “fair value”.

However, while seemingly financially fair, this effectively cuts across the intent of Sharia inheritance and so these provisions are almost certainly unenforceable in the onshore courts.

Indeed, and no doubt to reflect the onshore legal position, the standard form of constitution for an onshore company is straightforward, and it is very difficult to introduce bespoke provisions even though they may suit the requirements and interests of a family business and its family member shareholders.

It is largely because of the lack of flexibility in the onshore laws and regulations that families increasingly consider managing their businesses or locating investment assets offshore. However, this can create administrative difficulties and is not appealing for obvious reasons to many GCC nationals.

As an alternative, an increasingly attractive middle ground solution is perhaps relying on the DIFC jurisdiction.

Here reasonably complex company constitutions can be established containing the type of provisions families would like to see in their own family companies.

These provisions can include enforceable buyback provisions where family shares fall outside the family through Sharia inheritance.

Another important point to note is that the DIFC also administers a sophisticated trust regime. Structures taking advantage of the DIFC jurisdiction can put a holding company in the DIFC and then have onshore operational companies, fully owned by the holding company, acting as separate units.

While this type of structure remains uncommon, it can go a long way towards meeting the requirements of many families dealing with generational change and may provide the best solution.

Damian Crosse and Osama Hassan are partners at Pinsent Masons.

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