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: Own Goal for Dana Gas

GOAL!!!!  (Sadly Own)

Without the Number Can't Tell If He's Management or an Advisor

DG’s maneuver—declaring the debt invalid, seeking court injunctions to restrict creditors’ rights, and apparently preferring UAE creditors with the Zora prepayment—is likely to have several effects. 

First, at the very least it will poison the initial phases of the restructuring negotiations. 

AA doesn’t understand why DG took this path. 

Unless completely somnolent, creditors were likely aware that they were not going to be repaid in full, though they were/are probably hoping for a significant “slice” of DG’s almost USD 300 million in cash to reduce outstandings. 

DG has a clearly compelling case that its ability to repay is restricted because its two main customers (95% of DG’s business) can’t or won’t honor their obligations in a timely fashion.  That allows DG to focus creditor anger away from itself to its customers.  

The creditors have limited opportunities to go on their own.  Additional security (more of those “current” receivables from the KRG and Egypt), a higher profit rate, tenor adjustments/principal amortization, etc. could probably secure a deal albeit with hard bargaining.    

Instead DG has in effect “declared war” on the Sukuk holders. 

Second, but that’s not all.  DG’s apparently half-baked strategy has caused it an even larger problem by creating more enemies who are likely allies for the creditors. 

Third parties whose interests are directly threatened by DG’s move are likely to oppose DG, providing ammunition to creditors in the courts.  Other third parties are likely to take positions that support the creditors, even if only indirectly. 

Instead of fighting battles with one adversary, DG has apparently though it wise to take on the “world”.

It’s hard to understand what DG are thinking, if indeed they are. 

A strategy like this is one that an obligor in a desperate situation adopts.  A very weak financial position, problems with ethics or legality that are about to emerge,  or an irrational set of creditors. 

If that's not the case, then the strategy is the result of some "clever boots" removing his shoes at the wrong moment during the decision process.

AA is not privy to insider information.

Third, but whatever the cause, it’s hard to see this turning out well for DG. It could "win" a pyrrhic victory or wind up on the pyre as the vanquished. 

• If DG’s Abu Yusuf legal arguments prevail, finding additional or new creditors is likely to be difficult.  Those few with an interest in providing future debt capital will probably seek to impose higher profit rates and enhanced protective terms – legal structure, collateral, etc.  That assumes that any such creditors will believe that legal structuring can create adequate defenses against an obligor who has clearly demonstrated disdain for contractual agreements.  
• If DG’s legal strategy collapses, creditors could well impose draconian terms on the company, e.g., a higher margin, additional collateral, shorter tenors, and a  requirement for a mandatory "sinking fund" or cashflow sweep. (More on this in a post to follow). Bond holders typically don't have the stomach or attention span to undertake these   In the worst case DG could wind up being managed for cashflow.  As I noted in my post about Global Investment House Kuwait, a creditor bent on principal recovery in an uncertain cashflow situation has little to no consideration for future growth of the firm. When creditors feel that an obligor cannot be trusted, that propensity is exacerbated. 

Dana Gas Restructuring: Almost Certain Winners

Well Almost Every Time

As promised earlier, some thoughts on potential winners and losers from Dana Gas’s “clever boots” maneuver.  Given AA's positive nature, let’s start this series of posts with the most likely winners. 

As with any restructuring, the most likely winners are the financial and legal advisors engaged by the obligor and the creditors as well as other firms that may be called upon to provide services, e.g.,  accounting firms, subject matter experts (here Shari'ah law and "Islamic" financial structuring), etc.  

Assuming payment of fees (particularly those owed by the obligor) there is a financial win for both sets of advisors.

But reputational risks remain until the restructuring is complete. And sometimes even after.

Did a financial advisor give bad advice that harmed its client and did news of that harm become public?  Sometimes an advisor makes a bone-headed demand. The other party’s advisor recognizes the mistake, prudently keeps silent itself and advises its client to do so. Its client reaps the benefit. 

Did a law firm miss a critical detail and a legal case went awry?  Did its pen make an unintentional slip in document drafting that resulted in unintended benefit to the other side?  Or did it miss an intentional attempt by the other party’s legal advisor to “redo” the termsheet through clever drafting?  As one of AA’s legal eagle friends notes when you’re on the benefit end you need to have a poker face.  When you’re on the receiving end of mischief intentional or otherwise, you need to have a sharp mind and loud voice. 

• DG’s advisors are Houlihan Lokey (financial) and Squire Patton Boggs (legal) as per the Company’s 5 June 2017 press release. 
• Creditors have reportedly engaged Moelis (financial) and Weil, Gotshal & Manges (legal) as per Reuters.  

At present, advisor reputational risks are focused on the advisors being tagged whether rightly or wrongly with DG’s high risk and poorly thought out strategy.   More on that point to follow.      

Dana Gas: Why Did They Do It?

It's More Than Just Hot Air

I promised in my first post to write again on the winners and losers from Dana Gas’s maneuver.  A post from Arkad has temporarily derailed that plan.

What I’d like to offer today is some hopefully intelligent speculation on DG’s motive for declaring the outstanding certificates as “illegal under Shari’ah and thus unenforceable” and obtaining court injunctions against payment, particularly because these two steps are almost certainly going to poison the relationship with creditors which is critical in a restructuring.

Dana’s 13 June 2017 press release offers two potential explanations: 

• An outflowing of piety perhaps triggered by prayerful meditation during the holy month of Ramadan.  “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.”
• A desire to avoid repeat alleged damage to the company because “During the 2012 restructuring, representatives of Holders unnecessarily declared a Technical Default while negotiations were still ongoing, causing lasting harm.” 

The press seems to share AA’s view that piety is not the motive and has seized upon the second: prevention of a Technical Default. 

AA thinks there’s more to the story.    

Simply put this is a maneuver to stop the creditors from exercising their rights under the security agreement to gain time and increase DG’s negotiating leverage in the restructuring.  

According to Reuters, last Sunday Dana advised that it has obtained an injunction from the High Court of Justice Commercial Division in British Virgin Islands (BVI) and a restraining order from the High Court of Justice in England blocking creditors from taking “hostile” action in addition to the Sharjah Court injunction. 

Why were these steps taken and why are they significant?

• The BVI is “home” to DG’s affiliates who conduct business in Iraq in territory of the so-called Kurdistan Regional Government and in Egypt and whose shares are “security” for the Sukuk.  USD 300 million of Egyptian receivables owed to Dana Egypt also part of the security package.   A BVI injunction complicates an already difficult road for creditors to realize the collateral whose enforcement (but only the first step) is subject to the jurisdiction of the BVI. 
• The laws of England and Wales apply to key transaction documents as I pointed out in my earlier post in particular those documents under which certificate holders would quite justifiably call a default.  

Another sign that protecting assets is a key concern are the steps Dana Gas has taken to minimize its exposure to potential actions by other creditors acting under cross default clauses.  This limits potential collateral (secondary) damage (pun intended).  It also lessens Sukuk holders’ negotiating leverage by reducing/eliminating this threat.

The step also prefers UAE creditors.  A step not likely to be received well by Sukuk holders. 

Let’s let DG make this case by using quotes from the Directors’ Report in its 1Q2017 interim unaudited financials.  As customary, red boldface to distinguish AA’s “distinguished” comments. Black boldface to highlight particularly relevant statements by DG. 

“Subsequent to quarter end, in early May, the Company prepaid the Zora outstanding loan amounting to USD 60 million (AED 220 million) plus applicable interests/costs.”    DG’s 1Q2107 financials were signed 11 May by the auditors which means that the prepayment took place before that date.  AA would hope that creditors would ask if that was before or after the 3 May announcement that the Sukuk was going to be rescheduled. 

But it gets even better.

After announcing the prepayment, in the very next sentence DG states: 

“On 3 May 2017 the Company announced that, due to continued challenges it faces around cash collections and the resulting need to focus on short to medium term cash preservation, it will commence restructuring discussions with the holders of both its Sukuk dated 8 May 2013.”

According to DG’s 1Q2017 interim report note 11, as per contractual terms, USD 33 million of the Zora facility was not due for repayment until 2018.  Zora is located in the UAE and the lending syndicate is composed of UAE banks.      

As a side note, interest due on the Sukuk next month would be approximately USD 14 million.  Apparently, the USD 14 million are worth more than the USD 33 million prepayment to local banks –roughly 2.4x as valuable – when it comes to cash “preservation”.    

Zora was secured by a very robust security package as is typical project finance structure.  Lots of tripwires and potential pain for DG. 

“Project Security covers, commercial mortgage over mortgage-able Zora gas field project assets (onshore & offshore), assignment of rights under Gas Sales Purchase Agreements, assignment of all Dana Gas Exploration FZE bank accounts, assignment of Zora Project Insurance proceeds, Project performance Guarantees from Contractors & Irrevocable Letter of Credits from Sharjah Petroleum Council. Dana Gas PJSC has pledged the shares of Dana Gas Explorations FZE in favour of security agent. Dana Gas PJSC is also a Guarantor for the entire tenure of the term facility”

As noted elsewhere in the note there was also a cash sweep mechanism. 

Prepayment neatly resolves the issue of cross default for an income earning project in the UAE albeit small “beer” earnings compared to its Iraqi and Egyptian operations. 

Dana also repaid roughly 84% of the FYE 2016 USD 12.5 million outstanding murabaha facility from Mashrekbank Egypt again as per note 11 1Q2017 financials.  This facility was cash collateralized. 

UAE banks’ exposure to Dana is eliminated or reduced.  Dana has clearly “preferred” UAE creditors over the Sukuk holders, though one might argue that these are relatively small amounts when compared to the approximate USD 700 million outstanding on the Sukuk and removing these makes the restructuring less complicated. 

Some USD 25 million of debt remains for two sale/lease back transactions for DG Egypt (DGE):  (a) a building in Egypt and (b) spare parts/equipment acquired some years ago that have yet to be used as per note 25 c.  Perhaps DGE would welcome returning the latter to the lessor. 

In following posts I’ll pick up the promised discussion of winners and losers, well mostly losers, from DG’s "clever boots" maneuver.