Analysis of DG Restructured Sukuk Terms -- Lessons for Other Investors

"دخول الحمام ليس مثل خروجه"

In this post we’ll take a detailed look at DG’s restructured sukuk (the “Nile Delta Sukuk”).

Our primary text is the listing particulars for Nile Delta published on the Irish Stock Exchange last August.   For those who want comparatives, here’s equivalent information for “Dana Gas Sukuk” the previous incarnation.

The DG restructuring saga provided investors some important lessons.  Not only the hapless group that invested in Dubious Gas, but also those considering other “Islamic” investments or doing business in the UAE.

Analytical comments (appearing below in italicized bold face) will be both descriptive and prescriptive.

Descriptive for those who’ve already entered the hammam (investors in the sukuk).  Other than a secondary sale they are “in” for what appears to be a prolonged bath.  As an aside, AA sincerely hopes he is wrong.

Prescriptive for those lucky investors who haven’t yet entered but may be considering so-called “Islamic” investments or dealing with obligors in Sharjah.  AA undertakes this task knowing full well that while repetition is said to be effective in teaching donkeys, history shows that teaching investors is a more difficult task.

Shari’ah Compliance

The self-averred devoutly scrupulous members of DG’s Board and management were mightily troubled that the previous sukuk was no longer Shari’ah compliant due to a change in scholarly interpretation on al-mudarabah transactions.  So much that they felt compelled to reject their contractual obligations.  As part of the proposed restructuring, they offered sukuk holders an opportunity to right that wrong with a Shari’ah compliant instrument.

What was the outcome?

As the Listing Particulars succinctly state on p 48:  “No assurance can be given as to Shari’ah rules.”

While the Shari’ah Advisory Board of Dar Al-Shari'ah has opined that the sukuk is Shari’ah compliant, the LP notes that there are no assurances that it will be deemed so by other Shari’ah scholars and boards.

You may also recall, and if you don’t, AA will remind you that DAS opined that the previous sukuk was Shari’ah compliant.  That’s not to cast aspersions on DAS scholarship or diligence.

It’s a simple fact that there is no central body that gives a definitive pronouncement on Shari’ah compliance.

As well a subsequent change in interpretation decided such transactions were not Shari’ah compliant. Whether this was intended to be retroactive or not was not explicitly stated.

This by itself should give pause to investors contemplating Shari’ah transactions for two reasons.  For the faithful -- compliance with religion.  For those prudent in conducting financial transactions  -- enforcement of issuer obligations.

Simply put if you’re looking for Shari’ah compliant investment opportunities, your best bet is equity.

Legal Enforceability

But there is more here that should increase anxiety.  Prudent investors usually craft legal agreements to protect their rights to enforce the issuer’s obligations in this world.

The learned courts of Sharjah accepted the argument that while Dana Gas Sukuk was Shari’ah compliant at inception a subsequent changed interpretation about the compliance (or in this case non-compliance) of mudarabah transactions made it non-compliant.  No grandfathering was granted to transactions began prior to the change in interpretation.

As the LP wryly notes on page 45:  “Investors may have difficulties in enforcing any English court judgments or arbitral awards, which do not satisfy the requirements of UAE laws, against Dana Gas in the courts of Sharjah.”

The history of the Dana Gas sukuk restructuring suggests that “may have” above is more appropriately written as “almost certainly”.   While there is no doctrine of case precedent in the UAE, prudent investors probably would want to avoid these courts.

Investors should pay particular attention to the courts whose acquiescence is required for enforcement.  The LP disclose the various shortcomings in key GCC/MENA legal systems not only regarding enforcement of foreign court judgements but also creation and enforcement of security rights.

But there are more than legal warnings in offering memoranda.  By creating the DIFC, the Ruler of Dubai made an unequivocally unfavorable statement about Dubai and UAE courts.  The DIFC is a partial answer.  But as events in Asia suggest, one would be well advised not to “bank” on “one country two systems”.

Reliance on Complex Structuring

These transactions involve elaborate structuring.

First, to attempt to create the “Islamic” equivalent of a bond.  Much of this involves the use of Abu-Yusuf-y transactions.   Often poorly or incompletely executed in light of legal requirements.

Second, to attempt to mitigate the legal risks of local jurisdictions.  Key transaction documents are made subject to the laws of what are perceived to be more investor friendly jurisdictions.  But as several cases, including DG, have shown ultimately this does not work unless the key local jurisdiction where enforcement will take place plays along.

The result is many “moving parts” which affords desperate issuers opportunities to seek to undermine the structure.

Before we turn to Nile Delta, let’s look at the case of Golden Belt Sukuk discussed in an earlier post on this site.

Investors wanted a bond-like structure with a fixed interest rate.  So clever lawyers created a transaction in which the Trustee on behalf of the investors would lease Maan’s properties in KSA back to him at a fixed rental.  However, for probably imagined to be very good reasons, the transaction did not require that he actually sell and re-register the properties in Trustee’s name.

Investors ignored (but the Offering Circular did not!) that a local KSA court was likely to compare the rental charge due under the sukuk to market rentals for similar properties.  And, if the sukuk rentals were above market rental rates, adjust the sukuk rentals according.  And, for some reason the local law requirement for a “wet” signature to make a document legally binding was missed.  But why quibble? What could possibly go wrong? Quite a great deal.

Back to DG on page 51 (the Nile Delta) Listing Particulars makes the following points about the transfer of the Trust Assets.

1. While the Purchase Agreement for the Trust Assets is governed by English Law, substantially all of the initial Ijara Assets are located in the Emirate of Sharjah.  
2. To the extent that the laws of the Emirate of Sharjah and, to the extent applicable in Sharjah, the federal laws of the UAE are applied in relation to any dispute relating to the Purchase Agreement or the transfer of the Ijara Assets, there are doubts whether an ownership interest in certain Ijara Assets can be effectively transferred without registration of the transfer with appropriate authorities. 
3. Accordingly, no assurance is given that any ownership interest in the Ijara Assets will be effectively transferred to the Trustee.  
4. Oops – not really a sale and transfer.  
5. Also note the bit about applicability of UAE federal laws in Sharjah.  One might be advised not to “bank” on UAE federal laws saving one in this transaction, if indeed one imagined they might. And perhaps in other transactions in other Emirates.

But the LP goes on to note potential remedies. 

1. Dana Gas has agreed in the Purchase Undertaking to indemnify the Issuer for the purposes of redemption in full of the outstanding Certificates in the event that any transfer of the Ijara Assets is found to be ineffective. 
2. Given the issuer’s past behavior, no doubt a source of great comfort to some investors.
3. In the event that the Trust Assets are not purchased by Dana Gas for any reason, the Delegate will seek to enforce the above provisions of the Purchase Undertaking.   Seek? Indeed! Achieve? Well, that did not seem to work out so well with the previous incarnation.
4. It is likely that, in any action heard by them, the courts of Sharjah would review the transaction as a whole and seek to uphold the intention of the parties to treat the arrangements as a financing transaction on the terms agreed, provided that the transaction is not recharacterised as a sale and purchase of assets as described below.   As they did with the previous sukuk?
5. A Sharjah court may characterise the transactions contemplated by the Transaction Documents as a sale and purchase of assets that is void as a result of the failure to register the transfer of the Ijara Assets as described above and may therefore refuse to enforce the indemnity in the Purchase Undertaking. 
6. Accordingly, Dana Gas would be required to return the purchase price it received for those assets to investors less any amounts already paid to investors in respect of those assets (i.e. Periodic Distribution Amounts paid under the Certificates). As a result, in this particular situation, investors in the Certificates may not receive back the full amount of their investment. 
7. This is a familiar argument.  Where have I heard it before? (Purely rhetorical question.) Positioning for October 2020 and another convenient attack of conscience?
8. Prospective investors should note that, to Dana Gas’ knowledge, this matter has not been considered by the courts of Sharjah, therefore there can be no assurance as to the approach that would be taken by the courts of Sharjah in such circumstances.  Since the legal concept of case precedents does not exist in Sharjah, does it matter whether or not they have?

In summary a highly structured instrument composed of several transactions subject to the laws of more than one jurisdiction with enforcement dependent on the jurisdiction—which just happens to be the one with the least reliable legal system—about whose validity as Shari’ah compliant there is no assurance.

A transaction that is therefore highly fragile.

Providing a borrower in distress the opportunity to seek to undermine the entire structure.

If you’re already in the hammam, you don’t have many options.  Striking when the iron is cold isn’t going to get you much.

If you’re thinking about investing, (فكر في الخروج قبل الدخول ).

It’s very simple.

1. Do not deal with people you do not trust.
2. Make sure the contract between you and your counterparty is specific – amounts, dates, rights and responsibilities—and contains a realistic path to enforce your rights.
3. Never rely on your contract to correct deficiencies in (a) your counterparty’s character and (b) local law. 
4. No matter how much some clever lawyer tries to persuade you he has "fixed" problems with his brilliant structuring. Be suspicious of transactions that have complex structures.  They often fall apart in times of distress.
5. Make sure, as much as you can, that if you have to enforce your rights under a contract, you will get a fair shake in the legal system and in certain jurisdictions a fair shaykh. Or in other words, that the law is fair and reasonably predictable.
6. If any of these elements are missing, take your money and business somewhere else.