Using a case study, Debashis Dey of Clifford Chance LLP sets out the benefits of Sukuk restructuring to settle trade creditor claims.
The worldwide economic events between 2008 and 2010 have presented both difficulties and opportunities to apply restructuring solutions familiar to those in the more developed markets into emerging markets where the techniques are novel and often being applied for the first time. The case study set out below discusses the restructuring of Nakheel PJSC’s outstanding debt and trade creditor claims using the Islamic capital markets as a solution.
On 25 November 2009, the government of Dubai announced that the Supreme Fiscal Committee of Dubai, acting on the government’s behalf, had authorised the Dubai Financial Support Fund to support the restructuring of Nakheel’s parent company, Dubai World, and its direct and indirect subsidiaries (together the Dubai World Group), with immediate effect. Following this announcement, both Dubai World and Nakheel requested a “standstill” from their respective creditors, effectively creating a moratorium against all debt claims against the companies.
Nakheel is one of the largest property developers and master planners in the Middle East and has been responsible for the development of some of the landmark developments in Dubai, such as the Palm. At the time of the announcement Nakheel faced outstanding debt and trade creditor claims in excess of US$20 billion, which included over US$5 billion of outstanding sukuk.
This case study focuses on the final element of Nakheel’s restructuring that led to the settlement of Nakheel’s numerous trade creditor claims. With insufficient cash to settle these claims, Nakheel chose to use a capital market instrument to solve its difficulties; however a conventional subscription-based capital markets issuance was out of the question. Instead, Nakheel, through a special purpose vehicle (the trustee), issued shariah-compliant sukuk certificates to its trade creditors in exchange for the cancellation of their respective debt claims against the company. This was the first time in the GCC that any company had sought to use a capital markets instrument in this way.
PERSUADING THE TRADE CREDITORS TO SETTLE
When considering the method of settling Nakheel’s trade creditor claims, Nakheel felt it was important to create a solution that would allow for the possibility of liquidity for the trade creditors, notwithstanding that Nakheel could not settle fully, in cash, the outstanding amounts owed to the trade creditors. Eventually Nakheel hit upon the solution of settling the claims partly in cash and partly through the placement of a security of the balance of the amount owing. However, for the security placement to be successful, the trade creditors would need to be persuaded that the capital market instruments they were being asked to take were more attractive than their debt claims against Nakheel and a solution had to be found to make the instrument appealing, notwithstanding that Nakheel’s commercial intention was to repay the security only after five years from the date of issue.
The solution was to allow for the issue of a shariah-compliant instrument (the trade creditor sukuk) as it was thought that having a shariah-compliant security would open the secondary market to the widest set of participants that the trade creditors could sell to after the initial issue. In addition, Nakheel sought to make the trade creditor sukuk a true “asset-backed” instrument, as opposed to the “asset-based” instruments that dominate the sukuk market. In Nakheel’s previous sukuk transactions, whilst land was sold on day one to the Trustee, the sales were not “true sales”, as, while the Trustee contractually owned the land backing the certificates, in a default scenario the Trustee was not free to sell the trust assets to anybody other than Nakheel. This contractual restriction is typical of the majority of sukuk issued and arises from the fact that the sukuk instrument has never been intended to replicate the characteristics of a true sale securitisation (notwithstanding the overarching structure that resembles a securitisation). A typical sukuk instrument instead mirrors its conventional (non-Islamic) equivalent, whereby an investor takes on the credit risk of the obligor and is typically unsecured.
Nakheel intended to replicate a structure broadly similar to a covered bond under its new trade creditor sukuk. Under the terms of the new sukuk, upon the dissolution of the relevant series (whether that is on the scheduled dissolution date or earlier, due to an event of default), the Trustee will exercise its rights under a purchase undertaking and require Nakheel to purchase all of the land that backs the relevant series of certificates. The consideration paid by Nakheel for this land (the exercise price) will form part of the dissolution proceeds that will be applied by the trustee to redeem the certificates. Contrary to the position adopted in typical sukuk structures, in the event that Nakheel fails to pay the exercise price in full, the trustee, through the delegate, has the ability to sell the land in the open market (this being the “cover asset” for the sukuk amounts falling due). The certificateholders’ ability to instruct the delegate to sell the land is unique in the UAE sukuk market and the incorporation of this feature was intended to provide trade creditors with a greater level of comfort than that provided by the mortgages in the previous sukuk issued by Nakheel.
During the preliminary structuring phase of the trade creditor sukuk, Nakheel realised that the time required to negotiate the debt claims of trade creditors was not something that could be reliably estimated. As such, from an early stage, it became apparent that Nakheel would need the flexibility to issue sukuk certificates as and when a large enough group of trade creditors agreed their claims with the company. Whilst multiple issuances of sukuk certificates can easily be achieved through the use of a sukuk programme, each series of certificates would not be fungible with any other series. In order to provide trade creditors with the highest degree of liquidity in secondary trading, Nakheel felt it was important that each trade creditor received a certificate that was fungible with that of another trade creditor’s, regardless of when that certificate was issued, thereby creating a deeper secondary market for the trading of the certificates.
Whilst fungibility amongst conventional bonds can be achieved through the use of “tap” issuances, such a mechanism had never previously been part of a sukuk programme. A key feature of shariah-compliant sukuk certificates is that each certificate must represent an undivided beneficial ownership interest in the trust assets. In a sukuk al-ijara, the trust assets are typically made up of land that is leased to the obligor. Whilst previous sukuk programmes effectively closed the pool of trust assets from day one, the Nakheel Trade Creditor Sukuk is more sophisticated in its approach.
On the face of it, the structure of the Trade Creditor Sukuk does not differ in many respects from a typical sukuk-al-ijara. On the date of issuance, the Trustee buys land from a seller, but instead of the consideration being derived from subscription proceeds, the land is sold to the Trustee in consideration for the cancellation of trade creditor debt. Once the land has been purchased by the Trustee, it is immediately leased to Nakheel and the rental stream funds the sukuk certificates’ profit payments.
A unique feature of the Trade Creditor Sukuk is Nakheel’s ability to over collateralise the pool of trust assets. During the planning stages, there was no certainty as to which land Nakheel would be able to sell to the trustee at the time of issuance. As such, the structure developed in such a way as to give Nakheel an unprecedented level of flexibility with respect to the sale of land to the trustee and the treatment of that land during the lifetime of the sukuk certificates.
FUNGIBLE TAP ISSUE – AN EXAMPLE
To demonstrate how this flexibility could work in practice, imagine a theoretical issue of a tranche of certificates with an aggregate value of US$100 million. Nakheel could either sell US$100 million of land to the trustee, pursuant to a sale agreement, or it could sell land with a much higher value. As a real estate company possessing large parcels of land that are often easily divisible, this feature of the trade creditor sukuk provides Nakheel with a great deal of flexibility, by allowing the company to limit the number of sales and land registrations taking place each time a sukuk tranche is to be issued. If Nakheel chose to sell land worth greater than US$200 million, whilst only issuing US$100 million of certificates, the trustee would owe Nakheel US$100 million of purchase price; however this payment obligation would be deferred. Any deferred purchase price may be paid by the trustee procuring the cancellation of additional trade creditor debt, or by the payment of cash on a potential subscription-based issuance under the trade creditor sukuk. Any outstanding deferred purchase price would ultimately be set off against Nakheel’s obligation to pay the exercise price to the trustee under the purchase undertaking.
Should Nakheel sell US$200 million of land to the Trustee, but choose to only issue US$100 million of certificates, Nakheel would retain the ability to make a tap issuance of an additional US$100 million of certificates. Any such tap issuance would be fungible with the first tranche of certificates issued in that same series. This fungibility was achieved through consultation with the shariah scholars who advised Nakheel on a structure whereby the existing certificate holders in the series will agree to share the trust assets with the holders of the new certificates issued pursuant to the tap. As such, each certificate outstanding in the series following the tap issuance will represent a pro rata share in the trust assets.
Should Nakheel wish to make a tap issuance of U.S.$200 million of certificates, additional land would have to be sold to the Trustee to ensure that the value of the trust assets was at least equal to the value of the certificates outstanding following the tap issuance. Following the sale of additional land, the trust would be extended to include that land, thus ensuring that all certificates in the series represent a pro rata share in the new enlarged trust assets, thereby ensuring full fungibility on the secondary market.
THE ABILITY TO SUBSTITUTE ASSETS
In a sukuk-al-ijara, any assets sold to the trustee are typically held by the trustee for the tenor of the sukuk certificate issued. It is only when the trust is dissolved that the obligor regains title to the assets and is once again free to deal with those assets in an unencumbered manner. As a company going through a restructuring, Nakheel required the ability to regain title to its assets before any certificates matured and the trust was dissolved. The Trade Creditor Sukuk therefore incorporates sophisticated substitution mechanics that are designed to protect the certificateholders, whilst providing Nakheel with the flexibility to regain title to its land early. Substitution of land may only take place provided replacement land is found which is at least equal in value to the land being replaced, with all valuations being undertaken by independent professionals. The importance attached to the valuations enables the trade creditor sukuk to maintain the integrity of an asset-backed instrument.
ESTABLISHMENT AND ISSUANCE
Nakheel established the Anka’a Sukuk Limited 8.5 billion dirham sukuk programme on 24 August 2011. Since the inaugural issuance under the programme was not being used to raise capital, the establishment took place without the involvement of arranging banks. The inaugural issuance of 3.8 billion dirham certificates occurred the day after establishment, with the certificates being issued directly to trade creditors, who had each opened their own custody account for the purpose of receiving the settled securities. On the 25 April 2012, Nakheel issued a further 227.4 million dirhams in certificates using the tap mechanism under the programme, thereby issuing the first and only tap issue of sukuk in the UAE to date.
SET OUT BELOW IS A SIMPLIFIED STRUCTURE OF THE TRADE CREDITOR SUKUK