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Islamic Finance Practices Face Their First Test With Dubai World Debt
The American Lawyer
The Am Law Daily wrote on Tuesday about the mass of law firms that rushed into Dubai over the past two years to get in on the real estate and financing boom sweeping the Gulf region, but we wanted to know a bit more about the climate there this week, now that Dubai World, the massive sovereign wealth conglomerate, has announced plans to restructure about half its $60 billion in outstanding debt. So we called Jawad Ali, a King & Spalding partner based in Dubai and the deputy head of the firm's Middle East & Islamic Finance practice group.
Ali, who has worked mostly in the Middle East since 1994, specializes in Islamic financial products, such as sukuk, products that act much like traditional bonds but remain in compliance with Islamic law, or Shariah. The law forbids interest as well as financial products that generally allow investors to, in Ali's words, "make money off of money." Investors must share profits with lenders, and there must be a real asset tied to the investment -- in the case of the Dubai World subsidiary in the most trouble (a unit called Nakheel), that asset is real estate.
Ali was kind enough to take us through Islamic finance and describe the climate in Dubai right now.
Hi, Jawad. Thanks for your time. I assume you are quite busy.
We are getting calls from investors and creditors holding Nakheel units from all corners of the world. Just non-stop calls. Any creditor in the Middle East, believe me, is looking into this -- whether they lent directly to Nakheel or to companies related to Dubai World. Everyone is assessing their own legal situation and trying to see what they can do to protect themselves.
Are these calls from existing firm clients or potential new ones?
It's a mixture. Some are our clients, and some are clients we have not previously represented but we've had interaction with them before. Some have been directly across the table from us in various deals.
Does the fact that a lot of these notes [Editor's note: including a $3.5 billion bond with repayment due Dec. 14] are Shariah-compliant make the repayment process more difficult? We always hear that Islamic law frowns on interest and risk, and that investors share in profits with lenders. Does that mean investors here have a greater expectation of being repaid in full?
No. Under Islamic law, the concept of bankruptcy is recognized. It's all based on risk-taking and profit-sharing, it's just that the instruments behind that cannot be traditional bonds. Under Shariah, noteholders cannot simply make money off of money. Investors have to park their money in a real asset. But still, the more risk you take, the more profit you are entitled to. The word "risk" is always there under Shariah, and there is always the risk that the business venture you are investing in may not succeed and you will not be able to recoup your initial investment.
Debt forgiveness is also there. Debt reduction is there. Shariah understands the concept of not kicking someone while they are down.
But people are panicking that the legal and financial systems there won't be able to handle this, right?
Well, in Dubai and the Middle East in general, there just haven't been any restructurings of this magnitude. In the U.S., what Dubai World would have done is file for Chapter 11 protection, and a whole set of procedures would have kicked in. In Dubai and the United Arab Emirates in general, there are bankruptcy laws, but those laws are so basic and rudimentary, and nobody who was writing these laws was thinking about mega-bankruptcies and mega-defaults that involve assets in multiple jurisdictions.
The procedures are very simplistic, and in my opinion it cannot absorb this.
So what's going to happen if Dubai World and Nakheel say they can't repay those bonds?
It will be like any other restructuring or potential default. The company will ask creditors to allow it to propose a restructuring plan that will allow it to work with all its creditors and continue as a going concern. Creditors can of course say no and demand payment, but would that be wise? I don't think so, and that's not just because this is in Dubai or the Middle East. The wise move is almost always to speak with the debtor and reach a resolution that is a win-win for everyone.
So despite all the unique things we have here -- Shariah-compliant notes, an unprepared court system, etc. -- the hope will be to achieve a normal out-of-court restructuring?
Yes. The fact that these are Islamic bonds does not really make any difference. A default is a default. The issue is that the Middle East does not have a legal system to absorb this. There is no precedent. But this is going to happen and hopefully the resolution will be done amicably and we'll never see the inside of a courtroom. If we do, we'll be involved in a new type of procedure.
You've been in the Middle East since 1994, and you've seen a bunch of law firms rush into Dubai and Abu Dhabi in the last two years. What does the Dubai World crisis mean for those firms?
I think it's too early to really feel the effect of what has happened here. But you are right that a lot of firms have rushed recently to the Middle East, and not all of them have a well-developed Middle East strategy. Some firms saw the Middle East and said, "We can see the Middle East is on the rise, so we'll go there and hire some people and develop a strategy." Those firms have experienced a hard time already and will continue to experience hard times. They will have to really change their model.
Interviews are condensed and edited for grammar, style, and clarity.
This article first appeared on The Am Law Daily blog on AmericanLawyer.com.