Dana Gas and an Existential Crisis for Islamic Finance
The very foundations of the Islamic finance world were shaken a few weeks ago when Dana Gas declared that $700 million of its Islamic bonds (sukuk) were invalid and obtained a preliminary injunction against creditor enforcement from a court in the UAE emirate of Sharjah. Like Marblegate on steriods, Dana made this announcement as a prelude to an exchange offer, proposing that creditors accept new, compliant bonds with a return less than half that offered by the earlier issuance.
Dana shockingly claimed that evolving standards of Islamic finance had rendered its earlier bonds unlawful under current interpretation of the Islamic prohibition on interest and the techniques Dana had used to issue bonds carrying an interest-like investment return. I had expected to read that Dana had used an aggressive structure like tawarruq (sometimes called commodity murabahah) that pushed the boundaries of what the Islamic finance world generally countenanced, but no. The structure Dana had used was totally mainstream, a partnership structure called mudarabah. Dana asserted that the mudarabah structure had been superseded by other structures, such as a leasing arrangement called ijarah, though in Islamic law as in other legal families, there are often multiple permissible ways of achieving a goal, not just one. And when an issuer prepares an Islamic finance structure like this, it invariably gets a sign-off from a shariah-compliance board of respected Islamic law experts (sometimes several such boards). For Dana Gas to suggest that its earlier board was wrong to the tune of $700 million, or worse yet that Islamic law had somehow changed in a few years through an abrupt alteration of opinion by the world of respected Islamic scholars is ... troubling.
The case in the Sharjah court will take some time, but I predict that this exceptionally aggressive attempt by Dana Gas to evade its bond obligations will fail. The bonds are governed by English law, and I can hardly imagine that there is anything so shocking in their terms that would prompt a level-headed UAE court to declare as a matter of a core principle of overriding Islamic law that the mudarabah structure is "illegal." This will be a case to watch, though, and a real test of a respected Middle Eastern court system in the eyes of western investors. The Islamic finance industry has exploded in recent years, with nearly $50 billion per year in new issuances. If Dana Gas gets away with this shocking evasion of its sukuk obligations, it will strike a death blow to an industry that developed to allow investors to engage with the world of commerce while staying true to their moral and religious beliefs. It would be a terrible shame if Dana Gas's venal sharp practices laid low such a beautiful idea.
Hat tip to Jay Westbrook for bringing the story to my attention.