Friday, June 16, 2017

Dana Gas Sukuk: The Providential Detection

Violation of Shariah Caught Just in Time
You’ve probably been reading articles-such as this, or this or this-- on Dana Gas’s 13 June announcement that its existing U.S.$425,040,000 Exchangeable Certificates and U.S.$425,040,000 Ordinary Certificates due October 2017 (together the “Sukuk”) are no longer Shari’ah compliant and therefore “illegal” under U.A.E. law, requiring their restructuring. 

As a consequence, the company announced it will not make the July “profit” payment or the October principal repayment.  This discovery appears to have been made during Ramadan.  Perhaps (but not likely) as a result of the company’s prayerful reflections during the holy month grounded in its fastidious adherence to both Shari’ah and UAE law.  

That this providential “detection” was made one month before payments are required under the allegedly “illegal” agreement is no doubt one of those “remarkable coincidences” that occur from time to time in the finance.

Apparently further compelled by its probity and piety, the company sought and obtained an injunction from the Sharjah courts that prohibits payment.  The courts will hear arguments on the case 25 December, that is roughly two months after the October principal due date.

Just coincidentally this will allow the company to conduct restructuring discussions with the certificate holders which Dana Gas asked for on 3 May 2017 before it seems it became aware of the “violation” of Shari’ah.  Then its only stated concern focused on more mundane cashflow related problems. 

Note that it gave its “solemn” word to proceed not only in a “practical” and “sensible” manner but to “balance the interests of all stakeholders”.  This probably does not apply.


“Dana Gas PJSC (the "Company"), the Middle East's largest regional independent natural gas company today announces that, due to continued challenges it faces around cash collections and resulting need to focus on short to medium term cash preservation, it will commence restructuring discussions with holders of its Sukuk dated 8th May 2013.  The Company will be addressing the way forward on the Sukuk, which has a maturity date of 31st October 2017 in a practical manner that balances the interests of all stakeholders. The remaining profit payments will be addressed sensibly as part of the solution.”
As near as AA can tell, the detection occurred sometime after that date and 13 June.  It wasn’t mentioned in the June 5 2017 press release announcing the appointment of Houlihan Lokey as financial advisors and Squire Patton Boggs as legal advisors.

AA sincerely hopes that neither of these firms advocated this transparent bit of Abu Yusuf-efry.  “Abu Yusuf” Yacub Ibn Ibrahim Ibn Habib Ibn Saad Al-Ansari for those who don’t immediately recognize the reference.
In a 13 June 2017 press release Dana broke the news about Shari’ah non-compliance.  AA comments in red boldface.  We’ll step through the press release one paragraph at a time.

“The Company has scheduled a call with the Committee for later today during which the Company will cover the following points and set out an initial proposal for restructuring the existing Sukuk based on these broad principles and terms: Due to the evolution and continual development of Islamic financial instruments and their interpretation, the Company has recently received legal advice that the Sukuk in its present form is not Shari'a compliant and is therefore unlawful under UAE law. As a result, a restructuring of the current Sukuk is necessary to ensure that it conforms to the relevant laws for the benefit of all stakeholders.
  • As a legal matter and AA claims no expertise in UAE law, it would seem that if Dana’s assertion is true (which AA doubts) the sukuk then would become a non-Shariah bond and that the legal concept of equity would require that Dana honor the debt as per the existing contractual terms.  There is no doubt that Dana borrowed the money (or more precisely restructured an earlier borrowing), agreed to the terms, and agreed not to challenge the legality of any of the transaction documents (more on that below).  Assuming Dana’s legal arguments are valid, one might expect Shari’ah scholars to “grandfather” this transaction which has a scant five months to run but forbid future such transactions.  But الله أعلم    
  • Dana’s assertion raises or should raise concerns among certificateholders that Dana will cite future such “continual development” and declare the replacement sukuk no longer “halal” to justify its non-payment in 2021.  See more on that below. 
  • Unlike The Investment Dar in its attempt to deny BLOM repayment, Dana has not alleged that the transaction was contrary to Shariah from inception, but has become so with the “evolution” of “interpretation” of Islamic financial instruments.  A neat way of not casting aspersions on the work of Dar al Shariah or Shaikh Hussain Hamed  Hassan  head of DAS Shariah Advisory Board.  AA hopes though that it will meet with the same stern rejection that TID did.   
"The Company therefore proposes to exchange the Sukuk with a new enforceable, Shari'a compliant instrument, which would have a tenor of four years, confer rights to profit distributions at less than half of the current profit rates and without a conversion feature.  Such new profit payments will comprise a cash and PIK element.
  • Dana does not appear to have provided details on why the existing sukuk is “illegal”. 
  • According to Reuters,  “a source with direct knowledge of the situation said the firm planned to argue the sukuk were not sharia-compliant because their repurchase price was fixed, the coupon was the result of interest-based not profit-based calculations, and the coupon paid out regardless of Dana's financial performance.”
  • The terms outlined above by Dana seem to mirror those of the existing transaction, albeit less generous than the existing sukuk as well as eliminating the conversion feature  
  • Given this is a second restructuring, credit risk has increased justifying a higher not a lower margin or profit share, absent of course of application of 2.280. 
  • But put that aside. 
  • If eating a ham sandwich is not halal, what makes eating one-half of the sandwich halal?  Or in other words, if the problem is a fixed rate, then how does a lower fixed rate solve the problem? 
  • If profit-sharing payments must be based on profit, don’t PIK (payment in kind) payments imply the company has not really realized profit?  And if so, will “evolving” legal advice in 2021 result not only in refusal to repay principal but also “invalidate” all the PIK payments.
"The new instrument would represent a fundamental improvement to the current situation for Holders as it would be enforceable and would provide repayment to Holders over time."
  • Since the courts have not ruled on this matter, this statement is an opinion by a party (Dana) which the less charitable of you out there might believe is not completely disinterested in this matter. 
  • Sharjah and the UAE still recognize conventional non-Islamic finance.   Thus, the local courts may rule that while the transaction is no longer “Islamic”, it is a debt Dana owes according to the contract signed by the parties.  
"As the Company's receivables and future damages payments may be unpredictable, Dana Gas proposes to make prepayments under the new Sukuk either in whole, or in part at par, prior to its maturity without any penalty thus providing a path for early pay-down for the Holders.
  • AA would advise the certificateholders to demand a cash sweep to make such payments mandatory and not rely on the company's good faith  of which there is scant evidence so far.  

"The next two Distributions scheduled for 31 July 2017 and 31 October 2017 cannot be paid now that the existing Sukuk is deemed unlawful but will be accounted for as part of the new Sukuk instrument."
  • As the courts have not ruled and given the very real possibility of conflicting opinions on Shariah as there is no single central authority, this is a mere assertion not a legal determination. 
  • Certificateholders should treat it with the derision it so richly deserves. 
"During the 2012 restructuring, representatives of the Holders unnecessarily declared a Technical Default while negotiations were still ongoing, causing lasting harm.  The Company now assures all parties that no Dissolution Event nor Technical Default has taken place, nor indeed can take place due to the unlawful nature of the Sukuk.  While the Company is keen to reach a consensual agreement with the Holders, Dana Gas has a duty to protect the assets of the Company for the benefit of all stakeholders and will take action to fulfill this duty.”
  • Another assertion. 
  • There is a very strong case for a default that’s default with a capital “D” not a “technical” default under transaction documents which are governed by English not local law which offer creditors a presumably easier path than the courts of Sharjah to call default.  And as outlined below default need not be called for a prospective (now) or actual (July) failure to pay.
  • The Offering Memorandum  page 108 outlines  events of default.  Here are a quick three.   (a) “Non-payment”: either the Obligor or the Mudarib fails to pay any amount payable pursuant to any Transaction Document to which it is a party and/or either the Obligor or the Mudarib fails to pay any amount payable or deliver any shares pursuant to any Transaction Document to which it is a party within three days of the due date for payment or delivery thereof; or  (c) “Repudiation”: either the Obligor or the Mudarib repudiates or challenges the valid, legal, binding and enforceable nature of any or any part of a Transaction Document to which it is a party or does or causes to be done any act or thing evidencing an intention to repudiate or challenge the valid, legal, binding and enforceable nature of any Transaction Document to which it is a party; or (d) “Illegality”: at any time it is or will become unlawful for either the Obligor or the Mudarib to perform or comply with any or all of its obligations under the Transaction Documents to which it is a party, or any of the obligations of either the Obligor or the Mudarib under the Transaction Documents are not, or cease to be legal, valid, binding and enforceable;
  • Dana has advised that it will not pay and has obtained a court injunction to engineer a legal obstacle to its payment.  The default under (a) will occur at the latest next month.    
  • In refusing to pay and seeking the court injunction, it has repudiated the transaction documents (c) as of at least 13 June.  
  • If on the other hand, its assertion that the transaction is illegal, then (d) is operative. By obtaining the injunction and applying for one in the BVI, the company is directly complicit in making its compliance with its obligations illegal.  It isn’t the Sharjah or UAE courts or a Shariah board which has initiated a legal action.  It is the company itself.
  • Bond indentures generally have a lower threshold than syndicated loans for an instructing group – 25% is a typical number and that is reflected in the offering circular at least in respect of some transaction documents.  Thus, a relatively small number of certificateholders can call default.
In following post(s) I’ll take a look at the "winners" and "losers" of Dana’s “maneuver”.  The former will require much less comment than the latter, if any.

3 comments:

Arkad said...

Great coverage - one can only wonder what kind of relationship Dana Gas hopes to build with debt markets. Perhaps they should stick to equity, a lot harder to suddenly decide your shareholders don't really own you.

Abu 'Arqala said...

Arkad, thanks.

Seems like a truly bone-headed move.

Dana has a compelling argument that it can't pay and thus needs to restructure the existing debt. It does 99% of so of its business with two customers whose credit is weak. Speculation is that this is an attempt to forestall a declaration of default, though DG seems to have scored an "own goal", not only be declaring the sukuk to be undeforceable but also by opening negotiations with clearly non-market terms, i.e., cut in pricing.

It would be interesting to know if this is the brainchild of DG's foreign management "clever boots", its recently hired advisors, or locals. Could the new crown prince of Saudi be giving advice?

If things quiet down at work, I hope to fulfill my promise to write about the losers and losers from this fiasco.

Best, AA

Abu 'Arqala said...

Arkad

To continue this discussion see my latest post Dana Gas: Why Did They Do It?