09 Nov 2015

Gratuity – a measured asset or a black hole?

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With almost 90% of the workforce in the UAE being expatriates, it is important for employers to be aware of end of service gratuity benefits that apply to all non-UAE nationals. With Federal Law No. 8 of 1980 ("UAE Labour Law") being implemented some 35 years ago, it is impossible for employers to escape the inevitable end of service payments upon termination of an employment relationship, except in circumstances where the employee has been terminated for cause.

In 2014, it was estimated that 84% of businesses in the Middle East did not fund end of service benefits but settled employees' benefits as they became due from company assets. It was estimated that employers in the GCC collectively faced a total end of service benefits liability of around $15-16 billion1.

Shiraz Sethi of Stephenson Harwood, Lynda O'Mahoney of Capita Asset Services and Simon Fielder of Ryland Gray, discuss some of the factors affecting end of service liabilities and what can be done to mitigate risk to companies in the region.

1 The Law

According to Article 132 of UAE Labour Law, end of service gratuity ("ESG") is a lump sum amount that an employer must pay to an employee who has completed one or more years of continuous service, upon their termination. It is important for employers in the Dubai International Financial Centre ("DIFC") to remember that they are not excluded from ESG payments. According to clause 62 of DIFC Law No. 3 of 2012, employees who have completed one or more years of continuous service are also entitled to ESG on termination of their employment. Businesses operating across the GCC should also bear in mind that the ESG concept is not unique to the UAE, with Bahrain, Qatar, Oman, Kuwait and Saudi Arabia operating similar provisions.

2 The practicalities

One issue businesses in the UAE often face in relation to accruing ESG, is that whilst companies are expanding and cash flow is positive, balance sheets look healthy, customers are increasing and staff are being recruited, the issue of having to pay out ESG seems a distant problem and something that can be addressed in the future.

However by contrast, where businesses are faced with recession, reduced customer numbers, negative cash flow, delicate balance sheets and as a consequence, companies have to lay off staff, this brings an additional complexity and cost [to already difficult financial times].

For a company that is suffering declining revenue and cash flow, the payment of ESG to redundant staff can often come at exactly the wrong time, particularly if no financial provision has been made in advance.

By way of example, we set out below a case study demonstrating the potential pitfalls facing companies who do not recognise the consequences of making advance provisions for ESG liability.

3 Case study

Company A: expertise in building construction and maintenance
During the early 2000’s, Company A commenced a steady expansion plan focussing on the UAE’s fast-developing construction industry.

Company A's workforce expanded from 500 to almost 1,200 until just after the peak of the boom in 2009. All surplus income generated was exported to bolster the balance sheet of the parent company outside the region.

In 2009, their largest customer encountered major financial problems; they cancelled contracts with their service providers, including Company A.

Company A had no choice but to reduce its staff numbers by terminating over 850 employees, resulting in Company A having to fund ESG payments to every eligible, terminated employee. Like many international cash generating companies in the GCC, much of Company A’s cash had been repatriated to the parent company who themselves were experiencing cash-flow problems. The only solution available to Company A was to borrow the funds.

The net result being, what was previously profitable company, is now a company with large debts accompanied by a harsh repayment schedule, but with greatly reduced revenue to fund that debt repayment.

The table below demonstrates by way of example, the steady rise in staff numbers and the increase in ESG liabilities. Unfortunately, this latter amount was not segregated, so when the redundancies took place in 2009, the company was liable to find $10 million to fund the departure of almost 1,000 staff.

Staff-Numbers

                                                                                                                       

4 The Alternative

One option available to employers is to provide an alternative plan for their non-national employees. A proactive alternative to the current passive arrangement is to fund ESG on an on-going basis, whilst concurrently segregating that fund from the balance sheet; in a similar way that a western style pension scheme is separated from the employers' assets.

Whilst not presently provided for under UAE Labour Law as an instrument, there is nothing barring such a vehicle from being used to fund ESG liabilities. According to Article 141 of UAE Labour Law, "Where an establishment has a retirement or insurance scheme, or any similar scheme, an Employee who is entitled to a retirement pension may opt between it and the prescribed severance pay or whatever he is entitled to receive from the pension or insurance fund, whichever of the two is more to his advantage." In addition, Article 62(5) of DIFC Employment Law states that, "Where an employer has established a pension scheme for his employees, he shall provide in writing to the employee, the option to choose between participating in the pension scheme or receiving the end of service gratuity payment." With the mobility and home country residency implications of employees in the GCC, a traditional pension would be difficult to implement and maintain, but establishing an Employee Benefit Trust to hold the accruing ESG, whilst also allowing employees to contribute direct from salary, is an increasingly attractive and viable alternative. The option to pay into a specialised trust on a monthly basis for each employee, will ensure that the employer is not caught short when it comes to its ESG liabilities.

As well as businesses devising growth plans for their companies, another alternative available to employers is to ensure that such growth plans include setting aside around an eighth of an employee's salary (or a thirteenth monthly salary), into a managed investment fund. The balance sheet of the company would therefore account for ESG liability and ensure that the company has mitigated any risk in the event of an economic downturn and does not face legal consequences as a result of failure to pay ESG.

5 Summary

Whilst economic growth forecasts indicate further growth in Dubai, it is important for businesses to learn lessons from the 2008 economic crisis. Organisations must fully comprehend their ESG obligations and ensure their ability to fund ESG payments should the need arise. With expatriates staying longer and the labour market increasing simultaneously, the region's ESG liabilities will only increase further. Unless there is a significant change in the law, it is imperative that businesses are aware of their ESG liabilities and plan accordingly.

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1 Emirates 24/7, 'What happens when GCC firms don’t pay gratuity', 2 February 2015.


OMahoney_Lynda Fielder_Simon
Lynda O'Mahoney
Head of Business Development
Capita Asset Services
T: +971 4 401 9155
M: +971 50 859 5564
Email Lynda


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Simon Fielder
Managing Director
Ryland Gray
T: +971 4 324 3033
M: 971 55 455 5831
Email Simon:


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