UAE Laws and Islamic Finance

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The Impact of Covid 19 on the Islamic Finance Industry

The Impact of Covid 19 on the Islamic Finance Sector

By: Camille Paldi

*Versions of this article were first published by the Journal of Islamic Banking and Finance (JIBF) and the Indian Centre of Islamic Finance.

Covid 19 has rocked the world economy and shaken up employment around the world. According to the IMF, the global economy is expected to shrink by over 3 percent in 2020, the steepest slowdown since the Great Depression of the 1930’s. The President of the Islamic Development Bank, Bandar Al Hajjar, says that more than 25 million jobs could be lost worldwide due to the Covid- 19 pandemic.  According to S&P, Covid- 19 is causing a significant slowdown in core Islamic finance markets and a spike in unemployment.  Especially hard hit are SME’s and low to middle income earners.  In terms of Islamic finance, the focus of product evolution can now shift to addressing the Covid – 19 pandemic.

In terms of the Islamic finance industry, which, according to Oxford Business Group, had 11.4% growth in 2019, Standard and Poor’s predicted that it will have a declining low – to mid-single digit growth in 2020-2021 due to the pandemic. Furthermore, according to the Oxford Business Group, 2019 saw $162 billion in sukuk issuance as compared to a mere $100 billion in 2020. In the first five months of 2020, S&P says that the total volume of sukuk issuance dropped 38% compared with the same period in 2019.  Although, negatively affected in terms of growth rates and numbers, the Covid-19 pandemic has pushed Islamic finance into new realms and provided room for diversification in product development, especially in the area of sukuk. In fact, Aamir Rehman says that SDG or Sustainable Development Goals-aligned sukuk can be an important source of long-term capital for governments and companies engaged in the COVID response and recovery.

For example, according to the Oxford Business Group, the Islamic Development Bank recently raised $1.5 billion with its’ Sustainability Sukuk, the purpose of which is to assist member countries in Covid-19 recovery. Furthermore, the ISDB prepared a $2 billion package, dedicating a significant portion of it to support and empower MSMEs or the micro, small, and medium size enterprises sector in member countries. The Islamic Development Bank has begun to pursue sustainable and social sukuk and programs to counter the consequences of the Covid-19 pandemic. In addition, the International Islamic Trade Finance Corporation (ITFC) has pledged an initial $300 million response package to support strategic health, food, and energy trade flows and further grant elements to build the capacity of medical personnel and laboratories in OIC countries.

Furthermore, according to the Oxford Business Group, in June, 2020, Indonesia issued a $2.5 billion wakalah global sukuk dedicated to sustainable development and to support the Indonesian government’s coronavirus program. 

The Covid-19 pandemic is encouraging the Islamic finance industry to explore other financial tools such as qard hassan, social sukuk, zakat, trade finance, and waqf to aid in Covid- 19 relief.

According to S&P, qard hassan could provide cost-free breathing space until the environment stabilizes.  S&P refers to one example of when some GCC central banks opened free liquidity lines for financial institutions to provide subsidized lending to their corporate and small and midsize enterprise clients. 

In terms of social sukuk, S&P says that these instruments could help support the education and health care systems and attract ESG investors.

According to Aamir Rehman, zakat can also be an important component of national and NGO emergency support programs during the pandemic.  Rehman says that donors typically require that zakat be disbursed within one year of being given.  Rehman says that this focus on immediate benefit is well suited for crisis response such as the Covid- 19 crisis.  Rehman explains that zakat donors support both the poor and the economically insecure, an area of increased need in the pandemic. Rehman says that zakat donors often give cash transfers, which can be especially important in emergencies such as the Covid-19 crisis. S&P believes that zakat could help compensate for lost household income due to Covid 19.

Rehman also says that the financing of equipment, vehicles, and other sources of livelihood and trade finance are key mechanisms by which Islamic banks and financial institutions can support recovery.

Rehman adds that waqf endowments can be important contributors to long-term resilience. Rehman explains that waqf occurs where financial or non-financial assets such as land or buildings are permanently dedicated to social purposes such as the Covid- 19 recovery effort. S&P asserts that waqf could help provide affordable housing solutions or access to health care and education for people that might have lost a portion of their income.

Sergio Rebelo says that the pandemic crisis has accelerated the pace of digital transformation, with further expansion in e-commerce and increases in the pace of adoption of telemedicine, videoconferencing, online teaching, and fintech.  In fact, S&P says that higher digitalization and fintech collaboration could help strengthen their resilience in a more volatile environment and open new avenues for growth.  According to Stuart Brown, there has been a considerable increase in digital banking transactions and activity, which in turn provides an added impetus driving the digital transformation push across Islamic banks. Browns says these may include increased automation of processes to minimize the need for human contact as well as digital structures for liquidity management. Brown says that due to the Covid 19 pandemic, fintech will continue to play a significant role in the industry’s development by improving access to financial services and transforming Islamic social finance.

In fact, the pandemic should push the Islamic Finance Industry into digitalization including establishing an online dispute resolution mechanism for the Islamic finance industry. There is no reason why an online dispute resolution system for the Islamic finance industry should not be introduced at this stage in its’ evolution. In fact, the pandemic is increasing the usage of online dispute resolution systems in many countries around the world. Such a system can streamline dispute resolution with the use of standardized contracts with built in dispute resolution mechanisms modeled on FIDIC contracts and with the use of an arbitration center as a means of last resort. Let’s use the misfortune of the Covid 19 pandemic to achieve positive results for the Islamic finance industry, which is also bracing for the pandemic storm.

Proposal for an Online Dispute Resolution Mechanism for the Islamic Finance Industry

Proposal for an Online Dispute Resolution Mechanism for the Islamic Finance Industry

 

By: Camille Paldi

 

The author proposes that for 2020 the Islamic finance industry aims to create an automated and online dispute resolution mechanism called (“DWIFAC”) or the Dubai World Islamic Finance Arbitration Centre and (“DWIFACJO”) or the Dubai World Islamic Finance Arbitration Centre Jurisprudence Office complete with an online Sukuk Bankruptcy Tribunal (“SBT”) and an online Takaful Tribunal (“TT”) and that DWIFACJO issue a standardized dispute resolution contract for each DWIFAC, SBT, and TT, which may be attached to the main contract (Paldi, 2020). The arbitration contracts may be delivered and executed online and uploaded through the secured DWIFAC online portal and DWIFAC App (Paldi, 2020). The DWIFACJO standardized dispute resolution contracts may contain a similar built-in dispute resolution mechanism as the FIDIC contract containing three stages including (1) the online Dispute Resolution Board (DAB), (2) online amicable settlement, and (3) final referral to online DWIFAC, SBT, and TT arbitration (Paldi, 2020). Within thirty days of the occurrence of the subject-matter of a dispute, any party to the contract may submit an online claim to the DAB through the DWIFAC online portal or DWIFAC App, addressed to the chairman of the DAB and with a copy e-mailed or texted to all parties of the contract (Paldi, 2020). The online claim can also be accessed through the online DWIFAC portal and DWIFAC App (Paldi, 2020). However, if any of the parties to the contract considers that there are circumstances, which justify the late submission, she may submit the details online through the online DWIFAC portal or DWIFAC App to the DAB for a ruling (Paldi, 2020). If the DAB considers that it, in all the circumstances, is fair and reasonable that the late submission be accepted, the DAB shall have the authority to override the relevant thirty-day limit and if it so decides, it shall advise both the parties accordingly via email or text message as well as upload the decision to the online DWIFAC portal and App (Paldi, 2020). All DAB decisions shall be accessible through the online DWIFAC portal and DWIFAC App (Paldi, 2020).

 

The DAB shall have sixty days to issue a binding online ruling, which must be implemented immediately and which will be available on the DWIFAC online portal and through the DWIFAC App (Paldi, 2020). The DAB decisions shall also be emailed or texted to the disputing parties (Paldi, 2020). The DAB may deliberate online and coordinate with other DAB members via text, e-mail, online chatrooms, and/or video-conferencing (Paldi, 2020). If either party is not satisfied with the DAB ruling, either party can give notice of dissatisfaction via email or text to the other party and upload the Notice of Dissatisfaction online on the online DWIFAC portal and/or the DWIFAC App before the thirty days after the day on which she received the decision on or before the thirty days after the day on which the said period of sixty days expired (Paldi, 2020). If there is no dissatisfaction within thirty days after the day on which she received the decision, the DAB’s decision, which shall be delivered electronically via email or text to all parties to the dispute and which shall be available on the online DWIFAC portal and/or through the DWIFAC App, shall become final and binding upon both parties (Paldi, 2020). The DAB’s decision may then only be overturned by online settlement or online arbitration at DWIFAC, SBT, or TT (Paldi, 2020).

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The DAB shall consist of three people who must be suitably qualified in law, Islamic finance, and Shari’ah (Paldi, 2020). Each party shall nominate one member for the approval of the other party (Paldi, 2020). The parties shall consult both these members and shall agree upon the third member, who shall be appointed to act as chairman (Paldi, 2020). However, if a list of potential members is included in the contract, the members shall be selected from those on the list, other than anyone who is unable or unwilling to accept appointment to the DAB (Paldi, 2020).

 

The agreement between the parties and either a sole member (adjudicator) or each of the three members shall incorporate by reference the General Conditions, which shall take into account all facets of Online Dispute Resolution, as written by DWIFACJO, with such amendments as agreed between them (Paldi, 2020). The composition of the DAB shall be by nomination and then joint-selection (Paldi, 2020). DAB members are to be re-numerated jointly by the parties with each paying half of any fees (Paldi, 2020). DAB members may only be replaced by mutual agreement (Paldi, 2020). The appointment of any member may be terminated by mutual agreement of both parties, but not by any party acting alone (Paldi, 2020). Unless otherwise agreed by both parties, the appointment of the DAB shall expire when the discharge of the matter shall have become effective (Paldi, 2020). Where the parties fail or are otherwise unable to agree upon the appointment, nomination or replacement of any member of the DAB, then the appointing official so named in the contract shall make the appointment (Paldi, 2020).

 

DWIFAC, SBT, and TT may establish an Ambassador’s List similar to the FIDIC President’s List, from which arbitrators and DAB members may be selected, if not specified in the contract (Paldi, 2020). Persons who have successfully completed a DWIFAC Adjudication Assessment Workshop and International Arbitrator’s Islamic Finance Contracts Course and applied for entry to the DWIFAC Ambassador’s List of Approved Dispute Adjudicators are entered on the List for five years (Paldi, 2020). Successful attendees at an Adjudication Assessment Workshop are required to be fluent in English and to be thoroughly familiar with Islamic finance, law, and Shari’ah (Paldi, 2020).

 

There may be situations where a party fails to comply with a DAB decision (Paldi, 2020). In such cases, the other party may refer the failure to online DWIFAC, SBT, or TT arbitration (Paldi, 2020). Where notice of dissatisfaction has been given, both Parties shall attempt to settle the dispute amicably online through video-conferencing, face-time, and/or chatrooms and texting before the commencement of arbitration (Paldi, 2020). However, unless both Parties agree otherwise, online arbitration may be commenced on or after the fiftieth day after the day on which notice of dissatisfaction was given (Paldi, 2020). The attempt to obtain an online amicable settlement during this prescribed period of fifty days is a condition precedent to a referral to online arbitration (Paldi, 2020). There is no given time frame to refer a dispute to online arbitration, however, it should be without undue delay (Paldi, 2020). Once the online arbitration procedure has been initiated, the online DWIFAC arbitration shall commence according to the online DWIFAC arbitration rules, the online SBT arbitration shall commence according to the online SBT arbitration rules, and the online TT arbitration shall commence according to the online TT arbitration rules (Paldi, 2020). Parties may upload statements and evidence for online DWIFAC, SBT, and TT arbitrations through the secured DWIFAC online portal and DWIFAC App (Paldi, 2020).

 

The arbitrator(s) shall deliberate the arbitration proceedings online and in conjunction with each other via e-mail, text, chatrooms, and/ or video-conferencing and face-time (Paldi, 2020). The arbitrators shall have full power to open up, review, and revise any decision of the DAB relevant to the dispute online (Paldi, 2020). Neither party shall be limited in the proceedings before the arbitrator(s) to the evidence or arguments previously put before the DAB to obtain its decision or to the reasons for dissatisfaction given in its notice of dissatisfaction (Paldi, 2020). Any decision of the DAB shall be admissible in evidence in the online arbitration (Paldi, 2020). Online arbitration may be commenced prior to or after completion of the contract (Paldi, 2020). The obligations of the Parties and the DAB shall not be altered by reason of any online arbitration being conducted during the progress of the contract (Paldi, 2020).

 

The online arbitration at DWIFAC, SBT, and TT shall be conducted in the English language and any arbitral decision shall be final and binding (Paldi, 2020). All of the online DWIFAC, SBT, and TT decisions are to be published online in English, French, and Arabic and the arbitration itself to be conducted in English (Paldi, 2020). All decisions are to be stored in electronically retrievable files (Paldi, 2020). In the event of a conflict of laws, the Shari’ah shall prevail (Paldi, 2020). A valid online arbitration decision should lead to a verdict that conforms to the rules of the Shari’ah (AAOIFI 2004:559) (Paldi, 2020). The Shari’ah and legal basis of the online arbitration decision shall be mentioned in the decision (AAOIFI 2004:559) (Paldi, 2020).

 

In the context of the online DWIFAC, SBT, and TT, the centers may make arrangements with the Dubai and DIFC or Dubai International Financial Center courts and Abu Dhabi Courts and the ADGM or Abu Dhabi Global Markets Courts for enforceability of online DWIFAC, SBT, and TT arbitration awards (Paldi, 2020). However, parties to the dispute must realize that the online arbitration award issued by DWIFAC, SBT, and TT may be overturned or enforced in other jurisdictions (International Bechtel Co. Ltd. v. Department of Civil Aviation of the Government of Dubai 300 F. Supp. 2d 112 (DDC. 2004) or challenged in UAE courts based on Article 216 of the Civil Procedure Law (Now Article 53 of the Arbitration Law) (Paldi, 2020). Higher Shari’ah Authority decisions shall act as a source of precedent and shall be binding, thus providing legal certainty to Islamic finance, takaful, and sukuk dispute adjudication (Paldi, 2020). The Higher Shari’ah Authority shall act as the highest Shari’ah authority for DWIFAC, SBT, and TT arbitration, the UAE, and the DIFC or Dubai International Financial Center and ADGM or Abu Dhabi Global Market (Paldi, 2020).

 

Bibliography

 

  1. FIDIC Red Book (1999) London; Thomas Telford Publishing.
  2. Paldi, Camille (2020) ‘Dispute Resolution in the Islamic Finance Industry’ in Abdul Rafay’s Handbook of Research on Theory and Practice of Global Islamic Finance, IGI Global Publishers, USA.

 

Islamic Finance in the United States

Islamic Finance United States Report 2019

By: Camille Paldi

 

*This article was first published by Islamic Finance News in their 15th Anniversary Edition in Feb. 2020.

 

Aside from the millions in sukuk issuances by East Cameron Gas, General Electric, and Goldman-Sachs and the billions in Islamic funds and under Islamic asset management in the USA, plus Islamic investing, and Islamic insurance or takaful, the main area of Islamic finance in the United States in 2019 is in Islamic home financing. The offering of retail investment products in the US is hindered by the fact that banks in the US allow consumers to share in profits, but not in losses. Under US regulations, a depositary amount must not be at risk and the system requires the backing of deposits by federal deposit insurance up to specified limits. In terms of equity investments, the US has had the Dow Jones Islamic Index among others since 1999. The index combines Islamic investment principles with the traditional Dow Jones index to allow Islamic investing in the United States. In 2019, the gross annual dollar value of retail Islamic finance transactions in the USA is approximately US$4 billion.

 

Although there is no nationally chartered Islamic bank in the United States, there are 25 Islamic financial institutions operating in the USA including University Bank’s subsidiary University Islamic Finance (UIF), LARIBA/Bank of Whittier, Devon Bank, and Guidance Residential among others. University Islamic offers home financing in the form of the Ijara home-financing model in California, Colorado, Connecticut, Florida, Georgia, Illinois, Indiana, Kansas, Kentucky, Maryland, Massachusetts, Michigan, Minnesota, Missouri, New Jersey, North Carolina, Ohio, Oregon, Pennsylvania, Tennessee, Texas, Virginia, and Washington, deposit accounts, and Islamic mutual fund shares. SHAPE Financial Corporation modified the deposit product it offers through University Bank so that the principal is guaranteed, and the deposit-holders share only in bank profits and not losses. SHAPE offers asset financing and deposit account products in the US, Canada, Singapore, and Lebanon. J P Morgan started Islamic banking in 2013 and currently offers products in debt and equity capital markets, investor products, cash management and Murabaha liquidity products, risk management and asset management funds. Standard Chartered (UK bank) conducts Islamic finance worldwide through its Islamic ‘Saadiq’. Devon Bank in Chicago offers a mix of Islamic products including Islamic home, construction, and business finance. Devon bank also offers commercial murabahah and Ijara transactions for real estate acquisitions to business customers in Arizona, California, Colorado, Florida, Georgia, Illinois, Indiana, Michigan, Minnesota, Missouri, North Carolina, Ohio, Oregon, Texas, Utah, Virginia, and Wisconsin.

 

LARIBA/ Bank of Whittier (CEO: Yahia Abdul Rahman), based in California, offers banking and home financing across the USA in all fifty states. LARIBA offers a lease-to-purchase model with terms up to 30 years, or a variation of the Ijara model to finance homes, autos, and medical clinics and equipment. LARIBA also offers leasing with declining equity for construction of single-family homes and finances small businesses and trade. Guidance Residential offers home financing through its declining balance co-ownership program or a variation of the Musharakah in Connecticut, Massachusetts, New Jersey, New York, Pennsylvania, Rhode Island, California, Oregon, Washington, Alabama, Arkansas, Florida, Georgia, Mississippi, North and South Carolina, Tennessee, Colorado, Kansas, Missouri, Texas, Arizona, Delaware, Kentucky, Maryland, Virginia, DC, West Virginia, Illinois, Indiana, Michigan, Minnesota, Ohio, and Wisconsin.

Saturna Capital, an investment advisor and fund management company, manages funds, which are invested in Shari’ah compliant mutual funds, including Amana Mutual Funds such as the Amana Income Fund, Amana Growth Fund, Amana Developing World Fund, and the Amana Participation Fund.  Other Islamic investment firms include Arcapita, Azzad Asset Management (Azzad Funds), and Allied Asset Advisors (the Iman Fund).

 

These institutions are state-chartered entities subject to the same state and federal regulatory guidelines, corporate governance, banking and insurance operations and tax treatment as conventional financial institutions in the US including the requirement to be insured by the Federal Deposit Insurance Corporation. The US has not adopted any federal legislation specifically addressing Islamic financing as of yet. Although Islamic financial institutions may be qualified to do business in different states, the majority of an Islamic financial institution’s assets are located in the institution’s home state and licensing and other conditions must be satisfied with respect to any state where the Islamic financial institution seeks to be qualified as a bank or mortgage or loan finance provider.

 

 

In 1997, the Office of the Comptroller in the United States (OCC) issued two rulings approving the Ijarah and Murabahah structures for home financing. These structures have now been approved by the federal government, the NYSBD or New York State Banking Department and the banking authorities of several other states. Furthermore, the relevant authorities have removed the double tax jeopardy of these products where tax was incurred by the initial purchase and at the transfer of final payment. The tax authorities in New York and other states have handled this issue by eliminating double tax burdens on a case-by-case basis where the Shari’ah compliant structure was equivalent to a conventional financing structure. In 2008, the New York State Tax Department determined that no real estate transfer tax is due when the deed is transferred by a bank to its customer at the end of the lease term in accordance with the terms of the Ijarah arrangement.

Currently, institutions such as Whittier Bank/LARIBA in California, University Islamic in Michigan, Devon Bank in Chicago, and Guidance Residential in Virginia among others offer Islamic home financing in the United States. The Federal National Mortgage Association (Fannie Mae) and the Federal Home Mortgage Corporation (Freddie Mac) purchase Shari’ah-compliant mortgage contracts from financial intermediaries, allowing providers to originate further mortgages. In 2007, Freddie Mac purchased more than $250 million in Islamic home loans, a small fraction of the enterprise’s $1.77 trillion in activities. For the purposes of this short article, the author will focus on the Islamic home financing product offered by Whittier Bank/LARIBA.

 

The no-interest Islamic home-financing of LARIBA/Whittier Bank is based on two concepts: (1) Commodity Indexation and (2) Marking to Market. The no-interest discipline clearly states that fiat (paper) money can be used, and the U.S. dollar may continue to be the reserve currency of the world along with maybe the euro, but gold or a basket of commodities may be used to calibrate the real value of the currency. President John F. Kennedy and James Baker III (1987) have both approved and proposed these concepts previously in US history and monetary policy. John F. Kennedy attempted to introduce silver certificates with Executive Order 11110. In fact, at one time in history, the US dollar was backed by gold. Under the rule of the British Empire, the British pound sterling and the gold standard were adopted around the world. In 1913, the gold cover for Federal Reserve notes was set by 1913 law to be 40%. In 1945, the gold reserves against Federal Reserve notes were reduced to 25%, and to continue the inflation spiral, this figure (25%) had to be reduced to zero. Toward the end of WWII, the US dollar and gold became the principal international reserve assets under the Bretton Woods Agreement. The US dollar became the world reserve currency, and it was treated as if it were gold because the agreement defined its value to be $35 per ounce of gold. On August 15, 1971, President Richard Nixon ordered the gold window closed, ending the international currency’s link to gold.

 

This no-interest discipline is implemented in order to price things fairly in the market while detecting any overpricing ‘bubble.’ In fact, it is interesting to note that Dr. Rahman of LARIBA through his LARIBA system detected the 2008 bubble as early as 2005 using this Commodity Indexation Discipline. In fact, this system helps to fairly define prices and to standardize and stabilize markets, allowing the efficient working of the market forces of supply and demand. It lays the foundation of fair pricing for products and services, based on real market values within an open and free market operation. Thus, we can see that the no-interest banking brand is not based on renting money at a rental price (interest), but on the actual measured fair market rent of properties, businesses, and services.

 

The following example illustrates how the no-interest discipline may be used to buy a house. The buyer who wants to obtain no-interest finance and the no-interest bank should mark the house to market. The best way of doing this is to find out how much a similar house in the same neighborhood and with similar specifications would rent/lease for in terms of U.S. dollars per square foot (or euros/square meter). This mutually agreed-upon live market lease rate is used to calculate the rate of return on investment of the proposed purchase and no interest transaction, looking at it as a no-interest investment. If the rate of return on investment makes economic sense, the no interest bank proceeds to finance (invest in) the property. In addition, the no-interest bank does its best to make the monthly payments in the no-interest mode of finance competitive with those offered by conventional banks. Basically, the no-interest banking and finance discipline, in an effort to neutralize the effects of the prevailing fiat currency in the local markets, requires that the financier first apply the Commodity Indexation Discipline to check, in a macroeconomic way, on the existence of a bubble in the business/asset that is being considered for finance. This process is followed by the Mark-to-Market Discipline and approach, evaluating the economic prudence by calculating the real return on investing in this item, using its actual real market rental value. In this way, it is affirmed that money is not rented with interest and that the rent is that of the market rent of the facility in the marketplace.

 

With federal and state regulatory approvals in effect for Islamic home financing in the United States, there is an increase in the number of institutions providing Islamic home finance above and beyond the major providers of Whittier Bank/Lariba, Devon Bank, University Islamic, and Guidance Residential in the USA including Ijara Community Development Corporation and Ameen Housing Cooperative of California plus others. For 2019 and ahead, Islamic home finance is the future of Islamic finance in the United States with room for sukuk, Islamic funds and asset management, Islamic investing, and Islamic insurance or takaful however, in general, Islamic finance remains a niche segment of the larger conventional financial world for Americans.

 

In terms of the takaful or Islamic insurance business such as offered by AIG through Risk Specialist Companies Inc., Lexington Insurance Company, and Zayan Takaful among others, the US has a state-regulated insurance system whereby each state determines its own licensing requirements for insurers. In order to obtain a license, a company must demonstrate that it has the experience and management capability to run the company and show that it is financially sound. Insurers are also required to justify their premium rates.

 

In addition, companies must fulfil the solvency requirements set by the state. Furthermore, there may be limits on the types and concentration of investments made with ‘held’ reserves. These issues should be addressed in the state and federal takaful laws. The biggest challenge in introducing takaful, sukuk and Islamic finance in the US is the First Amendment of the US Constitution, which prohibits the making of any law respecting an establishment of religion or impeding the free exercise of religion as well as the Establishment Clause. (Murray v Geithner)

 

In Murray v Geithner, a case was filed against the Federal government challenging the permissibility of bailout money provided to AIG under the Emergency Economic Stabilization Act (EESA) legislation saying it violated the Establishment Clause. The Act gives the Treasury the ability to purchase troubled assets from any institution. In this case, EESA was used to purchase $40 billion in AIG shares. AIG conducts takaful business in Bahrain and the US. The plaintiff alleged that tax dollars were going towards the financing of Shari’ah products and activities. The court found that the EESA legislation and the AIG bailout were created for a secular purpose and did not violate the First Amendment of the Constitution.

 

In the US, the only type of takaful being offered includes commercial and residential property insurance.

 

In the United States, there are no specific disclosure or reporting requirements for takaful, sukuk, or Islamic funds that differ from conventional products under applicable federal or state banking, insurance, and securities laws.

 

Court disputes will be dealt with by applying applicable state law or foreign law, if the governing law of the contract is that of another country and US courts will not comment on whether an agreement or contract complies with Shari’ah principles.

 

Although there is a green light for Islamic finance in the USA, Islamic financial institutions may be at a disadvantage in possibly not being able to gain access to federal funds. Islamic institutions may also experience compliance issues as well as legal challenges. There are currently no listings of sukuk on US security exchanges.

 

 

 

 

 

Dispute Resolution in Islamic Finance: Problems and Solutions

 

*New Book Release*

In this book, the author will examine the Abrahamic principles underpinning Islamic finance, the rationale for a distinct economic system based on Islamic values originating from the moral teachings of Islam, Islamic finance dispute resolution and some of the problems experienced in adjudicating Islamic finance disputes in the conventional court system, and solutions in the field of Online Dispute Resolution for the Islamic finance industry as Online Dispute Resolution or (“ODR”) is the wave of the future. Available on Amazon now!https://www.amazon.com/Dispute-Resolution-Islamic-Finance-Solutions/dp/1096353571

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Journey to Islam

By: Camille Paldi

This article was first published on Literary Yard.

 

It just came out of my mouth.

 

لَا إِلٰهَ إِلَّا ٱلله

There is no god but God.

lā ʾilāha ʾillā llāh

 

مُحَمَّدٌ رَسُولُ ٱلله

muḥammadun rasūlu llāh

Muhammad is the messenger of God (Wikipedia).

 

Now, I was officially Muslim after reciting the shahada or declaration of faith in Islam. The shahada is the central statement of faith in Islam, recited ceremonially by new converts, and consisting of an affirmation of the uniqueness of God and of Muhammad as God’s prophet (The Free Dictionary). Muslims believe in all of God’s prophets with Muhammad (p.b.u.h.) as the seal of all Prophets. Muslims believe that Jesus was a prophet and not son of God. I was in the midst of studying for an LL.M degree at University of Hawaii William S. Richardson School of Law. I had recently returned to the United States after living for three years in the Emirate of Dubai, United Arab Emirates.

 

In fact, three and a half years prior to this date, I had embarked on a solo journey to the Middle East from Hawaii, which would forever change my life. I flew to Dubai with a few suitcases, hopes and dreams, and the enthusiasm of a fresh graduate of law seeking out employment and a new adventurous life full of travel, learning, and the absorption of all the different cultures and nationalities, which would surround me for my entire stay in the Emirates. In fact, I was lucky enough to see the Islamic jewels of art, culture, and architecture in the UAE, Oman, Pakistan, Lebanon, Malaysia, Indonesia, Egypt, Bahrain, and Qatar. The mosques beautify the atmosphere with their stunning art, architecture, design, and display and of course, the remembrance of Allah.

 

I gained employment at a local law firm called Global Advocates and Legal Consultants in the Garhoud district of Dubai, directly across the street from a quaint mosque. The owner Ali, often gifted me informative books about Islam and Arabs, which I read fervently and with a thirst for knowledge about Islam. We even read the Qu’ran together line by line, word by word and discussed and pondered its’ deep meaning and content. Islam is such a beautiful and peaceful religion, focusing on preparing the individual for the Day of Judgement, on which day one’s good and bad deeds would be weighed and a decision would be made as to whether or not one would enter Heaven or Hell.

 

I can distinctly remember hearing the Muslims call to prayer or adhnan five times a day and remembering how beautiful and peaceful it sounded, especially at 5 AM in the morning when the atmosphere was still, silent, and dark. I once told Ali that it sounded like honey dripping into my ears. Prior to converting to Islam, every time I heard the adhnan, it would stop me in my tracks whatever I was doing and cause me to ponder my existence. Muslims are reminded five times a day to return and submit to Allah or God and to remember that their ultimate return is to Him. The mortal’s place on earth is temporary and we are only here to fulfill our assigned tasks – assigned at our conception.

 

You see our entire lives are already written including how much money we might make, our spouses and children, work, the places we might travel and the people we encounter…everything is part of a larger plan…Allah’s plan. Once one as an individual comes to accept the greater plan and submit to Allah’s will, one might feel more content and satisfied with everything one has been given in this life and strive for a greater eternal life in Jannah or Heaven. This can only be done by fulfilling Allah’s wishes such as caring for the needy and the poor, taking care of one’s family, fasting during Ramadan, giving in charity, and increasing oneself in knowledge towards Allah’s cause.

 

I was struck by how well women seemed to be treated in Islamic countries. It seemed girls and women were always protected either by their fathers and brothers or husbands and that they were well maintained physically, emotionally, spiritually, and monetarily. They dressed elegantly, covering all of their skin in black dresses and wore a scarf to cover their hair. Women were not seen in public without remaining fully covered. Human beings should cover all of their skin in public as we are distinct from other animals. It makes sense. Honor is key in the maintenance and protection of women. In Islam, there are no relations between males and females prior to marriage. It is a question of honor for the female and the family of the female in question.

 

Everything in Islam has a rhyme or reason. For instance, fasting for one month from sunrise to sunset during Ramadan helps one keep their weight and blood-sugar under control, prevents cancers, and boosts the immune system. Fasting causes a pause in the digestion system, which then allows the digestive system to clean itself out and re-boost. Islam operates on a lunar calendar and there is really something special about the month of Ramadan that permeates the air. This is the month that Allah sent the Qu’ran down to earth through his messenger Muhammad (pbuh). During this month, one should reflect upon the Qu’ran, help those in need including the hungry and homeless, and focus on one’s role in submission to Allah. If one cannot fast for health reasons, one can donate to charity in lieu of fasting.

 

Fasting has a lot of health benefits like prayer benefits the individual in many ways. The Islamic prayer allows oneself to stretch one’s body out, improve circulation, aid in digestion, stretch all of the internal organs, and acts as a spiritual bath, leaving one feeling refreshed and revitalized after prostrating and praying to Allah. The washing of oneself prior to prayer or wudhu allows oneself to purify oneself five times though out the day, even rinsing the nostrils. This makes sense as it cleans out germs and other impurities, which might cause disease. One rinses the feet, hands up to the elbows, face, nostrils, and hair. Usually, the Muslim is very clean, pure, with good posture and good physical and mental health.

 

Imagine if this was done in America? Can you imagine companies allowing their employees to either leave the office and go to a mosque or prayer room to pray five times a day? It would be unheard of. However, I did find my counterparts in the Islamic world much healthier physically, mentally, and spiritually then in the West. Of course, as one lives for Allah and submits to His will rather than living purely for the market. The sense of purpose of the Muslim is deep and extends to fulfilling Allah’s will. We are only here because Allah allows us to be and we should remember that constantly throughout the day. We are only trustees of the earth and all that we have belongs to Allah. Allah tests one with wealth and power, however, it is important to remember that these are only tests to see how one treats other people and fulfill’s the will of Allah. Life is a test to see which among us are worthy to enter Jannah or Heaven.

 

Through Islam, I also learned not to eat pork, as the pig is a filthy, disease-carrying animal that eats dead flesh. Furthermore, halal meat, or specified meats slaughtered in the Islamically prescribed method, should be consumed to preserve ideal human health. In addition, one should pay attention to the specified halal foods as mentioned in the Qur’an and sunnah or the actions of the Prophet Muhammad (PBUH). Sunnah is the body of literature which discusses and prescribes the traditional customs and practices of the Islamic community, both social and legal, often but not necessarily based on the verbally transmitted record of the teachings, deeds, sayings, and silent permissions (or disapprovals) of the Islamic Prophet Muhammad (PBUH) (Wikipedia).

 

One should also avoid alcohol, as it is a dangerous intoxicant that leads to the disruption of the fabric of society, the family, and the deterioration of the health and well-being of the individual. Gambling is also a dangerous activity which destroys society, as it is a zero-sum game in which one party wins at the other party’s expense.

 

The five pillars of Islam include (1) shahada or reciting the Muslim profession of faith; (2) salat or prayer; (3) zakat or paying alms (or charity) tax to benefit the poor; (4) sawm or fasting; (5) hajj or pilgrimage to Mecca.

 

My journey to Islam began with one brave soul stepping on a flight from Honolulu, Hawaii, to Dubai, United Arab Emirates, in 2008, and continues to this day as I study and contemplate Islam and the Qur’an.

 

Online Dispute Resolution and the Future of Islamic Finance

Online Dispute Resolution and the Future of Islamic Finance

By: Camille Paldi

 

 

Introduction

The Islamic finance industry is at a crossroads…a juncture of either continuing forward as a tremendous success or bursting at the seams due to the lack of a unique and independent (and online) dispute resolution mechanism tailored specifically for Islamic finance, sukuk, and takaful. The whole world is experimenting with online dispute resolution (“ODR”) and it is about time that an individual, group, organization, or state take the initiative to develop such a system for the Islamic finance industry. In addition, such a system should contain a standardized dispute resolution contract for Islamic finance, sukuk, and takaful each separately for the harmonization and standardization of dispute resolution across the Islamic finance, sukuk, and takaful industries. Let us examine the case of Australia and Online Dispute Resolution to get the creative ideas flowing.

 

Australian Online Dispute Resolution (“ODR”)

According to E. Wilson-Evered et al., “Online dispute resolution is a branch of dispute resolution, which uses technology to facilitate the resolution of disputes between parties.” (Wilson-Evered et al.) ODR is also considered an electronic form of Alternative Dispute Resolution, utilizing such techniques as arbitration, mediation, and conciliation assisted by the latest internet and other technologies.

 

In New South Wales, Australia, where the author has been previously admitted as a Solicitor, an initiative has been taken to produce an online court in inter alia the NSW Supreme Court, Land and Environment Court, District Court, and the Local Court. (Susskind, 2019, 173) According to Richard Susskind, “the forum allows judges and lawyers to exchange messages about cases rather than attending a physical court room.” (Susskind, 2019, 173)

 

“Online court is an online forum which allows judicial officers and legal representatives in a case to exchange written messages about NSW Supreme, District or Local Court matters, instead of attending court to have the same exchange in person. Online court is only available to legal practitioners who are representatives in a case, and their nominated support staff.” (Government of New South Wales, 2020)

 

Susskind says, “the main purpose of this online court is to allow lawyers, and sometimes (but less often) self-represented litigants, to manage interlocutory or procedural matters.” (Susskind, 2019, 173) Susskind reports that, “Users are able to make various requests and judges can make corresponding orders. Procedure in the online courts is governed by a series of protocols.” (Susskind, 2019, 173)

 

“In the Supreme and District Court, only some uncontested civil law matters are suitable for online court. A judge has to select a matter for online court, and invite legal representatives to participate. Online court matters are typically orders about court dates and when documents need to be filed.

In the local court, online court is currently only available for preliminary committal matters for strictly indictable offences being prosecuted by the Office of the Director of Public Prosecutions at the Downing Centre. The defendant must be legally represented. A magistrate may authorise an online court where the prosecution and defence legal representatives agree to its use.” (Government of New South Wales, 2020)

 

Susskind reports that there were over 100,000 registrations to use the online court in 2018 in Australia. (Susskind, 2019, 173)

 

Another online initiative, which has taken place in Australia, involves the internet and the Federal Court of Australia. “eCourtroom is a an online courtroom used by Judges and Judicial Registrars to assist with the management and hearing of some matters before the Federal Court of Australia or Federal Circuit Court of Australia.” (Federal Court of Australia, 2020) eCourtroom deals with such matters including, “ex parte applications for substituted service in bankruptcy proceedings; applications for examination summonses; and giving of directions and other orders in general federal law matters.” (Federal Court of Australia, 2020) eCourtroom is integrated with eLodgment, providing parties with a link between eCourtroom and eLodgment to facilitate the electronic filing of documents. (Federal Court of Australia, 2020)

 

eLodgment is the electronic filing facility for the Federal Court of Australia and for the general federal law jurisdiction of the Federal Circuit Court of Australia (previously the Federal Magistrates Court). eLodgment may be used to commence an action in either jurisdiction by enabling the filing of initiating documents and supporting documents. Similarly, documents pertaining to existing matters may be filed using eLodgment as long as the filing party enters the file number. The document(s) remain accessible via eLodgment users can monitor the progress of their elodgments as well as review the processed document(s) through their Lodgment History. They can access the sealed electronic versions of the documents should they require them to email or print out for service.” (Federal Court of Australia, 2020)

 

 

Furthermore, to make the process more transparent in the eCourtroom, Susskind says that “a transcript facility, viewable by the public and all parties, displays a record of all messages posted by the judges and the parties to the dispute.” (Susskind, 2019, 174)

 

“A transcript facility provides a record of all messages posted by the presiding Judicial Officer and the parties in any matter that is conducted on eCourtroom. This transcript is viewable by parties as well as the public. However, documents posted or filed can be viewed by the parties to the action only, the Judicial Officer and other Court officers.” (Federal Court of Australia, 2020)

 

Australia has taken certain steps towards the integration of Online Dispute Resolution and its’ judicial system. Let Australia serve as one of many examples for the Islamic finance industry and the creation of an ODR platform for Islamic finance, sukuk, and takaful.

Conclusion

In this brief article, the author has examined some of the initiatives of Australia in the field of Online Dispute Resolution in order to encourage the Islamic Finance Industry to start to model their own system of ODR for Islamic finance, sukuk, and takaful dispute resolution. The author encourages academics and practitioners to start to write and discuss about ideas and proposals on how to formulate a unique and independent online dispute resolution mechanism especially crafted for the Islamic finance, sukuk, and takaful industries.

 

Bibliography

  1. Susskind, Richard (2019) Online Courts and the Future of Justice, Oxford University Press, UK.
  2. Wilson-Evered, Elizabeth and Deborah Macfarlane and John Zeleznikow and Mark Thomson, ‘Towards an Online Family Dispute Resolution Service in Australia, in M. Poblet (ed) Mobile Technologies for Conflict Management: Online Dispute Resolution, Governance, Participation, Springer, New York.
  3. Government of New South Wales, ‘Online Courts’ [Online] Available: http://www.courts.justice.nsw.gov.au/Pages/cats/catscorporate_online_services/onlinecourt.aspx [January 4, 2020]
  4. Federal Court of Australia, ‘e-Courtroom’ [Online] Available: https://www.fedcourt.gov.au/online-services/ecourtroom [January 4, 2020].
  5. Federal Court of Australia, ‘e-Lodgment’ [Online] Available: https://www.fedcourt.gov.au/online-services/elodgment [January 4, 2020].

 

 

 

The Dana Gas Sukuk: An Example of Why We Need the Proposed Sukuk Bankruptcy Tribunal (SBT)

The Dana Gas Sukuk: An Example of Why We Need the Proposed Sukuk Bankruptcy Tribunal (SBT)

 

Introduction

According to S&P Global Ratings, one of the main faults of the Islamic financial system in 2019 is the lack of standardization of legal contracts. The lack of standardization expels potential investors as they are uncertain about the dispute resolution process and outcome in the event of a dispute or for example a sukuk bankruptcy or default. As the Islamic finance industry is nearing US$2.4 trillion in assets, it is about time that the Islamic finance industry created a unique and independent dispute resolution mechanism, which would boost investor confidence and solidify the Islamic finance industry for many years into the future. This brief article aims to show how the Dana Gas debacle reveals that the Islamic finance industry is ill-equipped to handle sukuk defaults and introduces the concept of the Sukuk Bankruptcy Tribunal (“SBT”), which is part of the wider (“DWIFAC”) or Dubai World Islamic Finance Arbitration Centre dispute resolution mechanism.

 

The Dana Gas Sukuk

Dana Gas is an independent gas company headquartered in Sharjah, United Arab Emirates. (Wikipedia, 2019) Dana Gas was established in December, 2005 with a public listing on the Abu Dhabi Securities Exchange (ADX). (Wikipedia, 2019) Dana Gas has exploration and production assets in Egypt, Kurdistan Region of Iraq, and the UAE, with an average production output of 67,600 boepd in 2017. (Wikipedia, 2019)

 

In 2013, Dana Gas issued a dual-tranche Mudarabah sukuk with an aggregate principal amount of approximately US $950 million listed on the Irish Stock Exchange. (Cleary Gottlieb, 2018) Each tranche of the sukuk was subsequently reduced to US $350 million following sukuk buyback and conversion, bringing the total principal amount to US $700 million due in October 2017. (Cleary Gottlieb, 2018)

 

On May 3, 2017, Dana Gas asked sukuk-holders to form an Ad Hoc Committee to engage in talks on May 8, 2017 to discuss the restructuring of the debt. (Wikipedia, 2019) On June 13, 2017, Dana Gas presented an offer to the Ad Hoc Committee to restructure the $700 million sukuk. Dana Gas also explained that according to Dana Gas and its advisors, the sukuk were no longer Shari’ah compliant. (Wikipedia, 2019) Dana Gas declined to make payment on the sukuk. (Wikipedia, 2019) Dana Gas offered to exchange the sukuk with a new one, which would ‘confer rights to profit distributions at less than half of the current profit rates and without a conversion feature.’ (Wikipedia, 2019) The sukuk holders declined this offer. (Cleary Gottlieb, 2018)

 

According to White and Case, the move by Dana Gas to declare its approximately US$700 million of outstanding sukuk certificates unlawful and unenforceable on the grounds that in the company’s view and that of its advisors, the sukuk had ceased to be Shari’ah compliant is a potentially destabilizing development for the international sukuk market and to the Islamic Finance Industry as a whole with implications for the sukuk industry’s future survival. (White and Case, 2017) Conventional investors may come to view sukuk as ‘high-risk’ and uncertain financial instruments and the Dana Gas debacle may encourage other issuers to use the argument that their instruments are not Shari’ah compliant to force creditors into debt-restructurings in the future. (White and Case, 2017) There is an obvious and immediate need for a central Sukuk Bankruptcy Tribunal (“SBT”) to adjudicate all of the world’s sukuk disputes in one location under one mechanism according to a standardized sukuk dispute contract.

The key question in this case according to White and Case is whether non-compliance with Shari’ah principles effects the legal enforceability of these instruments. (White and Case, 2017) The outcome of this case may impact whether or not conventional investors wish to continue investing in Islamic sukuk versus conventional bonds in the future. The alternative is to implement the Sukuk Bankruptcy Tribunal or SBT with immediate effect to avoid this type of sukuk default dispute in the future. Rather than splitting jurisdiction between the UAE and the UK, a centralized Sukuk Bankruptcy Tribunal in Dubai, UAE would provide one jurisdiction with a standardized dispute resolution contract for the adjudication of all sukuk disputes under the auspices of the Higher Shari’ah Authority. The streamlined sukuk dispute mechanism would provide investor confidence in the sukuk instrument and encourage sukuk investing well into the future.

 

On June 14, 2017, Dana Gas obtained an injunction from the Sharjah Federal Court of First Instance restraining anyone from taking any action, inside or outside the UAE, to enforce against any of the securities Dana Gas and its affiliates under Dana Gas’s Security Agreement until a final determination was made by the Court in the lawsuit. (Wikipedia) This was followed by an injunction in the English High Court of Justice and the British Virgin Islands. (Wikipedia, 2019) On July 5, 2017, Dana Gas and the CEO held a scheduled call to explain to the sukuk holders why this deal offered to them was to their benefit. (Wikipedia, 2019)

 

In September, 2017, a creditor’s committee supported by 70% of the sukuk holders offered Dana Gas a restructuring proposal involving a US $300 million cash payment and a three-year extension of the outstanding sukuk’s life. (Cleary Gottlieb, 2018) Dana Gas rejected the proposal and the dispute between Dana Gas and the sukuk holders was left to the courts to resolve. (Cleary Gottlieb, 2018)

 

Dana Gas brought an action in the High Court of London requesting that the English law governed purchase undertaking between Dana Gas and the SPV (the “Purchase Undertaking”) be declared void and unenforceable. (Cleary Gottlieb, 2018) Simultaneously, Dana Gas brought an action in the UAE seeking to challenge the validity of the UAE law governed Mudarabah documents for their non-compliance with the Shari’ah law. (Cleary Gottlieb, 2018)

 

In November 2017, the High Court rendered a preliminary judgment rejecting the arguments put forward by Dana Gas and ruling the English law governed Purchase Undertaking to be valid. (Cleary Gottlieb, 2018)

 

On May 13, 2018, Dana Gas announced that it had reached an agreement with the Ad Hoc Committee of sukuk holders to restructure and refinance the Dana Gas Sukuk. (Wikipedia, 2019) Investors could exit the sukuk at 90.5 cents on the dollar or roll over into a new three-year US$530 million sukuk with a four percent profit rate, while receiving final profit payments owed to them before the old sukuk matured. (Reuters, 2018) On May 23, 2018, Dana Gas launched the tender. (Wikipedia, 2019)

 

In this case, while the Purchase Undertaking was subject to English Law and the non-exclusive jurisdiction of English Courts, and had been determined by the High Court to be valid under English Law, the Mudarabah Agreement was subject to UAE law and to the non-exclusive jurisdiction of UAE courts. (Cleary Gottlieb, 2018)

 

The UAE courts could have refused to apply English law to the Purchase Undertaking or denied enforcement of an English court judgment based on the enforceability of the Purchase Undertaking on the basis that the terms of the Purchase Undertaking violated the Shari’ah law and are contrary to the public order.

 

It is quite confusing and against the administration of justice that the terms in the Dana Gas prospectus stipulate that the governing law and jurisdiction were split between English and UAE law. The Declaration of Trust, the Agency Agreement, the Purchase Undertaking, the Sale Agreement, the Security Agreement, the Security Agency Agreement, the Ordinary Certificates, and the Exchangeable Certificates were governed by English law and subject to the non-exclusive jurisdiction of the English Courts. The Mudarabah Agreement, the UAE Share Pledges, and the UAE mortgage were governed by the laws of the UAE. The courts of the UAE had non-exclusive jurisdiction to hear all disputes relating to the UAE mortgage. (Hekmatyar and Parkar, 2018)

 

A question arises, if the Dana Gas Sukuk is partially or fully non-compliant with Shari’ah, does this entail it unlawful under UAE law? Secondly, does this negate the obligation of profit payments, rescinding the terms of the contract and making it unenforceable legally? (Hekmatyar and Parkar, 2018) These are serious questions for potential investors in future sukuk offerings and questions, which are essentially split between two possibly conflicting jurisdictions, the UK and the UAE. The time is ripe to create the Sukuk Bankruptcy Tribunal and the future of the sukuk industry depends on it.

 

Sukuk Bankruptcy Tribunal (“SBT”)

The author proposes that for 2020 the Islamic finance industry aims to create (“DWIFAC”) or the Dubai World Islamic Finance Arbitration Centre and (“DWIFACJO”) or the Dubai World Islamic Finance Arbitration Centre Jurisprudence Office complete with a Sukuk Bankruptcy Tribunal (“SBT”) and a Takaful Tribunal (“TT”) and that DWIFACJO issue a standardized dispute resolution contract for each DWIFAC, SBT, and TT, which may be attached to the main contract. The DWIFACJO standardized dispute resolution contracts may contain a similar built-in dispute resolution mechanism as the FIDIC contract containing three stages including (1) the Dispute Resolution Board (DAB), (2) amicable settlement, and (3) final referral to DWIFAC, SBT, and TT arbitration. Within thirty days of the occurrence of the subject-matter of a dispute, any party to the contract may submit a claim to the DAB, addressed to the chairman of the DAB and with a copy to all parties of the contract. However, if any of the parties to the contract considers that there are circumstances, which justify the late submission, she may submit the details to the DAB for a ruling. If the DAB considers that it, in all the circumstances, is fair and reasonable that the late submission be accepted, the DAB shall have the authority to override the relevant thirty- day limit and if it so decides, it shall advise both the parties accordingly.

 

The DAB shall have sixty days to issue a binding ruling, which must be implemented immediately. If either party is not satisfied with the DAB ruling, either party can give notice of dissatisfaction to the other before the thirty days after the day on which she received the decision on or before the thirty days after the day on which the said period of sixty days expired. If there is no dissatisfaction within thirty days after the day on which she received the decision, the DAB’s decision shall become final and binding upon both parties. The DAB’s decision may then only be overturned by settlement or arbitration at DWIFAC, SBT, or TT.

 

The DAB shall consist of three people who must be suitably qualified in law, Islamic finance, and Shari’ah.   Each party shall nominate one member for the approval of the other party. The parties shall consult both these members and shall agree upon the third member, who shall be appointed to act as chairman. However, if a list of potential members is included in the contract, the members shall be selected from those on the list, other than anyone who is unable or unwilling to accept appointment to the DAB.

 

The agreement between the parties and either a sole member (adjudicator) or each of the three members shall incorporate by reference the General Conditions as written by DWIFACJO, with such amendments as agreed between them. The composition of the DAB shall be by nomination and then joint-selection.   DAB members are to be re-numerated jointly by the parties with each paying half of any fees. DAB members may only be replaced by mutual agreement. The appointment of any member may be terminated by mutual agreement of both parties, but not by any party acting alone. Unless otherwise agreed by both parties, the appointment of the DAB shall expire when the discharge of the matter shall have become effective. Where the parties fail or are otherwise unable to agree upon the appointment, nomination or replacement of any member of the DAB, then the appointing official so named in the contract shall make the appointment.

 

DWIFAC, SBT, and TT may establish an Ambassador’s List similar to the FIDIC President’s List, from which arbitrators and DAB members may be selected, if not specified in the contract. Persons who have successfully completed a DWIFAC Adjudication Assessment Workshop and International Arbitrator’s Islamic Finance Contracts Course and applied for entry to the DWIFAC Ambassador’s List of Approved Dispute Adjudicators are entered on the List for five years. Successful attendees at an Adjudication Assessment Workshop are required to be fluent in English and to be thoroughly familiar with Islamic finance, law, and Shari’ah.

 

There may be situations where a party fails to comply with a DAB decision. In such cases, the other party may refer the failure to DWIFAC, SBT, or TT arbitration. Where notice of dissatisfaction has been given, both Parties shall attempt to settle the dispute amicably before the commencement of arbitration. However, unless both Parties agree otherwise, arbitration may be commenced on or after the fiftieth day after the day on which notice of dissatisfaction was given. The attempt to obtain an amicable settlement during this prescribed period of fifty days is a condition precedent to a referral to arbitration. There is no given time frame to refer a dispute to arbitration, however, it should be without undue delay. Once the arbitration procedure has been initiated, the DWIFAC arbitration shall commence according to the DWIFAC arbitration rules, the SBT arbitration shall commence according to the SBT arbitration rules, and the TT arbitration shall commence according to the TT arbitration rules.

 

 

The arbitrator(s) shall have full power to open up, review, and revise any decision of the DAB relevant to the dispute. Neither party shall be limited in the proceedings before the arbitrator(s) to the evidence or arguments previously put before the DAB to obtain its decision or to the reasons for dissatisfaction given in its notice of dissatisfaction. Any decision of the DAB shall be admissible in evidence in the arbitration. Arbitration may be commenced prior to or after completion of the contract. The obligations of the Parties and the DAB shall not be altered by reason of any arbitration being conducted during the progress of the contract.

 

The arbitration at DWIFAC, SBT, and TT shall be conducted in the English language and any arbitral decision shall be final and binding. All of the DWIFAC, SBT, and TT decisions are to be published in English, French, and Arabic and the arbitration itself to be conducted in English. In the event of a conflict of laws, the Shari’ah shall prevail. A valid arbitration decision should lead to a verdict that conforms to the rules of the Shari’ah (AAOIFI 2004:559). The Shari’ah and legal basis of the arbitration decision shall be mentioned in the decision (AAOIFI 2004:559).

 

In the context of DWIFAC, SBT, and TT, the centers may make arrangements with the Dubai and DIFC courts and Abu Dhabi Courts and the ADGM or Abu Dhabi Global Markets Courts for enforceability of DWIFAC, SBT, and TT arbitration awards. However, parties to the dispute must realize that the arbitration award issued by DWIFAC, SBT, and TT may be overturned or enforced in other jurisdictions (International Bechtel Co. Ltd. v. Department of Civil Aviation of the Government of Dubai 300 F. Supp. 2d 112 (DDC. 2004)) or challenged in UAE courts based on Article 216 of the Civil Procedure Law (Now Article 53 of the Arbitration Law). Higher Shari’ah Authority decisions shall act as a source of precedent and shall be binding, thus providing legal certainty to Islamic finance and sukuk dispute adjudication. The Higher Shari’ah Authority shall act as the highest Shari’ah authority for DWIFAC, SBT, and TT arbitration, the UAE, and the DIFC and ADGM.

 

Conclusion

If the Sukuk Bankruptcy Tribunal was in existence at the time of the Dana Gas sukuk dispute, there would have been a contractual, streamlined, and standardized dispute resolution mechanism in place to resolve the dispute while the contract continued. Using a built-in-contractual dispute resolution mechanism such as the afore-mentioned system allows the contract to continue while solving the dispute through the Dispute Adjudication Board and if necessary, ultimately through arbitration. I believe the Islamic Finance Industry should seriously consider the implementation of the Sukuk Bankruptcy Tribunal as part of the wider DWIFAC dispute resolution mechanism.

 

Bibliography

 

  1. Billington, Daniel and Mohamed Taha (Cleary Gottlieb) (2017-2018), “Can the Sukuk Industry Survive the Dana Gas Dispute?” Emerging Markets Restructuring Journal, Issue No. 5 – Winter 2017-2018.
  2. Dey, Debashis, Xuan Jin, Sankalp Labroo, Hashim Eltumi (White & Case)(2017), “Dana Gas Sukuk: A Red Herring or Cause for Concern?” Client Alert Islamic Finance, August 2017.
  3. FIDIC Red Book (1999) London: Thomas Telford Publishing.
  4. Gnana, Jennifer (2018) “Dana Gas Issues New Sukuk, Drawing Earlier Dispute to a Close” The National.
  5. Hekmatyar, Muhammad Salahuddin and Ebrahim Parker (2018), “An Evaluation of Dana Gas’s Mudarabah Sukuk from Shari’ah and Legal Perspectives” European Journal of Islamic Finance, No. 9 April (2018).
  6. Paldi, Camille (2019) “Islamic Finance Dispute Resolution Proposal for 2020” Islamic Finance News, December 4, 2019, Volume 16 Issue 48.
  7. Smith, Robert (2018) “Dana Gas Strikes Restructuring Deal to End Sukuk Dispute” The Financial Times.
  8. Torchia, Andrew (2018) “Update 1 – UAE’s Dana Gas Agrees $700 Million Sukuk Restructuring Deal”
  9. Wikipedia, Dana Gas, [Online] Available: https://en.wikipedia.org/wiki/Dana_Gas [November 25, 2019].

 

 

 

 

 

 

Outlook for Halal investment in North and South America

This article was first published in Islamic Finance News on April 10, 2019.

 

Sector Feature: Halal Financing

Outlook for Halal investment in North and South America

The outlook for Halal investment in North and South America looks promising with regulatory adjustments occurring in the US in the 1990s; banks offering Islamic products and services in California, Illinois and Michigan; mortgage lenders active in the Islamic home finance sector in all 50 states of the US; the introduction of a fully-fledged Islamic bank in Suriname on the 7th December 2017, a three year US$900 million aid package from the IDB to Guyana in 2018 and a partnership between the Inter-American Development Bank Group and the IDB Group to co-finance projects in Suriname and Guyana starting in October 2017. Brazil also looks ripe for Islamic finance with a few other countries including Colombia, Argentina, Venezuela, Panama, Paraguay and Trinidad and Tobago exhibiting potential as Islamic finance contenders. CAMILLE PALDI delves further.

The US

In the US, Whittier Bank operates Islamic home financing in California and Devon Bank in Illinois offers Islamic finance services and products, as well as the University Bank in Michigan. Another popular Islamic home financing provider is Guidance Residential, which uses a grassroots community approach to reach thousands of customers across the nation. There are currently a total of 25 Islamic financial institutions operating in the US. These institutions are state-chartered entities subject to the same state and federal regulatory guidelines, corporate governance, banking and insurance operations and tax treatment as conventional financial institutions in the US including the requirement to be insured by the Federal Deposit Insurance Corporation.

 

The US has not adopted any federal legislation specifically addressing Islamic financing as of yet. Although Islamic financial institutions may be qualified to do business in different states, the majority of an Islamic financial institution’s assets are located in the institution’s home state and licensing and other conditions must be satisfied with respect to any state where the Islamic financial institution seeks to be qualified as a bank or mortgage or loan finance provider.

 

Only two rulings have been issued by the Office of the Comptroller of the Currency (OCC) in 1997, approving Ijarah and Murabahah structures for home financing and other retail financial products. In 1997, the United Bank of Kuwait requested interpretive letters from its regulator, the OCC, on Ijarah and Murabahah mortgage products. The OCC approved both on the grounds that they were economically equivalent to traditional conventional products. In terms of Ijarah, the OCC determined that Ijarah is the functional equivalent of secured lending. In 1999, the New York State Banking Department (NYSBD) also approved the Ijarah structure and agreed with the OCC that the product was functionally equivalent to secured real estate lending. In terms of Murabahah, the OCC determined that the bank would be functioning as a riskless principal.

These structures have now been approved by the federal government, the NYSBD and the banking authorities of several other states. Furthermore, the relevant authorities have removed the double tax jeopardy of these products where tax was incurred by the initial purchase and at the transfer of final payment. The tax authorities in New York and other states have handled this issue by eliminating double tax burdens on a case-by-case basis where the Shariah compliant structure was equivalent to a conventional financing transaction.

In 2008, the New York State Tax Department determined that no real estate transfer tax is due when the deed is transferred by a bank to its customer at the end of the lease term in accordance with the terms of the Ijarah arrangement. Thus, the US is wide open in terms of Islamic home financing based on the approved models mentioned herein and is also ripe for Takaful, funds, Islamic asset and wealth management, and Sukuk.

The US has seen two major Sukuk issuances — the US$165.67 million East Cameron Gas Sukuk facility, which was the first Sukuk Musharakah in the US backed by oil and gas assets and the US$500 million General Electric Sukuk (Sukuk Ijarah backed by aircraft leases). Both New York and Illinois have enacted legislation enabling Sukuk transactions and Islamic finance. Goldman Sachs issued a US$2 billion Sukuk facility in 2012. There are currently no listings of Sukuk on the US security exchanges. Although there are no applications for fully-fledged Islamic banks pending in the US, there exists a plethora of Islamic financing businesses within the US borders and being done overseas by US entities. The outlook for Halal investment seems promising within the US borders and by US companies abroad.

Suriname

Suriname hosts the South American continent’s first fully-fledged Islamic bank, Trustbank Amanah, which came into existence on the 7th December 2017 with the help of the Islamic Corporation for the Development of the Private Sector (ICD). The bank focuses on financing SMEs with financing based on Islamic and ethical principles, serves as a mechanism for wealth distribution in Suriname and promotes the economic development and stability of the country.

The ICD also signed an MoU with the Ministry of Trade, Industry and Tourism and the Association for Surinamese Business to work together to support and develop local SMEs. Trustbank Amanah conducts Islamic banking in Suriname and aims to become the Islamic financial hub of the Caribbean and Latin America. Suriname is definitely the South American nation to pick as a headquarters for South American Halal investment due to the support of the Central Bank of Suriname, the Surinamese business community and the Surinamese government for Islamic financing.

Guyana

Guyana joined the OIC in 1998 and the IDB in 2017 as its 57th member country, which was formalized with a commitment to a five-year work program. The IDB approved a three-year aid package (2018–20) of US$900 million targeting key development areas including economic, infrastructure, rural development, trade and competitiveness for Guyana. Furthermore, the Islamic Research Training Institute — the training arm of the IDB — provides support toward promoting awareness on Islamic finance in Guyana. Guyana also receives grants from the OIC and the Economic and Social Research and Training Centre for Islamic Countries and the Islamic Centre for the Development of Trade.

In addition, Guyana receives funding from the Standing Committee for Economic and Commercial Cooperation of the OIC and project funding for six areas, namely agriculture; finance; poverty alleviation; transport and communication; tourism; and trade. Also, with the support of Malaysia, Indonesia and Suriname through Trust Amanah Islamic Bank, Guyana desires to import modern technology and improve its agricultural and tourism sectors as well as offer Islamic financial products.

Winston Jordan, Guyana’s minister of finance, invited several Islamic development and finance institutions to Guyana in early 2019 in order to assess the appetite and capacity of the local private sector to utilize Shariah compliant financial products and other services of the IDB Group. One of the key objectives of the IDB is to bring together the public and private sectors as well as civil society groups to foster development through public–private partnerships and other joint projects. The future of Halal investment in Guyana appears solidly backed by the Guyanian government, business community and the IDB.

Brazil

Brazil actively trades with the Middle East with a 400% growth rate over the last 10 years. Brazil exported approximately 1.48 billion tons of Halal chicken in 2014 to the Middle East and North Africa and has been exporting Halal chicken to these regions for decades.

Brazil is equally open to the Islamic finance market as it is to the Halal industry. In 2007, Vicente Rossetto of CVM made a proposal for Brazilian Sukuk at the 19th Asian-Pacific Conference on International Accounting Issues in Kuala Lumpur and in 2008, Brazilian stock exchange Bovespa held a conference on how to leverage Islamic finance in Brazil. It was stressed at the Bovespa conference that tax legislation required alteration in order to avoid double taxation in Islamic finance transactions in Brazil.

A tax change, which should be implemented, involves the indirect taxes levied when Brazilian financial institutions buy or sell tangible assets in order to finance them. A reference can be made to UK tax law, which understands that Islamic finance trading of a tangible asset should not mean higher taxation than normal financing. It is also recommended that the Brazilian central bank amend its rules to accommodate Islamic finance, for example, with regards to the limits imposed on financial institutions in acquiring non-financial assets.

 

Brazil has already experienced the introduction of a Shariah compliant equity fund in June 2014, which concentrates on Brazilian commodities, mining, construction, public services and the oil and gas sector. In April 2014, Brasil Investimentos and Negocios promoted Islamic finance by hosting an Islamic finance workshop to educate people about the benefits of such financing in Brazil.

Furthermore, the Brazil: Excellence in Securities Transactions roadshow visited the Middle East and returned to promote Islamic finance and Shariah compliant assets in Brazil. Recent Brazilian legislation changes have guaranteed beneficial tax treatments for non-resident wealth fund investors and in some financial assets. This move promotes Halal investment into Brazil from other countries especially the Middle East and Asia. However, challenges remain on the regulatory, accounting and tax fronts in Brazil including:

(i)                  what prevails for accounting and tax purposes — the substance or the form of contracts

(ii)                how to account for the time value of money and non-interest bonds

(iii)              responsibility for the exposure of default risks, and

(iv)               limitations on banks to acquire and sell non-financial assets.

According to law firm Souza Cescon Barrieu and Flesch in 2017, the Brazilian legal system is well-suited to receive Islamic finance as Brazil has legislation which recognizes atypical contracts or forms of agreements not specifically provided for by legislation and gives formal and substantial flexibility to contracting parties. Furthermore, infrastructure projects involve projects with tangible assets that can be the object of various forms of Halal agreements. Souza Cescon Barrieu and Flesch stated that the projected growing demand for Islamic investment products and the large capital demand for investment in infrastructure projects present a favorable platform for the use of Islamic finance and Halal investment into Brazil. The firm is clear that even in the absence of legal reforms, the Brazilian market is ripe for alternative means of infrastructure financing including through Islamic finance.

Conclusion

The South American nations of Guyana, Suriname and Brazil might also encourage other Latin American or Caribbean nations to act as SPV holders for international Sukuk transactions and take the lead in Islamic finance dispute resolution by establishing an Islamic finance tribunal for the world’s Islamic finance, Sukuk and Takaful transactions. The US might attract a lot of global business by establishing an international dispute resolution center for Islamic finance, Sukuk and Takaful transactions.

For now, we should encourage the governments of North and South American nations to enact federal Islamic finance regulations and legislation and encourage cooperation with the IDB and other Islamic finance entities such as the ISDB, AAOIFI and the many organizations based in Malaysia, Bahrain and Saudi Arabia. Although a small niche business, Islamic finance complements capitalism in promoting the distribution of wealth to SMEs and the citizen as an owner and partner in business transactions rather than as a borrower in the traditional creditor/lender relationship.

 

Camille Paldi is the founder of the Ethical Finance Forum. She can be contacted at paldi16@gmail.com.

Book Review for Islamic Banking, How Is It Different from Conventional Banking? By Professor Muhammad Ali Shaikh by Camille Paldi

Book Review for Islamic Banking, How Is It Different from Conventional Banking? By Professor Muhammad Ali Shaikh by Camille Paldi

 

This book provides a hands down approach to explaining the difference between Islamic and Conventional Banking.  In a clear, methodological, straightforward approach, the author delves into a practical exploration of the key differences between Islamic and conventional banking while simultaneously pointing out the opportunities Islamic Banking has to offer the world at this moment in time.  In an innovative narrative, the author illuminates the Islamic and Conventional Banking framework, systems, operations, products, risks, financial reporting methods, and Shari’ah governance framework and answers key questions such as how a debt-ridden society transfers resources from the poor to the rich through interest financing. 

 

The author points out that in the United States as of 2007, the top 1% of households owned 34.6% of all privately held wealth, and the next 19% had 50.5%, which means that just 20% of the people owned a remarkable 85% leaving only 15% of the wealth for the bottom 80% (wage and salary workers).  The author purports that Islamic economics can cure this inequality by redistributing wealth, turning the average person into a business partner with the bank and financial institutions in Islamic finance and takaful (Islamic insurance) and an asset owner through the Islamic bond or sukuk.  The author explains all of the different modes of Islamic finance and shows how each structure evades interest finance and redistributes wealth to the business partner of the bank (the average citizen).  It is no longer a creditor/debtor relationship, however, the banking relationship becomes one of business partners or investor/fund manager where surplus and loss are shared on a profit- and- loss sharing (PLS) method.  The author explains that in the Islamic economic system, financing through the sale of goods or the profit- and- loss sharing method in real business activities promotes the creation of real assets in the economy.  The author says, ‘The Islamic system encourages supply and moderation in consumption and spending surplus on others, which promotes balance and distributive justice and ensures savings and investment.’

 

The author emphasizes the injustice of interest-based financing.  The author says that, ‘In an interest-based loan, the financier’s return is ensured, while the return of the borrower depends on the actual results of the business.  In case of loss, the borrower gets nothing, but still pays interest and in case of huge profits, he retains major part of the profit leaving the financier to take a fixed rate of return, which may be far less than what he would have gotten on the basis of profit-sharing in a joint-venture.  This is unfair to both.’

 

The author points out that money is not a commodity as is so treated in the conventional financial system.  The author says that, ‘We have assumed that like commodities, money can also be sold for a price higher than its face value or lent against interest.’  The author says this is incorrect because: (1) Money has no intrinsic utility, while a commodity has intrinsic utility; (b) Commodities have different qualities, while money has no quality; (c) Money has no value except which is assigned to it.  In case of commodities, it is the actual worth of the goods depending on their type and quality.’  The author explains that ‘Therefore, money of the same denomination cannot be the subject-matter of a sale, like other commodities. Its basic purpose is to act as a medium of exchange and a measure of value.’  The author points out that conventional banks make money by the pricing and time-value of money. 

 

Furthermore, the author reveals that Interest-financing and the creation of money by the banks causes a mismatch between the supply of money and the production of goods and services, which fuels inflation.  The money creation is far in excess of 90% of the total money supply and therefore causes over 90% of our inflation. 

 

The author explains that there are two permissible financing methods in Islamic finance: fixed- income methods and investment and profit- and- loss sharing methods.  The author says that fixed- income methods include trade modes, leasing modes, and diminishing ownership of assets or diminishing lease musharakah.  The investment or profit and loss sharing modes are based on musharakah and mudarabah.  The author explains in detail in the book each mode of Islamic finance often using real-world examples of how each modes of Islamic finance operates in the Islamic financial system.  Next, the author explores Islamic financial contracts and how they are utilized in each mode of finance.  In terms of Islamic bank deposits, the author points out that the relationship between bank and client is that of investor/manager or buyer/seller rather than the conventional creditor/lender relationship. 

 

In order to have a valid sale contract, there must be offer and acceptance, parties capacity to contract, the contract should be instant and absolute i.e. not for a future date and non-contingent, delivery must be certain, and the sale must be without any void condition.  The author explores each aspect of a valid sale contract and then goes onto to describe sale contracts commonly used by Islamic banks including bai muajjal or credit sale, murabahah, murabahah muajjal, musuwama, salam, and istisna’a contracts.  Next, the author discusses trade-based financing products including murabahah, musuwamah, salam, and istisna’a contracts.  This discussion is followed by an explanation of financing based on Ijarah.  The author then goes on to explain partnership-based financing products including musharakah, mudarabah, and diminishing musharakah (for home finance).  The author also includes discussion on import financing, export financing, financing through mudarabah funds, and profit- and- loss sharing methods and fixed-income methods of finance.  The author sheds light on the fact that Islamic banks tend to avoid musharakah and mudarabah modes of finance due to high risk and expense for Islamic banks and that this should be changed. 

 

The author then explores equity investments and capital markets.  The author begins with an explanation of Shari’ah stock screening, a process, which is required to ensure the Shari’ah compliance of equity investments.  The author then moves on to discuss Islamic capital markets and sukuk or Islamic bonds.  The author states that, ‘Sukuk is one of the major emerging instruments, which is used as a financing and risk management tool.  During the period 2001-2005, there were 18 sovereign ijarah sukuk issues amounting to USD 5.6 billion and 10 corporate ijarah sukuk issues amounting to USD 1.599 billion.  Ijarah sukuk is the major one.  Other sukuk structures include musharakah, murabahah, and Istisna’a.

 

The author continues with an exploration of deposit takings by Islamic and conventional banks.  The author says that ‘Islamic Banks raise deposits through a mudarabah contract whereby the relationship between the bank and the depositor is that of an investor and fund manager.  These funds are used to provide financing to individuals and businesses using Shari’ah compliant methods such as musharakah or mudarabah (investment modes) or murabahah, salam, and istisna’a (trade modes) and Ijarah (leasing modes).  The income so realized is not based on interest, but is either a trading profit or rent or an actual return on the investments made by the bank as manager of these funds.  This income earned by the deposit pool is shared between the bank as manager of the funds and depositors who are treated as investors.’  In a conventional bank, the relationship between the bank and customer is that of creditor/lender.  The income earned is based on interest.  Thus, in Islamic banking, the depositors receive a rate based on actual profits rather than a fixed rate of interest on deposits as in conventional banking. 

 

The author also emphasizes the need to create a unique system of financial reporting for Islamic banks due to the many differences with conventional banking.  The author points out that International accounting standards are meant for interest-based transactions and cannot be used by Islamic banks.  The author recommends adopting a financial reporting mechanism based on AAOIFI standards. 

 

I recommend this book for students, academics, Islamic finance practitioners, and practitioners of conventional finance who want to obtain an understanding between the main differences between conventional and Islamic banking.  

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.

UAE Laws and Islamic Finance

Laws of the UAE and Islamic Finance