Safeguarding Your Digital Wealth: A Deep Dive into UAE's Virtual Asset Protection Regime Amidst Insolvency
Banking & Finance / UAE
Sarah El-SerafySenior Associate,Banking & Finance
Mehrul AroraAssociate,Banking & Finance
Husain DawaniTrainee Solicitor,Banking & Finance
In the digital finance landscape, Virtual Asset Service Providers (“VASP”) operate by typically facilitating the custody and management of virtual assets for their customers. Notably, the unique nature of virtual assets existing on decentralized blockchains and often transcending geographical boundaries, presents novel complexities in ensuring effective asset recovery and protection in potential insolvency scenarios.
While the prominence of virtual assets continues to grow in the UAE and despite the introduction of a new bankruptcy and restructuring regime, there remains a lack of clear understanding regarding the treatment of client assets held by VASPs in the event of potential insolvency. This article highlights the uncertainties in VASP insolvency, examining the status of VASPs and their services, with a primary focus on protecting client assets managed by VASPs.
Despite the introduction of a new bankruptcy and restructuring regime, there remains a lack of clear understanding regarding the treatment of client assets held by VASPs in the event of potential insolvency.
According to the Virtual Assets Regulatory Authority’s (“VARA”) Virtual Assets and Related Activities Regulations 2023 (“Vara Regulation”) which is given effect by Dubai Law No. 4 of 2022, a VASP is any person authorised by VARA to conduct any of the activities that require a permit from VARA and are subject to VARA’s oversight.
In relation to client virtual assets held by a VASP that is in financial distress and facing insolvency, the UAE's Federal Bankruptcy Law 9 of 2016 (“Bankruptcy Law”) allows interested parties (e.g. the customer) to request exclusion of specific assets from the debtor's bankruptcy inventory. Article 178 of the law permits asset recovery upon an interested party proving to the court-appointed trustee that the ownership of the asset is not of the debtor. The bankruptcy trustee then decides on the request's approval or rejection. This process, termed as 'redemption' or 'reclaim' (which is different from debt recovery), aims to retrieve assets that are not part of the debtor's estate. It is important to note that a new bankruptcy law, Federal Law No. (51) of 2023 that is effective from 1 May 2024, will replace the Bankruptcy Law but retains similar redemption and reclaim provisions.
In the context of the ‘redemption’ or ‘reclaim’ process, to recover assets from a debtor's bankruptcy estate, proving ownership to the bankruptcy trustee is essential. A trustee that is mandated by the court in the bankruptcy scenario will prepare a list of the debtor's assets, including those accessible within the UAE. We understand that title documents that a trustee reviews to establish title to assets may involve examining contractual arrangements evidencing ownership or rights to assets. Digital assets pose a challenge for UAE bankruptcy trustees as this realm of assets may require expert opinions on ownership and to establish the jurisdiction of the client’s virtual assets. Interested parties can request the court to appoint experts to assess ownership factors outlined in guidelines, aiding in asset attachment within the UAE.
Furthermore, although the Bankruptcy Law does not explicitly mention digital assets, the new Commercial Transactions Law - Federal Decree-Law No. 50 of 2022 ("Commercial Code") covers all commercial activities, including those carried out in the technological landscape or utilise modern technological means. This includes virtual assets. Therefore. the Commercial Code treats virtual asset business similarly to tangible or intangible assets effectively extending the application of bankruptcy laws to digital assets and VASPs. Consequently, based on the treatment of virtual assets by the Commercial Code, a trustee in bankruptcy should identify those assets in a manner consistent with how other intangible or tangible assets of the debtor are identified.
Evolving treatment of Virtual AssetsConsidering the unique nature of virtual assets and how they are held on decentralized blockchains by VASPs, the insolvency of VASPs and the recovery of client assets requires a robust technical expertise in this area. Furthermore, the application of the Bankruptcy Law to virtual assets is a new and evolving area and remains largely untested in the UAE courts. For example, while a court-appointed bankruptcy trustee should be able to identify and access UAE-based virtual assets, practical challenges arise in determining how and where such assets are held. These complexities may necessitate the appointment of experts to navigate technical issues in the recovery of the virtual assets. For instance, this may include identifying how to access virtual wallets holding client assets.
Jurisdictional challengesAlthough a court-appointed bankruptcy trustee may trace and recover virtual assets within the UAE as part of the ‘recovery’ and ‘redemption’ process, practical constraints may arise where virtual assets are held outside the UAE.
We understand that although bankruptcy trustees are permitted by law to trace and recover relevant assets in the UAE and other jurisdictions in the context of an insolvency, the recovery of UAE client assets held outside the UAE becomes a multifaceted issue which requires consideration of international legal frameworks and cooperation with foreign jurisdictions. However, in practice, we note that a UAE trustee may not have control over tracing and identifying assets located outside the UAE and that they often avoid tracing assets outside of the UAE.
Given the more technical and complex nature of tracing and recovering virtual assets, a court appointed trustee may not be able to include the wallets or assets held in a VASP’s name in its bankruptcy inventory unless such assets are located and accessible (held directly) in the UAE and the trustee can have access to those assets. Therefore, a grey area lies in whether assets held by VASPs abroad are truly protected under the existing relevant UAE laws and regulations in practice.
In summary, the landscape of virtual assets and virtual asset services poses complex challenges for protecting customers’ virtual assets by VASPs, particularly in potential insolvency scenarios. While existing laws provide a foundation for protection such as asset ‘redemption’ and ‘recovery’, the practical application of these laws and regulations to virtual assets remain untested in UAE courts and are more difficult to effect in practice in relation to assets held outside the UAE’s jurisdiction.
The untested nature of the virtual asset landscape in the context of insolvency underpins the importance and need for comprehensive frameworks to protect client assets. This is crucial, as there remains a discord between laws and regulations concerning the insolvency of VASPs and the practical implementation of recourse mechanisms favouring customers in relation to their assets.
For further information,please contact Sarah El-Serafy, Mehrul Arora and Husain Dawani.
Published in April 2024
