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| "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.
- 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.
- 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.
- Accordingly, no assurance is given that any ownership interest in the Ijara Assets will be effectively transferred to the Trustee.
- Oops – not really a sale and transfer.
- 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.
- 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.
- Given the issuer’s past behavior, no doubt a source of great comfort to some investors.
- 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.
- 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?
- 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.
- 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.
- This is a familiar argument. Where have I heard it before? (Purely rhetorical question.) Positioning for October 2020 and another convenient attack of conscience?
- 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.- Do not deal with people you do not trust.
- 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.
- Never rely on your contract to correct deficiencies in (a) your counterparty’s character and (b) local law.
- 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.
- 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.
- If any of these elements are missing, take your money and business somewhere else.
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