Damas Debt Restructuring Deal Near?

The National reports that Damas may be near to striking a deal with its lenders to restructure some AED3.2 billion (US$812.7 million).  That number seemed a "tad" high based on my recollection of their31 March 2009 financials.  If you look at Damas' 30 September 2009 financials, you'll see that that amount is the total of all liabilities.  Bank debt is some AED1.028 billion (US$280.1 million).  This is the amount to be restructured with the banks.  The Directors' Loan of AED150 million is likely to be set off against the Abdullah Brothers' obligations to the Company.

The Company reportedly has about 20 lenders.  It has been negotiating with an informal steering committee comprised of  Standard Chartered, HSBC, Emirates NBD, Mashreqbank, Gulf International Bank and ABN Amro.

The recent DFSA action should give the lenders comfort that the most abusive of the corporate looting is now over.  The DFSA Enforceable Undertaking will remove many but not all of those who were  atctive participants or complicit.   I would expect the banks to ask for the heads of the remaining members of  senior management as part of the restructuring deal.

Probably the best recovery for the banks is via a restructuring.  The Company has a complicated web of subsidiaries and affiliates with a jury-rigged ownership structure to get around constraints in other countries on "foreign" ownership.  Getting comfortable with all this will be another headache for the bankers.

Amwal Al Khaleej Sues Abdullah Brothers

The National reports that Saudi private equity group, Amwal AlKhaleej, is suing the Abdullah Brothers for US$ 22 million over the Brothers failure to pay for some 22 million shares in Amwal AlKhaleej they agreed to purchase in June 2008.

Apparently, Amwal transferred the shares before getting the cash.  

 

A payment plan agreed in November was not honored by the Abdullahs.

Ernst and Young "Fully Stands By" Its 31 March 2009 Audit of Damas

The National Abu Dhabi reports that E&Y has issued the following statement.

“We fully stand by our audit report on the financial statements of Damas International Limited for the period ended 31 March 2009,” the company said.

You can read the Auditors' Report in the 31 March 2009 financial statements here and draw your own conclusions.

Damas - The DFSA Report in Detail

In my previous post I made the comment that the DFSA enforcement actions revealed three themes:

1. An almost unbelievable  pattern of  disregard for the health of DIL and the rights of minority shareholders and other stakeholders by the Abdullah Brothers.  They treated the company as their personal "piggy bank" withdrawing funds when it suited them and then "repaying" the Draws by selling the company assets. 
2. A profound failure of corporate governance at the board, senior officer and auditor levels.   The Board seems to have failed to ask the most basic of questions and to have the most basic of procedures.  Senior management was aware of the Abdullah's practice of "Drawing" funds and other shortcomings, but did not advise the Board.  In March 2009, a DIL Internal Audit Report stated "a large scale diversion of funds from the company by the directors.  The total exposure stands at a whopping AED525.19 million as on 30th  September  2008".  The Report was only circulated to the DIL Managing Director (one of the Abdullah Brothers) and the CFO, but not to the Board or Audit Committee.  In both cases it's hard to understand why independent directors were not notified.
3. A transaction connected with Damas IPO which raises some troubling questions about the involvement of DIG and some of its affiliates, all of whom are part of Dubai Holding.

Given what went on at DIL, I think a detailed review of the DFSA's findings outlined in their Enforceable Undertakings is worthwhile.  Let's step through the Enforceable Undertaking with Damas International Limited ("DIL").  The one for the Abdullah Brothers repeats the same findings. 

Section 6.1:  Board Meetings 

1. Inadequate or no financial info given to Board to enable it to assess DIL's situation.
2. Board packs given to directors only at the Board meetings.  Not before.  Information in packs  insufficient to make decisions.
3. Board minutes poorly maintained and did not accurately reflect decisions and discussions.

Section 6.2:  Audit Committee

1. Did not meet formally during the 2008-2009 fiscal year. It's first formal meeting was 26 July 2009.
2. "Failed at all material times" to meet with Damas Internal Audit team.  Did not receive nor ask for any internal audit reports.  See no evil, hear no evil ...
3. The AC didn't set its own Terms of Reference or establish procedures for Internal Audit reporting to it or the Board.
4. Failed to monitor the Internal Audit function.  

Section 7:  Directors' Draws

1. The Abdullah Brothers treated DIL as their personal "piggy bank" and withdrew money from company accounts with apparent little concern for the impact on the company itself or shareholders even after they had taken the company public.  Only the Brothers were entitled to make such Draws.
2. DIL's Board, Finance Department, Internal Auditor and external auditor were all aware of this practice. More importantly there were no controls on the amounts or purposes for drawings until October 2009.  That is, until after the abuses had become so large they could no longer be ignored.. 
3. Between 1 July 2008 (sale of shares was ongoing at this point) until 27 October 2009, the Brothers made some 2,200 draws for relatively trivial amounts (fuel expenses) all the way to substantial  sums for personal investments, personal loan repayments, etc.  A total  AED 600 million was withdrawn and then retroactively settled by what appear to be questionable netting transactions, reducing the Directors' Draw to AED 365 million.  Tawhid Abdullah borrowed 1,940,250 grams of gold to repay his third party personal gold loan. DIL has yet to be repaid by Tawhid.

Section 9:  DVG Transaction (DIFX Listing)

1. When it was clear that DIL's IPO was not going to get enough investor take-up to secure the 25% free float required for a listing on the DIFC (now Nasdaq Dubai), Tawhid Abdullah arranged to create artificial demand.  He approached Dubai Investment Group, Dubai Ventures and Dubai Financial, apparently proposing that they buy shares in their own names but that the Brothers would provide the funding.  Either that or that they would "lend" their names and front for the Abdullah Brothers.  These three entities subscribed for some 100,000,000 shares in toto - roughly divided equally.
2. As a side note, this amount represented 37% of the total Offering.  Original Offer Circular here.
3. The three Abdullah Brothers withdrew a total of AED293,843,000 from DIL accounts during July 2008 and transferred AED275,480,000 to DIG and AED 18,363,000 to Dubai Ventures.
4. This transaction was documented as a US$100,000,000 personal loan from Tawhid Abdullah to Dubai Ventures dated dated 19 August 2008 (the "First Loan").  Unclear why the loan was for this amount as the cost of the shares was roughly US$80 million.
5. In March or April 2009, a series of subsequent documents were drawn up but backdated to August 2008 and some forward-dated to August 2009.  The purpose of these documents was to disguise the nature of the transaction and to reduce the Directors' Draws used to fund the share purchase.
6. The First Loan was assigned to Damas Jewelry in an assignment dated 20 August 2008.  Mr. Tawhid signed both on behalf of himself  as original lender and on behalf of Damas Jewelry to legally document the assignment!  That is, he signed for both parties in the transaction: assignor and assignee.  This assignment effectively reduced the Directors' Draw.  Note despite its date, it was actually signed in March/April 2009.
7. The First Term Loan was replaced by a Second Term Loan between Damas Jewelry and Dubai Ventures for US$80,000,000 via a document back dated 21 August 2008.  In a document dated 22 August 2008, the Second Term Loan was assigned from Dubai Ventures to DVG (a related company).
8. Then there was an exchange of letters actually signed in March/April 2009 but dated 19 and 20 August 2009 to convert the loan to an investment arrangement.

It's pretty clear that at inception this was a fraudulent transaction designed to trick the DIFX into believing  that the IPO had sold enough shares to the public to meet the Exchange's listing requirements. The subsequent  loan agreements, assignments, and investment management agreement were designed to cover up the draws by the Abdullah Brothers and provide "cover" for reducing their Director Draws.

Frankly, many out there reading this saga are going to have some pretty fundamental questions about the behavior of DIG and its subsidiaries - all entities owned by the Government of Dubai's Dubai Holdings.  How they came to be involved.  And what sort of business judgment and ethics they employed in participating in this transaction.

Section 10:  The Sharjah Transaction

1. Damas Real Estate ("DRE"), a company owned by the Abdullah Brothers, purchased land in Sharjah for AED5,141,700 in January 2005.  This predates the July 2008 share flotation. 
2. Between January 2005 through 25 March 2009, the Abdullah Brothers used an unspecified amount of Damas Company funds to develop the property including erecting a building.
3. Around 25 March 2009, Tawhid Abdullah, former Managing Director of DIL, proposed to the Board to sell DIL the land for AED70,000,000 to AED90,000.000.  The clear goal was to use the transaction to reduce Director Draws prior to the issuance of the year end financials.  The Board was not told that Damas funds had been used to develop the project. 
4. At least that's what the DFSA says. As I read this transaction and others, it's hard not to have the nagging suspicion that the Board may have realized that it was critical to regularize (reduce) the Directors' Draw situation as soon as possible. And was so delighted at any transaction that would lead to a reduction that they didn't look too closely. 
5. The Board agreed to the sale after a Cluttons valuation and paid some AED85,000.000.  Instead of paying cash Directors' Draws were reduced by an equal amount.
6. As part of the transaction, the project was supposed to be developed for staff to live in with investment opportunities offered to staff.  As per the DFSA up to 21 March 2009, Tawhid did not formulate or implement the employee residential property investment scheme.

 Section 11:  AlWasl Transaction

1. AlWasl DMCC (owned by Tawhid and Tamjid Abdullah and a third party) bought two plots of land in the DMCC free zone in June 2007, again well before the DIL IPO.
2. In December 2008, Tawhid Abdullah proposed to the Board that DIL buy the plots, but did not inform the Board of the Brothers' interest in AlWasl.
3. No reasonable due diligence was done.   Board approved the purchase.
4. DIL acquired the land by paying AED46,200,000 - though again there was no cash outflow.  The asset was put on the books and the Directors' Draws reduced by an equivalent amount.

Section 12:  DRE Transaction

1. In December 2007, Damas placed an AED150,000,000 deposit with United Arab Bank ("UAB")  to secure a loan of an equivalent amount made by UAB to DRE.  In January 2008, the deposit was legally pledged as collateral.  The Board was not advised.  This was before the IPO.
2. In October 2008, UAB used the deposit to repay the loan.
3. Presumably, but not mentioned, this was also treated as a Directors' Draw. 

Section 13:  Mashreq Bank Loan

1.  On 13 July 2008 (after the IPO), DRE received an AED70,000,000 loan from Mashreq.  The loan was drawn on 14 July with proceeds transferred to a personal account of the Brothers at First Gulf Bank.
2. On 11 September 2008, Tawfique Abdullah authorized the transfer of AED70,000.000 from a Damas account at UAB to Mashreq to pay off the loan.
3. Again presumably treated at DIL as a Directors' Draw though this is not specified.

Section 14:  Gayrimenkul Transaction

1. In August 2008 (after the IPO) in a series of transactions the Brothers withdrew AED66,301,560 from a Damas account at UAB and transferred it to Gayrimenkul to buy real estate in Turkey.
2. These withdrawals were not advised to the Board until October 2009.

Section 15:  AED42.5 Million Directors' Draw

1. On 18 July 2008, Tawfique Abdullah authorized the transfer for AED42,500,000 from a Damas account to a bank account held by the Brothers.
2. The withdrawal was not disclosed to the Board. 

Section 16:  Gold "Borrowing"

1. In December 2007, Tawhid Abdullah borrowed 2,000 kilograms of gold from a third party.
2. On 1 September 2009, he allowed the lender to take 1,940250 grams of gold from DIL to repay his personal "gold loan".  No disclosure was made to the Board.
3. Tawhid has not yet restored the gold to DIL.

This is a damning report on the Abdullah Brothers and many others involved in the running and monitoring of the company.

I had posted this back in December.  The DFSA Report only re-emphasizes the importance.

When investing in a family company make sure you've got adequate control  at the Board over the family members' management of the company and signature authorities (enhanced requirements for Board approval is one technique), robust corporate governance actually implemented, and of course detailed disclosure of company affairs.

DFSA "Fires" Damas Board and Levies Fine - Dramatic But There's Much More Behind the Headlines

Following the conclusion of its investigation which began last October, the DFSA announced 21 March a series of actions against the Abdullah Brothers (Tamjid, Tawhid, and Tawfique) and Damas International Limited ("DIL").

Abdullah Brothers (Enforceable Undertaking)

1. Resignation from the Board of DIL and the Boards of any of its subsidiaries within 30 days.
2. A 10 year ban on the Tawhid Abdullah from acting as a director  of Damas or any other company on the DIFC or with the promotion, formation or management of any DIFC company or reporting entity without the prior permission of the DFSA.  His two brothers are subject to a similar ban but only for five years.  Though all three may serve as consultants to DIL.
3. Agreement to disclose assets and liabilities in excess of AED300,000.  This clearly to provide the information necessary for Point #4 below.
4. Reimbursement of DIL funds (Directors' Draws, gold borrowing, etc).
5. Restriction on the Brothers dealing in their assets in excess of AED300,000 except with written permission from the Board or its delegate . Another safeguard to secure repayment.
6. A US$3,000,000 fine.  $300,000 payable immediately with the remainder suspended indefinitely, though if the Brothers fail to comply with their undertaking, some or all of this amount can be made "due".

 Damas International Limited (Enforceable Undertaking)

1. DIL shall take actions to secure the resignation of all Board members in 30 days.  Some press reports have referred to the "voluntary" resignation of the Board.  This is scarcely voluntary.
2. Calling of an Extraordinary General Meeting of shareholders to elect replacement directors within 30 days.
3. Creation of Board Committees:  Audit, Compliance and Risk Committee, Nomination Committee, and Remuneration.  With follow-up on their effectiveness.
4. Appointment of qualified and experienced individuals to the Audit Committee.  Bimonthly mandatory meetings.  You can read that as an assessment of the previous Audit Committee.
5. Establishment of an effective Internal Audit function with adequate Board oversight.
6. Replacement of the existing external auditor with a firm acceptable to the (new) Board and the DFSA for the financial year beginning 1 April 2010. You can read that as a decided vote of "no confidence" in the existing auditor.
7. Enhancement of Board information and reports.
8. Establishment of a Risk Management Department with adequate procedures and Board oversight.
9. Establish, maintain and regularly review its financial controls.  Included immediate termination of Directors' right to draw funds.  And enhanced procedures for related party transactions.
10. Greater clarity in roles and responsibilities between the Board and senior managers with specific accountabilities assigned.
11. Appointment of a compliance officer.
12. Appointment of a company secretary.
13. Establishment of a connected persons register.
14. Recovery of the Abdullah Brothers' "Director Drawings" with quarterly reports to shareholders on progress.
15. Submission to periodic DFSA reviews of compliance with the enforceable undertaking. 
16. A US$700,000 fine. US$100,000 is payable immediately.  US$600,000 is suspended.   However, if DIL fails to comply with the Enforceable Undertaking, all or some of the suspended amount can be reinstated.

Dramatic as this is, it is really just the tip of the iceberg.  What's more significant are the detailed DFSA findings that led to these rather severe enforcement actions.

I'll take a look at these in more detail in a subsequent post.  For now, a summary around two key themes: 

1. An almost unbelievable  pattern of  disregard for the health of DIL and the rights of minority shareholders and other stakeholders by the Abdullah Brothers.  
2. A profound failure of corporate governance at the board, senior officer and auditor levels.

Sad as it is, this sort of behavior is not unknown.  

But what is troubling is the involvement of a Government of Dubai  related company,  DIG, a subsidiary of Dubai Holding, in a transaction designed to inflate the amount of  investor demand for the Damas IPO.  As presented in the DFSA Report, the Abdullah Brothers transferred DIL funds to three DIG related companies who "bought" shares, ostensibly for their own account.  This sale helped secure a listing on the DIFX (now Nasdaq Dubai) by creating the impression that the Exchange's 25% free float requirement. had been met.  Later a series of back dated transactions were used in an attempt to disguise the nature of the initial transaction.

Were DIG and its affiliates innocent dupes in this process?  Or complicit?  The DFSA does not take a position.  Many who read the portion  of the DFSA document dealing with this transaction are going to come away with serious questions about the business practice and ethics of DIG and its affiliates.

Damas Voluntarily Suspends Share Trading on Nasdaq Dubai

Today Damas voluntarily suspended trading in its shares on Nasdaq Dubai pending an announcement.

Damas Appoints Chief Restructuring Advisor

Damas announced some senior management changes at Nasdaq Dubai today.  Most of these are interim appointments while the Board conducts a search for a permanent replacement.

But one appointment did stand out:  that of  Mr. Sanjay Manchanda, a Partner at PricewaterhouseCoopers,  as  Chief Restructuring Advisor.

Damas: Abdullah Brothers Sell Tower to Repay Obligations

Copyright Imre Solt - Usage under GFDL

The National reports that the Abdullah Brothers have sold one of their twin towers in Dubai to pay back what the The National charitably refers to as debt arising from "unauthorized" investments.  Applying that same standard, I guess one could characterize Brother Bernie's fund as having engaged in some "unauthorized" investments.  It was no doubt an oversight that he didn't give his investors up-to-date and accurate performance figures.

No word on how much was received for the building.  A safe assumption is that the sale involved a substantial haircut.

Good luck to the Brothers on raising the money to make Damas whole for their own unauthorized oversight.

Damas - Manifest Absurdity

The National has another article on the Damas saga.

This one about the plight of the Abdallah Brothers who are having difficulty making restitution for the unauthorized withdrawal of funds from Damas to fund speculation in the Dubai real estate market.  They may have to sell their yacht pictured above and fish from two smaller boats.  It takes a hard soul to hear a story like this and not feel compassion, I suppose.  Mark AA down as having no sympathy. 

But the gem in the article was this quote.

“There is nothing mysterious in the unauthorised withdrawals. It was an oversight in getting the approvals,” said the source, who declined to be named because of a continuing investigation into the transactions.

As I understand it, the funds were withdrawn from Damas to make personal investments in real estate.  That is, these assets are not registered in the name of Damas.  Call me old fashioned but when you take someone else's money and use it for your own purpose, that's not an oversight. 

Damas - Looks To Sign Standstill With Lenders

The National reports that Damas is on the verge of signing a formal standstill agreement with its creditors, noting that an informal standstill had been in place since last November.   As per the article, the plan is to freeze principal repayments until 31 May though to continue to accrue interest.  Clearly, this is just the first step.  A revised repayment plan will have to be devised.  For that purpose and probably to give creditors some comfort, there are rumors that the company will hire a partner from PricewaterhouseCoopers to act as chief restructuring advisor.  It is unclear if this will be an advisory assignment in which Damas engages the firm.  Or whether a partner will be engaged to work at Damas in a capacity similar to that used by The Investment Dar (Mike Grant) or Dubai World (Aidan Birkett).

Assuming The National's sources have the correct story, what's revealing in the article are two comments which go to the heart of corporate governance as well as raise issues of defalcation.

First, that the conversion of Damas' loan to Dubai Ventures to a managed investment account was not authorized by the Board.  What is even more relevant is the authorization of the loan in the first place.  What on earth was a jewelry company doing in the loan business?  A reasonable guess would be that the loan like the conversion was not authorized by the Board.

Second, that the funds that Mr. Abdullah borrowed from Damas and which he and his brothers have agreed to pay back were used for real estate speculation in Dubai.   No doubt the belief was that the investments were a "sure thing" and that the profit could be realized and the original funds returned without problem.  The Brothers now are faced with trying to sell these assets in a depressed market.  I believe that the Board should resist any attempt to have them accept these assets as satisfaction for the obligation.  The risk on the assets should remain with those who purchased them.

Also as I've noted before, it's always very wise idea when investing in a business with a dominant shareholder to make sure the boundaries are very clearly set between that shareholder's money and the company's and that there are adequate controls in place to minimize "crossover" transactions (via signing authorities, etc) and robust mechanisms to monitor the company to detect any violations.

A Gem of an Investment: Damas

One of this blog's select group of readers raised a question about Damas and provided a link to an article in The National newspaper from Abu Dhabi.  I promised to put a few thoughts together in a post and belatedly am making good on that promise.

First, a bit of background to set the stage.

1. In Summer 2008 Damas offered 270.6 million shares of which 233.9 million were new shares.  36.7 were sold by Amwal al Khaleej Commerical Investment Company (Saudi Arabia)  as per the Final Offering Circular ("FOC").  As per page 72 of the FOC, the three Abdulla Brothers (Tawfique, Tamjid and Tawhid) would own more than 51% of the Company after the Offer.
   
2. Fees and expenses on the transaction were reported as US$10.4 as  (page 19 FOC).
3. In July 2008, Damas listed on the DIFX, now NasdaqDubai.
4. In December 2008, the Company changed its fiscal year from 31 December to 31 March with the following justification:  "The Board of Directors of the Company vide their resolution dated 22 December, 2008 has changed its Financial Year End from 31 December, 2008 to 31 March, 2009 due to the following reasons.
   i) Since the market conditions were very much volatile, the first part of 2009 would give the Company, some time to see how expansions could be made effectively in the later part of the calendar year.
   ii) All the Auditors were extremely busy at the end of the calendar year and feel pressurised to deliver and that it would be a better option to choose a lean period for audit reviews and for consolidation of more than 75 Group companies."    
5. On 12 October 2009, Damas announced the resignation of Mr. Tawhid as Managing Director and CEO "due to his disclosure to the Board of what is understood to be unauthorized transactions conducted by him.  The full extent of these transactions has not been ascertained at this time but the Company’s initial estimate is that these transactions could amount to approximately USD 165 million."
6.  On 15 October 2009,  the Board of Damas announced "the appointment of PricewaterhouseCoopers (PWC) as an independent auditor to examine the unauthorized transactions conducted by the former CEO and Managing Director Tawhid Abdulla."
7. On 4 November 2009,  the Company announced a Settlement Agreement with the three Abdulla Brothers to repay US$165 million over the following 18 months in three installments of US$55million due within each of the three six-month periods comprising that longer period.  Certain real estate was pledged as were 350 million shares of Damas to be taken in the event that the Settlement Agreement was not honored.

Now to more recent details.

On 16 December 2009, Damas published its September 2009 interim financials.

The following five notes particularly caught my eye:

(1) Note 6:  Provision Against Consignment and Receivables Exposure

"Included in unimpaired receivables (note 9) are debts amounting to AED 53 million (31 March 2009: AED 47 million) due from particular consignment debtors and AED 32 million (31 March 2009: AED 54 million) due from certain high net worth customers who are familiar and acquainted with certain Directors."  AA:  It would be interesting to know who these "high net worth" customers are who apparently forgot their credit cards or chequebooks at the time of  purchase.

(2) Note 11 Related Party Transactions

"The Executive Directors have provided personal guarantees amounting to AED 150 million (31 March 2009: AED 150 million) in respect of risks associated with unfixed gold lying with certain parties, dues from particular consignment debtors and certain high net worth and important customers (note 6)."  AA: I wonder if these "important customers" are among those who haven't settled their purchase payments yet.

(3) Note 12 Directors' Current Account

"The above balances relate to Mr.Tawfique Abdulla, Mr. Tamjid Abdulla and Mr. Tawhid Abdulla. Against the balance above there are loans due to these directors amounting to a total of AED 150 million which are subordinated to bank facilities.

Subsequent to the period end, the management has entered in to a Settlement Agreement with the concerned directors wherein they have undertaken to repay an amount of US$55 million within 6 months; an aggregate of US$110 million within 12 months; and an aggregate of US$165 million within 18 months; and, should there be any balance in excess of the US$165 million as a result of any findings arising from an ongoing independent investigation or otherwise, any such excess amounts in cash and/or unencumbered assets within 24 months. All payments are to be made in cash and/or unencumbered assets.

As part of the Settlement Agreement, the concerned directors have produced a list of assets that are potentially available for liquidation to be converted by them into cash and/or to be contributed to the Group as unencumbered assets to meet their obligations under the Settlement Agreement. Such assets consist principally of real estate investments in the Middle East and North Africa (including a number of residential and commercial buildings and units in the United Arab Emirates) and an investment in a shopping mall in Turkey.

As part of the Settlement Agreement, the concerned directors have pledged 350 million of their shares in the Company that would be transferred in whole or in part back to the Company in the event the terms of the Settlement Agreement are breached. These shares had a market value of AED 275 million as at 25 November 2009.

As at the date of authorisation of this financial statement, the process of independent valuation of the assets available for liquidation is still under process. An independent investigation is also ongoing into transactions undertaken by the former CEO and Managing Director of the Company. This investigation is being overseen by a subcommittee of the Board.

Subsequent to the period end due to increase in the price of gold and additional transactions the amount due from the directors was AED 635 million as at 25 November 2009 (net of loans due to directors amounting to AED 150 million)."  AA: There are several more interesting details in this note in the comparative table of outstandings and their movements, including the use of a company deposit to secure a related party's loan.  Presumably, one of the unauthorized transactions.  Or at least one hopes so.

(4) Note 13:

"* A subsidiary of the Company had provided a loan amounting to AED 294 million (USD 80 million) to Dubai Ventures Group Limited (“Dubai Ventures”) at a rate of interest of 6% p.a. which was due to be repaid in August 2009. On 18 August 2009 an investment agreement was signed with Dubai Ventures, wherein Dubai Ventures confirmed that all monies previously provided to it under the loan facility were held by it as money provided for investment purposes and would be transferred into a investment account over which Dubai Ventures would have discretionary management powers. Subsequently when the Group requested information as to the nature and value of the investments held in the investment management account they were informed that the account held shares in Damas International Limited with a value of only AED 73.5 million and that no other assets were available to the Company. Although discretion had been given to Dubai Ventures in respect of investment choice, the Board of Directors of Damas International Limited had not authorised Dubai Ventures to invest in shares of the Company. The Board intends to dispute Dubai Ventures actions in this regard and will seek to recover the full amount due under the original loan facility agreement.  For reasons of prudence a provision has been made amounting to AED 312 million against the total loan amount including accrued interest."

(5) Note 17 Going Concern

"The increasing spot price for gold has resulted in a decline in sales and an increase in margin calls from financial institutions from whom the Group obtains gold loans. These factors combined with the amounts withdrawn by a director (note 12) have resulted in a significant decline in the liquidity of the Company. It has also resulted in the Group defaulting on certain of their facilities subsequent to the period end and a number of financial institutions reassessing their facilities with the Group.

Discussions are currently ongoing with banks regarding renewal/restructuring of facilities and securing sustained funding to carry on its operations. As part of this process the Group has signed an agreement with certain institutions that may result in certain diamond inventory being sold at a loss in future as an additional cost of finance. Additional funding is required to ensure that the Company can continue its operations and meet its financial obligations as they fall due.

Whilst the results of the negotiations with the banks cannot be determined at this time, the Board of Directors has elected to prepare these financial statements on a going concern basis as they are optimistic that agreement will ultimately be reached with the banks."

Now to some commentary.

How did this happen?  

It appears from the timing that the conversion of the loan to Dubai Ventures happened during the tenure of the previous Managing Director/CEO.  Earlier I had raised a question as to what a jewelry company was doing making a commercial loan to another entity and whether this was ultra vires.  A glance at Damas' Articles of Association show that the answer to the latter question is a resounding no. 

Basically Article 1.4 (b) allows the company to anything that's not illegal.  As well, Article 15.3 would seem to permit the delegation of authority to engage in such transactions to the MD/CEO by the Board.

Of course, there is still the valid question of why this company got into the loan business, when it appears to have been in financial distress from unfavorable developments in its core business.  This loan was disclosed in Damas' 2008 fiscal financials issued in July 2009.  So the Board  cannot disavow knowledge, though its knowledge may have been post facto after the loan was granted.   It would be interesting to know the Board discussion that took place on this issue.

As indicated in Note 13, when the loan was not repaid, presumably because Dubai Ventures could not, it was converted to an investment account.  Not an untypical strategy to prevent the recognition of an impairment or a loss.  The AED64,000 question here is whether the MD/CEO undertook this decision on his own or the Board was involved.

What is also intriguing is whether Dubai Ventures inability to pay is evidence of a wider pattern of cash shortages or other financial distress within Dubai Inc.

What about the Settlement Agreement?

As is probably obvious from previous posts, AA has a particular fancy for settling obligations in cash.   As per Note 12 it seems that settlement can be made in "cash and/or unencumbered assets".   Since Damas is not a real estate investor (or at least AA hopes they're not), it would seem that settlement should be in cash.  Any real estate should be sold and the proceeds given to the company with the Abdulla Brothers bearing the conversion risk, not the Company.   

Also I'd note that Article 2.15 of the Company's Articles states:  "The Company may not take a lien over any of the shares."  Presumably legal work has been undertaken by clever counsel to make the pledge by the three Abdulla Brothers legally effective.

Bottom Line

When investing in a family company make sure you've got adequate control  at the Board over the family members' management of the company and signature authorities (enhanced requirements for Board approval is one technique), robust corporate governance actually implemented, and of course detailed disclosure of company affairs.