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.   

Dana Gas Restructuring: Friendly Fire - Sharjah and the UAE

DG has placed the courts of Sharjah in a difficult place.  But the uncomfortable situation won’t stop there. Creditors are almost certain to appeal any Sharjah ruling in favor of DG in UAE Federal courts. 

The Sharjah courts are in a proverbial “pickle”.  The Sharjah ruler is Honorary Chairman of DG.  His son sits on the Board.  DG is also a “home-town” company.    

Do they rule with these considerations in mind?  Or do they rule in view of the impact on the UAE, “Islamic” finance?  Or do they rule in DG’s favor and kick the can to the Federal level?

Hard to tell.  Perhaps, though, there’s an indication:  the 25 December date for the hearing on the injunction granted earlier this month. 

AA would think that a highly visible case involving a USD 700 million restructuring and touching on the fundamental validity of “Islamic” finance would warrant a higher priority waiting six months. 

Perhaps, Sharjah Courts are occupied with even larger and more significant cases.  Who would have thought?  Not AA.

If local courts including the Federal Courts uphold DG’s assertion, the reputation of these courts and the UAE’s system of law will suffer, though as an Emirati banker once said to AA.  “By creating the DIFC and the DFSA the Government of Dubai have expressed their opinion on the state of our onshore laws and courts.” 

An assessment shared as well by other parties, I might note.  I'd end by noting that DG is not the only UAE entity to have issued Murabaha based Sukuk

Dana Gas Restructuring: Collateral Damage - "Islamic" Finance

By asserting that changing Shari’ah interpretations can void a borrower’s existing legal obligation to pay principal and “profit” as well as adhere to covenants, DG’s strategy strikes directly at the heart of “Islamic” finance by creating fundamental uncertainty about the legal validity of “Islamic” transactions. 

Simply put, the result of a DG victory is that “Islamic” legal documentation couldnot  be relied on.

Who is affected? 

Here are three potential key affected parties along with some idea of potential injuries. 

• Existing investors whose Sukuk become subject to fundamental uncertainty.  If the market in general were to mark down these transactions due to the uncertainty, investors (including financial institutions that hold Sukuk as investments) could suddenly lose substantial amounts.  For those investors unlucky enough to be holding the Sukuk of DG or a copycat obligor, value loss could be more substantial as debts and interest are repudiated. 
• Existing and potential borrowers who prefer or depend on this form of financing could well find it much more expensive (higher required profit rates, additional collateral, etc.), assuming that finance were available at all.   In some cases skittish investors may decide to exercise rights to accelerate repayment rather than forebear to avoid being caught by a surprise alleged re-interpretation of Shari’ah.  
• Shari’ah experts, commercial and investment banks, legal firms, and other entities who structure and place “Islamic” finance transactions could well see a significant drop in business.

All of the above have a strong motive to oppose DG’s maneuver as well as individuals and entities with primarily religious and not economic reasons for promoting “Islamic” finance. 

At least three parties have already spoken out.

• Shari’ah law experts have begun to challenge DG’s position.  Sheikh Yusuf Talal DeLorenzo (USA) and Mohamad Akram Laldin (Malaysia) as per Reuters both not based in the GCC.  For those who don’t know, there is no central Shari’ah authority.  There is no Rome or Pope in Islam. 
• In a 22 June press release Fitch Ratings have in effect stated that they do not accept DG’s interpretation/assertion: “We believe our current assumption that sharia compliance typically does not have credit implications for Fitch-rated sukuk remains appropriate”.  More importantly Fitch have noted the results if DG’s position is legally upheld: “For this reason, if non-compliance had credit implications and such implications cannot be quantified under our criteria for rating sukuk, instruments may not be rateable”.  If instruments are not rateable, the impact is twofold: (1) higher pricing and (2) less demand.  
• On 27 June Moody’s issued a statement (because this is paywalled, I’m using a press report) which quoted it as follows:  “Although Dana Gas is a small issuer in the UAE market, the credit implications of a court decision in its favour would test Sukuk regulatory and legal frameworks beyond Dana Gas as an issuer or the UAE as a jurisdiction.”  And “The implications [of “illegality” voiding responsibility to repay] include concerns about the legality of existing Sukuk and the effect on their issuers, the role and authority of Shari'ah boards, the responsibilities of the lead arrangers’ due diligence on the issuances, our approach to analysing Sukuk structures, and the liquidity of Sukuk markets.

AA suspects that many more third parties will join the chorus.  

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 8^th May 2013.  The Company will be addressing the way forward on the Sukuk, which has a maturity date of 31^st 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.