UAE Laws and Islamic Finance

Laws of the UAE and Islamic Finance

Archive for April 19, 2019

The Nakheel Sukuk and the Special Tribunal Related to Dubai World

The Nakheel Sukuk and the Special Tribunal Related to Dubai World


Nakheel is a member of Dubai world and one of the UAE’s largest property developers.  Dubai World is one of the largest global holding companies and was established to hold the interests of the government of Dubai in companies under common management control.  In December 2006, Dubai Islamic Bank arranged the Pre-Qualified Public offer Equity Linked Sukuk issue for Nakheel.  The sukuk was approved by the Shari’ah Board of Dubai Islamic Bank.  It was documented according to the Eurobond Standard (Reg S) and was listed on the Dubai International Financial Exchange.  It was the largest sukuk offering executed in the world at US$3.52 billion at that time.  The issue was oversubscribed by 2.5 times and the total order book was US$6 Billion.  As the sukuk were given the status of sovereign bond, investors assumed this was a government guaranteed sukuk, which gave them a false sense of security.  Moody’s and Standard and Poor’s gave the sukuk an A+ rating.  The governing law of the sukuk was English and UAE law. (Islamic Finance News Deals of the Year: 2006)


The underlying sukuk structure was the sukuk manfaa-ijarah.  Salah says that this structure resembles a conventional lease-and-lease back transaction between the party who is in need of financing or the originator and a Special Purpose Vehicle (SPV).  The transaction starts with the originator, who sets up an SPV and selects certain tangible assets for the transaction.  The originator leases the tangible assets pursuant to a Head Ijarah Lease Agreement to the SPV, usually for a long period of time (i.e. 50 years).   The entire lease sum is paid up front.  This amount is financed by the SPV through the issuance of sukuk.  The SPV holds the assets in trust for the sukuk holders.  For the sukuk to be tradable in the secondary markets, the sukuk holders must gain some form of ownership in these underlying tangible assets.  This is structured by giving the sukuk holders the beneficial ownership of these assets.  As the beneficial owners, the sukuk holders are entitled to the profit that is generated over these underlying assets.  Next, the SPV leases the tangible assets back to the originator in accordance with the sub-ijarah lease agreement for a short period i.e. three years.  During the lease period, the SPV holds the assets in trusts as a trustee for the sukuk holders.  The originator makes periodic lease payments to the SPV.  The sukuk holders are entitled to these lease payments, since they are the beneficiaries of the underlying tangible assets.  The SPV in turn pays these lease payments as periodic payments on the sukuk to the sukuk holders.  At maturity date (I.e. after three years), the Sub Ijarah Lease Agreement ends and the Head Ijarah Lease Agreement is terminated.  The originator pays an amount of money equal to the principal amount of the sukuk holders.  The SPV will use this sum to repay the principal amount to the sukuk holders.  (Salah: 2010)


Specifically, the sukuk proceeds were used to fund the development of several projects including Jebel Ali Village, Jumeirah Islands, Dubai Promenade, the Lost City, Jumeirah Park, Jumeirah Village, Dubai Waterfront, and International City.  The developer wanted to build a city twice the size of Hong Kong Island, with skyscrapers for 1.5 million residents ringed by a 75 Km canal at Dubai Waterfront. (Salah: 2010). The return on the certificates were calculated on the basis of a fixed return of 6.345% per annum (the QPO yield).  On the 14th June and 14th December in each year (Each periodic distribution date) commencing on 14th June 2007, the issuer will pay periodic distribution amounts to each certificate holder calculated as the product of 50% of the QPO yield and the principal amount of the certificate on a 30/360 basis. In addition, on the redemption date the issuer will pay to each certificate holder (i) the final distribution amount calculated as the product of 50% of the QPO Yield and the principal amount of the certificates on a 30/360 basis.  (Islamic finance News Deals of the Year: 2006)


The originator was Nakheel Holdings – 1 LLC.  Nakheel Holdings 1, 2, and 3 were subsidiaries of Nakheel World LLC, which held 100% of the shares in all three Nakheel Holdings.  All three Nakheel Holdings had a subsidiary, Nakheel PJSC, which was operating in the real estate sector in Dubai.  The parent company and 100% shareholder of Nakheel World was Dubai World, a 100% state-owned company.


The Nakheel Sukuk was structured as a 3 year Pre-QPO Equity Linked Ijarah Sukuk wherein funds were raised at the Nakheel Holdings 1 (obligor) level.  Under a purchase agreement, certain pre-identified assets were sold to Nakheel Development Limited, an offshore special purpose vehicle (Issuer SPV) that was formulated as a free zone company in the Jebel Ali Free Zone. (Islamic finance News Deals of the Year: 2006)  The SPV issued trust certificates (sukuk) for US$3.52 billion in order to purchase assets from Nakheel Holdings 1 for 50 years including land, building, and property at the Dubai Waterfront valued at AED 15.5 billion dated October 31, 2006 by Jone Lang Lasalle. (Zaheer: 2013 )  The purchased assets were subsequently leased by the SPV, as trustee to the sukuk holders, to Nakheel Holdings 2 for a period of 3 years. Half of the lease amount was paid to sukuk holders via the SPV and the other half is deferred until the maturity of the sukuk.  (Zaheer: 2013)


The lease comprised six consecutive periods of six months each. (Salah: 2010) The rental payments of the lease periods matched the periodic distribution payments on the sukuk so Nakheel SPV would pay the lease payments to the sukuk holders.  At the redemption date of the sukuk, the lessee had to purchase the sukuk assets from the lessor in accordance with a purchase undertaking at a certain exercise price.  This exercise price was equal to the redemption amount of the sukuk and would be used to pay back the principal amount to the sukuk holders.  In this way, the sukuk were redeemed (Salah: 2010).


A co-obligor guarantee was executed by Nakheel Holdings 1, Nakheel Holdings 2, and Nakheel Holdings 3 (together the co-obligors) in favor of the issuer SPV under which the co-obligors jointly and severally, irrevocably, and unconditionally guarantee the payment, delivery, and other obligations of each other under the transaction documents.  (Islamic finance News Deals of the Year: 2006)


As a form of credit enhancement, Dubai World (Guarantor) also granted a guarantee in favor of the issuer under which the guarantor has irrevocably and unconditionally guaranteed the payment obligations of the guarantor under the Dubai World guarantee constitute unsecured, direct, unconditional, and insubordinate obligations of the guarantor, which will at all times rank pari passu with all other unsecured and insubordinate obligations of the guarantor. Further, in order to secure the payment obligations of the co-obligors, Nakheel Holdings 1 has granted a mortgage over property and a share pledge of Nakheel PJSC shares in favor of the security trustee.  (Islamic finance News Deals of the Year: 2006)


There is a guaranteed allocation in the sukuk structure.  Under the subscription rights sale undertaking, the sukuk structure incorporated a guaranteed allocation of 25% of the sukuk amount to investors in any qualifying public offering (QPO) undertaken by the Nakheel group during the tenor of the sukuk.  A QPO means any primary or secondary equity offering of the authorized or issued share capital by any member of the Nakheel Group including in the form of global depository receipts, American depositary receipts, any offering of mandatory exchangeable or convertible bonds, warrants and rights issues, in each case listed on any international stock exchange. Each certificate provides the holder the right to subscribe for QPO shares at the discount of 5% on the indicative share price on each QPO that is launched prior to redemption of the certificates.  A QPO shall be deemed to be launched when the initial, preliminary, pathfinder or other equivalent offering document is published and/or made available to potential investors in connection with that QPO.  The rights of certificate holders in aggregate is limited to an aggregate number of QPO shares equal to 30% of the aggregate number of QPO shares to be issued.  As such, the aggregate value of the subscription rights in all QPO launched after the closing date and prior to the redemption date including the value of the subscription rights in that QPO does not exceed in aggregate US$880 million, being 25% of the sukuk issuance amount.  However, in the event that the Nakheel Group does not float shares, then investors will receive a higher yield of up to 200 bps depending on the value of the subscription rights allocated to the sukuk holders.  (Islamic finance News Deals of the Year: 2006)


The sukuk had a three year tenor, but investors will also receive look back rights for allocation of Nakheel Group QPO shares that extend into a fourth year.  If a QPO takes place between years 3 and 4, investors can participate as though the QPO had taken place at the end of three years.  On December 14, 2009, the lessee had to purchase the sukuk assets from the lessor in accordance with a purchase undertaking at a certain exercise price.  However, the Nakheel sukuk was now nearing default as the Nakheel Holding was highly leveraged and it cash flow dried up when Dubai’s property sector experienced a slow-down after the global financial crisis.  (Islamic finance News Deals of the Year: 2006)  In November 2009, Dubai World requested a restructuring of its $26 billion debt.  Investors feared that its $4 Billion Nakheel sukuk would also default.


The question arises as to how a default or disputes involving Nakheel or Dubai World would be settled under English and UAE laws?  According to Friel and Kumpf, the sukuk was governed by English law and structured using English trust law concepts to bestow only beneficial ownership on the investors in the form of leasehold rights. (Friel and Kumf: 2015)  This means that there was no proprietary transfer of ownership rights in these underlying tangible assets from Nakheel Holdings 1 to Nakheel SPV – there was merely a transfer of leasehold rights. (Salah: 2010)  Leasehold rights are not considered real rights under UAE law, where the assets indirectly owned by the government were located.  Government assets may not be attached under UAE law. (Friel and Kumf: 2015)  Because  the contractual agreements (i.e. purchase undertakings, guarantees, etc.) are not sufficient to give protection to creditors in an insolvency scenario involving all parties (including the guarantors), proprietary rights are especially important.  (Salah: 2010)  In Dubai, they are viewed as unregistered personal contractual rights binding the parties as opposed to rights attached to the land in question.  (Salah: 2010)  In the case of insolvency, proprietary protection is more important than a contractual agreement.  (Salah: 2010)


In order to secure the position of the sukuk holders as secured creditors through Nakheel SPV, security rights were granted.  In addition, there were also rights of mortgages granted by Nakheel Holdings 1 to the underlying tangible assets.  (Salah: 2010) However, neither security rights or rights or mortgages offered the protection required by sukuk holders to safeguard their investments.


Although the default was prevented by an Abu Dhabi bail out, a Special Tribunal Related to Dubai World was created to adjudicate disputes involving Nakheel, Dubai World, and its’ subsidiaries using amended DIFC law, commercial custom, principles of justice, Dubai legislation, and various Regulations at the DIFC Courts.  The Ruler of Dubai, His Highness Sheikh Mohammed Bin Rashed Al Makhtoum, issued (Dubai) Decree 57 of 2009 to establish the Dubai World Tribunal related to the settlement of the financial position of Dubai World and its subsidiaries.  This stipulated that any claims by or against Dubai World and its subsidiaries were to be decided by a three to five man tribunal.  (Holman Fenwick Willan)


The Tribunal is entitled to hear and decide, inter alia, any demand to dissolve or liquidate the state-owned corporation, which is Dubai World and/or its subsidiaries.  The Tribunal has jurisdiction to hear and decide any demand or claim submitted against the Dubai World Group including hearing and deciding any demand to dissolve or liquidate the Dubai World Group; and any person related to the settlement of the financial obligations of the Dubai World Group, including the Chairman and members of the Board of Directors, as well as all the employees and workers of the Dubai World Group.  That jurisdiction was extended to include disputes brought by Dubai World and its subsidiaries by Decree No. 11 of 2010 – Amending Decree No. 57 of 2009.  The Tribunal has power to issue any interim and interlocutory orders and decisions, including injunctions preventing any person from undertaking an act or requiring a person to perform an act, or other order as the Tribunal considers appropriate.  Decisions and orders of the Tribunal are to be issued by the unanimous or majority votes of its members and in the name of the HH The Ruler of Dubai.  The decisions and orders of the Tribunal are final, irrevocable and not subject to any appeal or review. The decisions and orders issued in the Emirate by the Tribunal are to be executed by a competent execution judge.  The execution judge is not to take any action that may hinder the execution of the decision or order issued by the Tribunal.  The Tribunal is to have its seat and hold hearings in the DIFC.  All proceedings are to be open to the public unless the Tribunal decides otherwise for considerations relating to the conduct of justice or to protect confidentiality of information.


Rather than create a tribunal for each individual sukuk default with its own laws, rules, and seat, it makes more sense and would streamline sukuk dispute and default adjudication if there existed one global entity such as the Sukuk Bankruptcy Tribunal (SBT) where all sukuk disputes and defaults were settled according to a standardized dispute resolution contract with a built in dispute resolution mechanism, arbitration centre, SBT law, arbitration rules, and  the procedural laws of the Seat, which would be Dubai.


In fact, Dubai World is an interesting case because as the laws of England and the UAE were designated in the prospectus, both English law and UAE law have bankruptcy laws and procedures.  However, the Ruler of Dubai, Mohammed Bin Rashid Al Maktoum, authorized the formation of an independent ad hoc tribunal based on the laws of the DIFC with amendments to settle any claims arising from the Dubai World and Nakheel bankruptcies.  It would certainly be erratic and harmful to the Islamic finance industry if every time we have a sukuk default, an ad hoc and independent tribunal formulated on its own laws, rules, and procedures was established to adjudicate the sukuk default, dispute, or bankruptcy.


Decree No. 57 for 2009 set up a three to five man tribunal (Article 2) to hear and decide any demand or claim against (a) Dubai World and/or its Subsidiaries, including hearing and deciding any demand to dissolve or liquidate Dubai World and/or its Subsidiaries; and (b) Any person related to the settlement of the financial obligations of Dubai World and/or its Subsidiaries, including the Chairman and members of the Board of Directors, as well as all the employees and workers of Dubai World and/or its Subsidiaries.  The Tribunal can also issue the interim and interlocutory orders and decisions, including injunctions to any person to act or not to act, or other order as the Tribunal considers appropriate.  The Tribunal, may as it considers appropriate, assign or appoint as experts persons having expertise and competence in the matters submitted to it.  (Article 3)


As its governing law, the Tribunal chose (Article 4) (1) DIFC Law No (3) of 2009 Concerning the law of insolvency, according to the amendments in the Schedule hereto; (2) The Regulations issued by the Board of Directors of the DIFCA Concerning DIFC Insolvency Regulation, according to the amendments stated in the Schedule hereto; (3) DIFC Law No (10) of 2004 Concerning the Court of DIFC, according to the amendments stated in the Schedule hereto; (4) Legislation in force in the Emirate; (5) Commercial Custom; and (6) Principles of Justice, and rules of righteousness and equity.


Article 5 states that the Tribunal shall have its seat and hold its hearings in the DIFC and that all decisions are final, irrevocable, and not subject to any appeal or review.  According to Article 8, the Government and the DIFC shall provide the necessary administrative and financial support to the Tribunal for it to discharge its duties under this Decree.  The Chairman of the Tribunal or the Tribunal member, to who he delegates such responsibility, shall undertake the task of supervising all the administrative and financial affairs relating to the work of the Tribunal.


The Tribunal issued its first Practice Direction on 30 March 2010 clarifying that it will respect and enforce arbitration agreements.  Counterparties who agreed to arbitration clauses in their contracts with Nakheel (and related Dubai World entities) are not entitled to commence their proceedings before the Tribunal.  In this case, the parties to the dispute would have to initiate arbitration and then apply to the Tribunal for the enforcement of the arbitration award. (Holman Fenwick Willan)


On 22 September 2011, the Tribunal issued Practice Direction 3 of 2011, which mentions that Nakheel PJSC and certain of its subsidiaries and affiliates ceased to be subsidiaries of Dubai World with effect from 23 August 2011.  The Tribunal continues to exercise jurisdiction over proceedings commenced before 23 August 2011, but it is unclear how things will proceed for disputes arising after this date.  (Holman Fenwick Willan)


Potential claimants may now have to apply to the Director General of the Department of Legal Affairs for the Government of Dubai pursuant to Government Claim Law No. 3 of 1996 (as amended) and the law establishing the Department of Legal Affairs for the Government of Dubai Law No. 32 of 2008.  This would add a further layer to the dispute resolution process.  In addition, one must have the approval of the Government of Dubai to enforce an award against the Government of Dubai. (Holman Fenwick Willan) Hence, with the split of Nakheel to the government, even with this Special Tribunal Related to Dubai World, it is difficult to enforce judgments against the Government of Dubai as their approval is required for such enforcement.  Once a judgment is enforced at the Special Tribunal Related to Dubai World, it is final, irrevocable, and not subject to review and/or appeal as per Article 5 of Decree No. 57 of 2009.


I think it is clearly evident the advantages of creating the Sukuk Bankruptcy Tribunal (SBT) as part of the Dubai World Islamic Finance Arbitration Centre (DWIFAC) and Jurisprudence Office (DWIFACJO) in settling the world’s sukuk disputes.  A standardized dispute resolution contract with a built in dispute resolution mechanism would be attached to all sukuk transactions around the world designating the SBT as the dispute resolution mechanism.  Any dispute in a sukuk would be dealt with first by the built in contractual dispute resolution mechanism in the SBT sukuk contract as described herein in the DWIFAC procedure and only if the ruling of the Dispute Adjudication Board (DAB) was not followed or a Notice of Dissatisfaction was filed can the dispute then be directed to the SBT for arbitration.

East Cameron Gas Sukuk Bankruptcy

East Cameron Gas Sukuk Bankruptcy

East Cameron Partners (ECP) issued sukuk of USD165.67 million in June 2006 with a maturity period of 13 years as a private placement under Regulation D and an international offering under Regulation S, which means that the sukuk certificates represented an ownership stake in ECG. (Colon: 2019)  East Cameron Partners (ECP) was an independent oil and gas exploration company that owned leasehold interests in a producing natural gas and condensate field in federal waters adjacent to Cameron Parish, Louisiana.  East Cameron’s leasehold interests consisted of a 100% undivided record title interest with a 79.87% net revenue interest subject to certain Overriding Royalty Interests in East Cameron Block 71/72.  These lease interests arose from federal oil and gas leases governed by the Outer Continental Shelf Lands Act and administered by the Minerals Management Service of the United States Department of the Interior. (East Cameron Partners L.P. v. Louisiana Offshore Holding LLC & Ors [2009]..)

ECP saw the sukuk issuance as an affordable and flexible finance opportunity through which it could raise the funds needed to purchase other shares from the non-operating partner, Macquarie Bank, whom wished to sell its share in the business.  The underlying contract was musharakah in which sukuk investors owned so called Overriding Royalty Interest (ORRI) in two gas properties located in the shallow waters offshore the state of Louisiana, USA through an SPV.  Specifically, the structure of the transaction involved the purchase of an ORRI carved out of US federal offshore leases as mentioned herein.  Under local (Louisiana) law, ORRI are considered real property.  Because the transaction involved real property, the Shari’ah Scholars approved this as an asset-backed securitization in the form of a sukuk al-Musharakah.  The sukuk investors share the profits and losses in the production of the originators in a pre-determined ratio determined by their relative capital shares fixed in the sukuk documents.  The SPV was called East Cameron Gas Company (ECGP) and incorporated in the Cayman Islands.  (Goud: 2010)

The Issuer entered into a funding arrangement with Louisiana Offshore Holdings (LOH) with the proceeds of the issue flowing back to the oil and gas operating company, ECP.  Proceeds from the gas production flowed to LOH (Owner of the ORRI) and were shared between the Issuer and ECP.  The Issuer passed along its share of the proceeds to the ECP sukuk investors to repay the 11.25% expected return and part of the principal. (Hawkamah Institute of Corporate Governance: 2011)  Although the investors would share in the profits or losses derived from the success or failure of the underlying assets, the investors bore the risk of the oil and gas reserves being insufficient to fully support the issuance of the sukuk, natural disaster risk, and price fluctuation risk.  (Hawkamah Institute of Corporate Governance: 2011)


This was the first sukuk issued by a company based in the United States and rated by Standard and Poor’s.  The sukuk were initially rated CCC+ by Standard and Poor’s and then downgraded to CC and finally D. Although the East Cameron Gas sukuk had a fixed payment of 11.25% annually, there was also a variable component because the sukuk returns depended upon the production quantities  (the ORRI specified a fixed quantity of natural gas be delivered to the SPV).  It also contained a redemption feature by where a percentage of the sukuk would be redeemed if production exceeded a certain level.

Sukuk holders were also exposed to risks found in the energy sector i.e. the volatility of natural gas and condensate prices, which may adversely affect payments on the sukuk.  In order to hedge against severe price fluctuations in oil and gas markets, there was a Shari’ah compliant hedge that established a price collar between $7 and $8 per million BTU (MMbtu) on half the expected products gas production and a put option at $6 per MMbtu for an additional quarter of anticipated production (Goud: 2010).

Further described in the offering document was that closing transactions would occur including “purchase of natural gas put options for US$4.05 million pursuant to a Hedge Agreement (the “Hedge” Agreement) with Merrill Lynch Commodities, Inc. (the “Hedge Counterparty”) that, in combination with other hedges provided under the Hedge Agreement, are intended to mitigate the Purchaser SPV’s exposure to change in natural gas prices.  In addition, Merrill Lynch Credit Products LLC would provide a letter of credit on behalf of the Purchaser SPV to secure the Purchaser SPV’s obligations under the Hedge Agreement.  The Shari’ah compliant hedges limited the impact of rising and falling prices on the ability of the production to be sufficient to generate returns for investors.  (Goud: 2010)


In sum, the issuer SPV, East Cameron Gas Company (ECGP), incorporated in the Cayman Islands issued USD165.7 million of sukuk whose proceeds would be used to buy the ORRI from the Purchaser SPV following a Funding Agreement for USD$113.8 million.  The remaining amount was appropriated for a development plan, a reserve account, and the purchase of put options for natural gas to hedge against the risk of fall in gas prices.  The originator contributed his share of the capital in the form of transfer of ORRI into the purchaser SPV.  Next, the purchaser SPV, holding ORRI in the properties, would be entitled to around 90 percent of ECP’s net revenue generated through gas production.  (Zaheer: 2013)

The production would be sold to two off-takers with Merrill Lynch as a backup off-taker.  Proceedings of the oil and gas sale would be transferred to an allocation account.  After paying around 20 percent to government and private ORRI, the remaining amount would be transferred to the Purchaser SPV.  Next, the purchaser SPV would allocate 10 percent for the originator and the remainder for the payment of expenses, periodic sukuk returns, and redemption amount.  Any excess amount would go to originator and early redemption of the sukuk equally.  Upon maturity of sukuk, the issuer SPV would redeem all the sukuk against the amount left to be transferred to the sukuk holders (Zaheer: 2013).

Instead of being solely used to support the capital and operating costs of drilling and operating wells in the Gulf of Mexico for East Cameron Partners, the proceeds were also used to pay most of the conventional debt of the company.   This brought the debt-to-equity ratio of the company to a Shari’ah compliant level, however, also bankrupted the sukuk.

Furthermore, the originator’s business was located in the Gulf Of Mexico making it vulnerable to severe weather and other effects.  Shortly after the September 2008 Hurricane Katrina damaged the underlying assets of the sukuk, S & P downgraded the issuance as a result of the negative impact from the hydrocarbon mix shortfall enforcement event on the overriding royalty interest in oil and gas reserves (ORRI), which was the primary collateral for the sukuk.  This enforcement event was triggered by the breach of the 90% minimum stressed reserve level of the hydrocarbon mix threshold stipulated in the transaction documents (Lampasona, 2009).  Thus, in 2008 ECP experienced a shortfall on the ORRI in oil and gas, which is the primary collateral used as the underlying asset to the sukuk contract.  Consequently, the shortfall event triggered breach of approximately 90% of the reserve level of the threshold contained in the contractual agreement. (Busari: 2019)

On September 17, 2008, a Notice that an Exogenous Enforcement Event, namely a Hydrocarbon Mix Shortfall Exogenous Enforcement Event, was served on the Purchaser SPV (LOH) and East Cameron Partners LP (the “Originator” and, subsequently, the “Debtor”)(McMillen: 2011)  S& P downgraded the transaction to CC from CCC+ when the structure hit the aforementioned trigger, breaching 90% minimum stressed reserve level of the hydrocarbon mix threshold.

On October 16, 2008 East Cameron Partners filed for bankruptcy protection under chapter 11 in the United States Bankruptcy Court for the Western District of Louisiana “Bankruptcy Court”, claiming its inability to pay the periodic returns on the East Cameron Gas sukuk to sukuk certificate holders.

In March 2009, the agency cut the deal to D on skipped payments and withdrew the rating; the latter event was in response to a failure to receive service reports (Lampasona: 2009).


The issue at hand for the Bankruptcy Court was whether or not the transaction  was a secured loan or a true sale.  True sale is a situation whereby contractual parties agree to transfer a financial asset for fair value with the intent of a sale (Busari: 2019)  The originator claimed that the transaction was not a true sale, but a secured loan.  ECP argued that the ownership of ORRI was not transferred from ECP to Louisiana Offshore Holdings or “LOH” as the transaction was not a true-sale agreement.  ECP further claimed that the underlying asset is merely a pledge as security for a loan in favour of LOH.  (Busari: 2019)


Specifically, according to Colon, ECP requested that the bankruptcy court declare (1) the sukuk transaction was a loan; (2) that the conveyance of the ORRI (i.e.) the underlying asst securitizing the sukuk and making the private/international offering of ECG a worthwhile investment, did not transfer ownership of the ORRI to ECG; and (3) the ORRI, was merely security for ECG’s loan to ECP.  (Colon: 2019).  Colon points out that ECP requested the court to interpret the distinctions of the sukuk transaction that made in Shari’ah compliant as ineffective, as nothing more than a conventional secured loan. (Colon: 2019)


Under conditions of a true sale, the sukuk investors would have the sole rights to the underlying assets and would not have to stand in line behind any other creditors.  The contractual agreement of the true sale would ensure the bankruptcy remoteness of the SPV whereby in the event of a default, the sukuk holders could have recourse to the underlying asset that has been established through a true sale agreement. (Busari: 2019)  Under the secured loan, the originator would have rights to the assets only after resolving creditor claims in Chapter 7 liquidation.


In a motion to dismiss ECP’s complaint and accompanying memorandum of law, the Sukuk Certificate Holders responded to the request for declaratory judgment by arguing: (1) that the ORRI conveyance was indeed a true sale under controlling Louisiana law; (2) that ECP’s statements of law should be disregarded in favour of Louisiana’s version of the Uniform Commercial Code; (3) that the complaint should be dismissed because it asked the court to rewrite the contract; and (4) the complaint should be dismissed because though asking the court to recharacterize the sukuk as a loan, it left out every major detail of what the loan should be. (Colon: 2019).  The Court granted the sukuk certificate holders motion to dismiss and the court did not deviate from the objective terms of the sukuk agreement. (Colon: 2019)


The court found that it was a true sale and that the sukuk investors had the sole rights to the underlying assets. Hence, it was decided that the sukuk holders are the owners of the ORRI from the oil and gas reserves as the ORRI is considered real property in the jurisdiction of the state of Louisiana. However, the matter was unclear as to whether sukuk holders enjoyed contractual rights to the assets like bondholders or creditors or whether they enjoyed proprietary rights and were, therefore, considered by the courts to be equity holders (Khnifer, 2010).


The court ruled that the SPV assets would be treated as the product of a true sale.  The sukuk certificate holders were able to get full ownership and possession of the assets without sharing it with the other creditors.  This essentially meant that the SPV did in fact own the assets and was not merely a collateral holder for secured loans.  While the event proved successful for sukuk investors, it was a setback for the Islamic finance industry in that the deal was structured as a purchase rather than a distribution to owners.  The assets of the sukuk went to the certificate holders free and clear of claims of creditors, however, a precedent was set that the sukuk certificate holders did not own undivided interest in the assets.  The sukuk certificate holders were treated as if they were third party buyers rather than the asset owners or even secured lenders (Khnifer: 2010).  The Bankruptcy Court did not apply Shari’ah law to the transaction and settled the sukuk bankruptcy as a conventional and common law transaction thereby turning it into a conventional transaction by default. However, the court did uphold the sukuk agreement.  It would be ideal if there was one Sukuk Bankruptcy Tribunal (SBT) attached to the Dubai World Islamic Finance Arbitration Centre (DWIFAC) to settle all of the world’s sukuk disputes and bankruptcies located in Dubai, UAE rather than common law jurisdictions scattered around the world.

UAE Laws and Islamic Finance

Laws of the UAE and Islamic Finance