The English High Court’s decision in Dana Gas PJSC v Dana Gas Sukuk Ltd & Ors  EWHC 2928 (Comm) issued in November 2017 (and updated in February 2018 following re-hearing) has alleviated some concerns about the robustness of the Islamic finance structures. It highlighted the fact that the Dana Gas saga in many ways is a beast of its own making (both from a sukuk structure and documentation perspectives), and when these risks are misunderstood, they are erroneously extended to Islamic financing as a whole. This case has raised important questions regarding the enforcement of security documentation in an Islamic finance transaction and whether non-compliance with Shari’ah principles is likely to make security documents unenforceable. This article discusses the approach taken by the High Court to these issues and the potential implications of the High Court’s judgment on Islamic finance transactions.
In 2007, the claimant (“Dana Gas”) raised USD1 billion through the issuance of Sukuks, i.e. certificates intended to be compliant with Shari’ah principles. The transaction was subsequently restructured in 2013. The Sukuks were issued in the form of a mudarabah agreement (the “Mudarabah Agreement”) governed by the law of the United Arab Emirates (“UAE”) and were due for redemption on 31 October 2017. Mudarabah is a partnership where one party contributes the capital (Rab Almal (the investor)) and the other party contributes its skills and expertise (Mudarib). The principles are that the investor solely bears the risk of loss of his investment and will only share the profit of the enterprise without any recourse against Mudarib for any potential losses. In this case the Mudarabah Agreement provided that the profits from the mudarabah assets (Shari’ah compliant investment assets) will be distributed quarterly in a ratio of 99% to Dana Gas Sukuk Ltd (the Trustee acting for investors) and 1% to Dana Gas (as Mudarib).
Alongside the Mudarabah Agreement, the parties executed a purchase undertaking governed by the English law (the “Purchase Undertaking”). The Purchase Undertaking granted an irrevocable right to the Trustee to oblige Dana Gas to purchase all of the Trustee’s rights, benefits, entitlements in and to the Mudarabah assets on an ‘as is’ basis at the relevant “Exercise Price”. The purpose behind the Purchase Undertaking was to protect the investors by obliging Dana Gas to repay the investment if certain events of default occur.
In June 2017, Dana Gas announced their refusal to honour the Purchase Undertaking on the basis that the Mudarabah Agreement was not Shari’ah compliant according to the legal opinions obtained by Dana Gas. These legal opinions contradicted the opinions obtained at the time when the transaction was restructured when they confirmed compliance of the Sukuks with Shari’ah, UAE law and English law.
Subsequently, Dana Gas applied to the High Court seeking declarations of unenforceability of its obligations under the Purchase Undertaking. The High Court did not address any of the UAE law issues and had a trial of a preliminary issue to determine whether, assuming (without deciding) that the transaction is invalid under UAE law, is the Purchase Undertaking valid and enforceable.
Commercial Court judgment
Dana Gas pursued three main arguments as to why the Purchase Undertaking shall not be enforced:
a. The Construction Argument: Dana Gas alleged that on the proper interpretation of the Purchase Undertaking, its obligation to pay the Exercise Price was dependent on the parties being able to enter into a valid Sale Agreement and since any potential Sale Agreement would be invalid under the UAE law, Dana Gas does not have to pay the Exercise Price.
b. Mistake: Dana Gas argued that the Purchase Undertaking is void for mistake. They alleged that when the parties entered into the Purchase Undertaking, they mistakenly understood that the Mudarabah Agreement and any potential Sale Agreement were lawful and enforceable.
c. English Public Policy: As a matter of public policy, the English courts should not enforce an obligation which requires a party to do something which is unlawful by the law of the country where the contract is to be performed. Dana Gas argued that the Purchase Undertaking requires the parties to enter into Sale Agreement, which is unlawful under the UAE law.
The High Court rejected all of the above arguments.
In response of the first argument, the Court construed the wording of the Purchase Undertaking such that Dana Gas’s obligation to pay the Exercise Price is separate from its obligation to enter into the Sale Agreement.
In relation to the second argument, the Court found that there is no room for the doctrine of mistake to operate if the contract expressly states what is going to happen in case of a particular event. In this case, the Purchase Undertaking expressly contemplated the possibility that the Mudarabah Agreement is unlawful and unenforceable and allocated this risk to Dana Gas.
Finally, the Court has rejected the public policy argument on the basis that no obligations have to be performed in the UAE. In particular, the Exercise Price must be paid into the transaction account, which is held in London. Therefore performance would take place in England where it is not unlawful.
The High Court’s judgment provides certainty in the context of Islamic finance transactions. A different result would have been highly concerning for any investors into the Shari’ah compliant structures.
Whilst the facts of Dana Gas are very specific to the documentation in the case, there are still valuable lessons to be learnt for anybody seeking to create robust Islamic finance instruments. The most obvious lesson is to ensure that the documentation includes explicit provisions dealing with potential current or future, actual or perceived, non-compliance with or unenforceability under the Shari’ah law. This would increase attractiveness of a particular Islamic finance structure to potential investors and can help to alleviate some of the perceived risks of such structures. For example, the Saudi Arabia-based Islamic Corporation for the Development of the Private Sector (ICD) has included new clauses in its latest sukuk prospectus that explicitly waive any right to challenge the Shari’ah compliance of the deal. The investors should also assess carefully the law applicable to each of the documents forming part of the transaction and security documentation as well as the place of performance of the obligations.