Tuesday 27, June 2017 by William Mullally

Fitch: Dana Gas case highlights Sukuk's legal uncertainties

Bashar Al Natoor, Global Head of Islamic Finance, Fitch Ratings and the Fitch team comment on the latest developments on the Dana Gas Sukuk lawsuit.

Any potential credit rating implications for Sukuk arising from Dana Gas's attempt to have its Mudharaba Sukuk declared unlawful will take time to emerge, and their scope and impact are likely to remain unclear until all relevant proceedings are resolved, if they ever are, Fitch Ratings says. We believe our current assumption that Shari'ah compliance typically does not have credit implications for Fitch-rated Sukuk remains appropriate. Resolving the relevant issues could be a complex and drawn-out process with uncertain implications and the potential for a market or regulatory response. Fitch does not rate Dana Gas or its Sukuk.

Dana Gas publicly stated on 13 June 2017 that it had "received legal advice that the Sukuk in its present form is not Shari'ah compliant and is therefore unlawful under UAE law" and that it had started court proceedings in the UAE to have the Sukuk declared unlawful and unenforceable. It has proposed restructuring the Sukuk "to ensure that it conforms to the relevant laws" and also to take into account "the Company's need to focus on short to medium term cash preservation". Sukuk distributions due on 31 July and 31 October "cannot be paid now that the existing Sukuk is deemed unlawful but will be accounted for" as part of the restructured instrument, Dana Gas said.

Sukuk regulations have been introduced and updated in several countries in recent years, but standardisation, harmonisation and legal precedents are limited in most jurisdictions. This case could set an important precedent for the relationship between Shari'ah compliance and credit risk, and give greater clarity on enforceability and how court interpretations of commercial law might be influenced by Shari'ah.

However, this will depend on numerous factors. Debt restructurings in the UAE have generally been informal, out-of-court arrangements, partly due to creditor perceptions that local courts have a limited track record (Dana Gas has said that it is seeking a consensual restructuring). It is not clear whether or when the case might result in a conclusive binding legal judgement, and if this would have implications for all Sukuk issues in multiple jurisdictions or only for Mudharaba Sukuk in a limited number of jurisdictions. An initial hearing is not due until 25 December, according to Dana Gas, and proceedings may be lengthy and multi-jurisdictional (the company said on Sunday, 18 June that it had been granted an injunction by the English High Court of Justice "against any hostile action" by Sukuk holders, following injunctions in the British Virgin Islands and the UAE).

Our Sukuk ratings are based on our assessment of credit risk and do not imply any confirmation that the Sukuk are Shari'ah compliant. This is usually the responsibility of the Shari'ah board of the lead manager/originator and to date questions of Shari'ah compliance have not had credit implications for Fitch-rated Sukuk. But while there is broad consensus among Shari'ah scholars and market participants on the key tenets of Shari'ah, there are differences of interpretation that Fitch would not be in a position to anticipate or assess.

For this reason, if non-compliance had credit implications and such implications cannot be quantified under our criteria for rating Sukuk, instruments may not be rateable. Our criteria state that our analysis and ratings "will reflect Fitch's view that the default of senior unsecured obligations would reflect default of the entity in accordance with Fitch's rating definitions". Sukuk are unrateable when contractual commitments do not fully cover timely full payment of principal and periodical distribution unless other mechanisms indemnify the Sukuk holders in the case of non-payment.

Fitch will continue to monitor the evolution of Sukuk structures and legal developments. Where this leads us to modify our rating approach, we will communicate the reasons and the consequences to market participants.

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