Dana Gas Strategy From Clever Boots to Clever Socks?

DG's New Strategy May Be Actually More Clever Than Depicted Above

As you’ve no doubt heard, following rejection from its creditors, Dana Gas withdrew its imagined generous offer of an exchange bond stripped of the conversion option and at an “attractive” 3% fixed interest rate compared to the 9% the Company paid until its moral principles “forced” it to withhold payment because “evolving” interpretations of Shari’ah voided the “Islamic” character of the sukuk. 

At that time according to press reports (Reuters here), the Company said it would pursue "litigation-driven outcomes". 

An initial assessment might be that Dana Gas has taken further leave of what scant senses it might have had.  Scant because its “clever boots” first strategy seemed an unnecessary provocation to the creditors and unlikely to succeed.  DG has a perfectly viable argument for a restructuring without resorting to what are almost certainly distortions of Shari’ah. 

On that score the uncharitable out there among you might say why should there be a difference between overall management of the business and financial management.  AA who fancies himself a charitable sort would of course never make such a comment. 

According to the report by Bloomberg, DG’s “evolved” strategy is based on successfully litigating one of the two following outcomes: 

1. Unwind the sukuk transaction from origin, repay the outstanding principal (roughly USD 690 million) but offset the allegedly now non-Shari’ah compliant “profit” (interest) payments made over the life of the sukuk (some USD 635 million over the life of the transaction). 
2. Convert the sukuk to equity in the Trust Assets (note the potentially fatal limitation agreed by the Sukuk holders in their initial irrational exuberance).  Based on profit earned by the Egyptian assets and the value of these assets now, DG reportedly believes that the sukuk holders owe it USD 150 million.  Details in the Bloomberg article.   

Abu Yusuf certainly has been a busy chap parsing the law.

Some observations. 

At first hearing a litigation-driven strategy sounds like a crackpot idea.

But there have been rulings in the past by UAE courts (Abu Dhabi based) that support such an approach, though AA understands that judicial precedent is not binding in the UAE. Back in the 1980s or thereabouts, UAE banks’ practice of lending on an overdraft basis and capitalizing interest “came a cropper” when borrowers couldn’t or wouldn’t pay.  NBAD took one such borrower to court.  The borrower noted he had recently “seen the light” and as a good Muslim could not pay interest as it would violate Shari’ah.  Producing bank statements he “proved” that on a cash-on-cash basis he had already repaid the original principal amount of his borrowings and more.  The learned judge ruled in his favor.  NBAD had to issue a check to the borrower for some million AED (the “overpayment”) and cancel the balance of his loan on its books.  One would hope that there has been change in judicial thinking in the Emirates since then but one doesn’t always get the “hope and change” wished for.   

As I read DG’s initial announcement, a key point of DG’s strategy is the assertion that evolving interpretation of Shari’ah made the transaction non-compliant. 

One could argue that that means that at some point the transaction was Shari’ah compliant.  If that is the case, then the date the transaction became non-compliant becomes very important in terms of the legality of profit payments.  Those before the new interpretation were perfectly halal.  Those after not. 

One might argue that the date of DG’s announcement of non-compliance is prima facie the date of non-compliance.  If DG were aware of non-compliance before that date but were silent, then should it be subject to paying damages to the sukuk holders perhaps equal to or greater than the profit payments they received between the end of Shari’ah compliance and the date of announcement?  Does Shari’ah impose a greater obligation on a mudarib with respect to rab al maal than a conventional loan arrangement would?

If Shari’ah holds that a change of interpretation is retroactive back to the inception of the transaction—which AA doubts--, then despite their best intentions the parties did not actually agree to a Shari’ah based transaction but instead agreed to conventional (non-Shari’ah) bond.  If so, then shouldn’t the non-Shari’ah terms as negotiated and agreed by the parties bind the parties?  Indeed with this development, might the sukuk holders be entitled to insist on a non-Shari'ah bond?

A telling point could well be if DG has engaged in non-Shari’ah based transactions.  This would establish that they do not only finance on a Shari’ah basis. As to the first point, on page 78 of its 2016 annual report Dana refers to the “Shari’ah tranche” of the Zora financing which clearly means there was at least one non-Shari’ah tranche to this financing.  That indicates to AA that DG’s conversion to “Islamic” principles is of recent date and no doubt feigned. 

As regards Scenario #2, the Bloomberg article contains an assertion ascribed to the Company that the Egyptian assets only generated USD 60 million during the life of the sukuk.  If the Bloomberg report is true, this is a rather shocking admission by DG’s management of failure.  Equity holders may want to take note.

More to the point, sharp-eyed creditors, pardon me, the creditors have demonstrated scant sharp eyes so far so let AA rephrase. The creditors’ advisors will no doubt parse this calculation carefully.  Presumably it does not include “profit” (interest) payments because the determination of profit is before the sharing of profit between mudarib and investors. 

As regards the USD 450 million valuation for the Egyptian assets, Section 3.2 of the offering memorandum refers to the distribution of the “realisation of the net proceeds” the Trust Assets.  AA is no lawyer but that would seem to argue that DG cannot merely give the sukuk holders shares in the Egyptian venture based on its own valuation, but rather that the Egyptian assets have to be sold.  If the proceeds are not enough to repay the sukuk, other of the Trust Assets have to be sold.  Since this is a limited recourse transaction, if all the Trust Assets are sold and the sukuk is not redeemed in full, then the creditors have no further recourse.  Requiring sale of the assets could upend DG’s strategy of claiming funds back from the creditors.  It is not without danger to the creditors given the limited recourse nature of the sukuk.  But since the creditors have a weak hand given that feature of the deal, a credible threat to “wreck” the Company might bring it to its senses.  If not the sukuk holders might take comfort in making DG share their pain. 

That DG has adopted this highly risky second strategy suggests to AA that DG believes it has a good chance of winning the case, plans to beat creditors into submission though interminable court action in the UAE, or has run out of viable alternatives.  That is, this is a desperation play:  the Company sees no other option.  That implies that DG’s management has assessed that DG’s value is minimal.  The rejected four-year deal would have given breathing space for a miracle in the form of the receipt of a substantial arbitral payment, collection of receivables, etc.  With that deal off the table, the state of the emperor’s clothes or lack thereof will become obvious. 

As regards, victory in the courts or prolonging the legal battle, perhaps the “fix” is already in the home town court.  As noted in other posts at SAM, the December hearing date is one indication.  Another is the complex but highly convenient requirements of the Sharjah court to lift its injunction frustrating DG’s ability to comply with the London court’s requirements.

Alternatively, DG may be hoping to drag matters out in the lengthy judicial process in the UAE’s fine courts similar to the roughly six-years of legal to-ing and fro-ing  between the National Bank of Umm al Quwain and Global Investment House Kuwait, hoping that this will wear the creditors down. Some details here on that epic legal battle which was finally “settled” via an out of court settlement. 

AA hopes that Emirati courts and rulers understand the impact a court decision in DG’s favor would have on the legal credibility of the UAE judicial system, local companies’ access to cross-border financing, and more widely on “Islamic” finance beyond the UAE.   

AA notes, however, that “hope” isn't really a basis for investments or for correcting problems with investments.  As to AA's judicial "hope", “change” may as well prove elusive.