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.