Read our introduction to Sukuk Structures here.
Dana Gas is attempting to render its USD 300m 9% 2017 sukuk and USD 350m 7% 2017 convertibles unenforceable under the guise of the Islamic debt not adhering to Shariah principles. But creditors, Islamic lawyers and market observers alike see the move as a delaying tactic and an attempt to jam an unfavourable proposal on the bonds.
If the company is successful in retrospectively declaring the bonds unlawful, it could send shockwaves through the Islamic Finance market and dent the confidence of investors in sukuk structures.
Recently, the bonds rallied on expectations of an amend-and-extend proposal, with enhanced economics for noteholders if multi-billion dollar arbitration awards came in. But following the latest news they have dived to 78/82, with the shares rallying hard – starting two days ahead of the announcement – as the threat of heavy dilution receded.
Yesterday morning (14 June), Dana stated an initial hearing is scheduled in the Sharjah Federal Court of First Instance for 25 December 2017. The court issued an injunction pending determination of the company’s application to have its sukuk dated 8 May 2013 declared unlawful and unenforceable.
Dana says that “due to the evolution and continual development of financial instruments and their interpretation, the company has received legal advice that the sukuk in its present form is not shariah compliant and therefore is unlawful under UAE law.”
Under the current structure, the existing instruments are not enforceable by bondholders for three reasons, which the company is using to push its claim in the courts, said a source close to the situation.
The existing terms stipulate that the profit rate gets paid regardless of performance, which does not comply with Islamic finance doctrine. Secondly, the repurchase price is pre-fixed, and, thirdly, the calculation of payments is based on interest and not profit, both of which do not appease current Shariah rules on Islamic finance, he said.
In addition, the company announced today it has filed an injunction in the British Virgin Islands. This is to stop bondholders enforcing at an intermediate HoldCo which has share pledges over the Egyptian assets, according to a second source close to the situation.
A veiled attempt to delay
Dana is setting itself up for yet another fight with its bondholders, after an acrimonious restructuring in 2012. The company has sufficient cash to make the upcoming profit payments on its bonds on 31 July, but has already declared it will not pay and will roll the payments into the restructuring.
It only recently hired financial advisors and has limited contact with creditors, and the latest move is seen by the creditors and their advisors as overtly aggressive.
“This is the one of worst starting points for negotiation that I’ve ever seen in a restructuring,” said the second source close.
Dana is employing an increasingly popular tactic, used when an issuer can’t make payment to buy time and negotiate, said one London-based Islamic Finance lawyer. “It’s not something that’s been laid before a judge previously. Some fairly vociferous factions claimed for a long time that being open to this type of retrospective claim is a major problem with Islamic finance.”
Two Dubai-based lawyers away from the deal said however that two companies from Bahrain and Kuwait had also attempted to invalidate Islamic debt by taking the matter to a judge.
“There was one case previously that might serve as a precedent when the borrower, Investment Dar in Kuwait, tried to walk away from its obligations, a UAE-based portfolio manager said. They claimed the deal was not Shariah-compliant even though it had been signed off by the company’s own Shariah scholars, who themselves made the point that this should have little bearing on its legality. “The case was duly thrown out.”
A GCC-based Islamic banker views the recent developments as a bold and opportunistic move from Dana Gas’s part. Whenever an issuer prints a sukuk, the lead arrangers, Shariah boards and scholars must conduct their due diligence, as they are tasked with interpreting the Shariah and ensuring the instrument is compliant, he said.
Dar Al-Sharia, who confirmed that the transaction documents were shariah-compliant at the time, have been involved in several high-profile deals, said the banker.
Legitimacy of Islamic debt structures
Doubting the legitimacy of the instruments under Islamic rules and taking the matter to court could set a dangerous precedent, continued the same banker. It could lead to other investors questioning the legitimacy of other Islamic debt instruments. If there were any doubts regarding the compliance of the notes, these should have been raised at the beginning of the deal, not half way down the line on the way to maturity, he said.
A second GCC-based banker thought the matter has more to do with Dana Gas’s poor business performance and less with the validity of the sukuk.
A second UAE-based portfolio manager expressed fears that the events brought on by Dana would put a dampener on global acceptance of sukuk as an investment. The company’s position as an issuer of a faulty sukuk is untenable. But, when the test for a sukuk in court means getting a ruling from a Sharjah court, why shouldn’t it create a precedent, he said.
The Dana Gas management has changed several times over the years, but clearly their [negotiating] approach hasn’t, said the first portfolio manager. If their plans prove successful, there will suddenly be a lot of risk out there for Islamic finance investors, he said.
“We haven’t had this level of dispute since the period when Taqi Usmani questioned whether the musharakah and murabaha structures were Shariah-compliant,” said the first portfolio manager. “We agreed with the AAOIFI (Accounting and Auditing Organization for Islamic Financial Institutions) standards on this, but it didn’t make contracts non-legally binding. No one was trying to wriggle out of their obligations, even though as it turned out a lot of these musharakah deals defaulted.”
The market was expecting a much more creditor-friendly restructuring, but this is looking more like the 2012 restructuring, when investors declared a technical default, he continued, adding that Dana seems to be getting its own back. “The majority of investors are international, so Dana will find themselves in court. Most of the Dana risk has gravitated to a couple of guys and the coordination could be a lot stronger than Dana expects.”
Filing in the wrong courts?
The sukuk documents are governed by English, Cayman and Egyptian law. But, the oil and natural gas company is pursuing the matter in a UAE court.
The two Dubai-based lawyers said the company requires a judgment from an English court in order to enforce it in the Emirate. While a mudaraba structure may be governed by the UAE law, Dana Gas won’t be able to get rid of the fact that they borrowed the funds in the first place, which the Sharjah court may easily argue that it enriched the company, said one of the lawyers. The bondholders injected money into the pot, and the company remains indebted to them.
A sukuk mudarabah is meant to operate on a profit-sharing basis. Guaranteeing payments under such structure goes against Shariah principles, said a third source close to the situation. A mudarabah should operate on a profit-sharing basis as a contract between two parties whereby one provides capital to the other party who manages the project, as reported. The profit is determined by a pre-agreed ratio. In the event of a loss under the mudaraba structure, the party putting up the capital incurs the loss.
For more details on mudaraba structures – see our sukuk primer.
The first source close said that Dana was filing in a UAE court because the mudabarah agreement and most of the securities are governed by the law of the United Arab Emirates. He added that the company is incorporated and domiciled in the UAE and its shares are listed on the Abu Dhabi stock exchange. Further the sukuk transaction documents offend both Shariah principles and UAE law, making a domestic court most appropriate to consider these issues. The adoption of English law in the other sukuk transaction documents is on a non-exclusive jurisdiction basis and does not exclude the UAE jurisdiction or court.
But the two lawyers pointed out that the non-exclusivity clause is used mostly for the benefit of bondholders and not the borrower.
A fourth lawyer saw Dana’s attempts as a sheer delaying tactic, insisting the company requires an English law ruling, which will be very difficult to attain.
English law is quite clear on retrospective changes in indentures, said the first lawyer. Shariah law isn’t a jurisdiction, and it can’t overlay the jurisdiction of the governing law of an indenture. The matter will thus be governed by English law.
The sukuk information memorandum for both the ordinary notes and the convertibles recognises four governing laws. The declaration of trust, the agency agreement, the purchase undertaking, the sale undertaking, the security agreement, the security agency agreement, the ordinary certificates and the exchangeable certificates are governed by English law and subject to the non-exclusive jurisdiction of the English courts, according to the document.
Further, the “Mudarabah Agreement, the UAE Share Pledges and the UAE Mortgage will be governed by the laws of the UAE. The courts of the UAE have non-exclusive jurisdiction to hear all disputes relating to the Mudarabah Agreement and the UAE Share Pledges, and exclusive jurisdiction to hear all disputes relating to the UAE Mortgage.”
The Bahrain share pledge and the Egyptian assignment agreement are respectively governed by the laws of Bahrain and Egypt, according to the info memo.
Dana Gas requires a 75% vote by the debt holders to eliminate the convertibility of its USD 350m 7% 2017 notes, according to two creditors. But the first source close pointed out that this would not be required should the paper be deemed unlawful, and thus unenforceable.
Bondholder advisors are considering their legal options, said the second source close. Dana statements constitute an event of default and holders need not wait for non-payment to accelerate. There could be a slew of litigations in BVI, the UK and Sharjah, but all this achieves is a ramp up in legal costs, and makes it more difficult to restructure the business, he said.
Profiting from distress
The Sharjah-based company says it is seeking to exchange the outstanding Islamic bonds into new four-year non-convertible Shariah-compliant instruments carrying profit rates at less than half the current rates. The profit payments would be part-PIK and part-cash, according to a stock exchange announcement dated 13 June.
The two creditors said that the only good news from the recent developments is that they won’t need to take a haircut on the debt, but see the proposed 4% profit rate that the new instrument would carry as significantly below market rate.
The company would be deluded if it thinks it can borrow at the same level as the Government of Dubai, one of the creditors suggested. He noted that an issuer couldn’t retroactively invalidate a sukuk, warning that this would open a can of worms should the courts grant it.
The proposed profit rate is completely out of line with Dana’s comparables, such as Genel and Kuwait Energy, said the creditors. Genel has a USD 730m 7.5% 2019 bond, while Kuwait Energy placed in July 2014 a USD 250m 9.5% 2019 callable bond.
But the first source close to the situation, who deems the current coupon Dana is paying its bondholder too high vis-à-vis the prevailing market conditions, said that the two Kurdistan Regional Government-focused energy companies do not offer a fair benchmark to Dana.
Unlike the others, Dana has USD 900m worth of enforceable claims confirmed. Also, Dana Gas is still owed USD 187m by the Government of Egypt. Egypt has paid Dana USD 135m in receivables during 2017. In addition it is seeking to enforce on arbitral awards in its favour via the US courts seeking USD 2bn from the Kurdistan regional government.
Debtwire reported earlier this month that Dana Gas hired Houlihan Lokey for the financial restructuring of its due October 2017 sukuk, and appointed Squire Patton Boggs as company-side lawyers. The first source close to the situation said Al Tamimi is providing local legal advice. Creditors have mandated Moelis as financial advisor and selected Weil, Gotshal & Manges as lawyers.
BlackRock and Goldman Sachs Asset Management are the biggest creditors on Dana, while the ad hoc group will comprise local and foreign debt holders across both bonds.