The reason I recounted the incident in last week’s article was connected to the discussion we are currently having on Sukuk default scenarios. The lawyers, raters and investors initially endeavored to corner the originator from all sides, as is normally the case with conventional banking and finance.

However, with proper explanation of the Islamic financing principles by the scholar, they gradually grasped the principles of fairness and realized the different nature of a Sukuk transaction compared to conventional bonds, and withdrew most of their demands and the Sukuk documentation was spared from being doctored.

With a strong conventional banking background, I was accustomed to staking all odds heavily against the borrower. However, the rule of distributing the odds evenly between the parties in Islamic financial transactions became clearer to me too back then, as it became apparent to the other participants of that important meeting.

Moving on, the next event of default in a Sukuk transaction I would like to discuss is highly sought after by the investors. It is the ‘cross-default scenario’ clause. Generally, it is defined as per the following gist in most Sukuk prospectuses and documentation:
Cross-default of the originator shall be considered to have occurred if any of the existing or future indebtedness of the originator or any of its subsidiaries becomes due and payable prior to its stated maturity as a result of an acceleration event. Also, if any of the creditors of the originator or of any of its subsidiaries exercises its rights, remedies, powers or discretions under any security interest granted to it pursuant to the occurrence of an event of its own default.

Breaking the jargon down, what is stated hereinabove is that if the originator of the Sukuk fails to fulfill any of its financial obligations in any other financial transaction (be it Islamic or conventional), or even if any of the originator’s subsidiaries does so, this will trigger the default in the Sukuk transaction as well.

The aforementioned is irrespective of the fact that the Sukuk transaction may have been running perfectly alright and all the obligations, financial information requirements, covenants or conditions subsequent are being satisfactorily complied with.

Although the cross-default clause appears in all Sukuk documentation and the Shariah scholars and advisors have come to terms with it, initially there was a resistance to accept it mutatis mutandis, as it is applied in conventional bond transaction documentation. The reason for such Shariah reservation for the clause was the spirit behind it which is ‘risk aversion’ as far as one can go.

Explaining it further, I would like readers to recall when I had written in detail about how the financial default is treated in Shariah. The first thing one must ascertain is whether the default was caused due to circumstances beyond the debtor’s control, or it could have been avoided had the debtor been prudent.
In the first scenario where the debtor was found to be innocent, Islamic teachings are clear to give more time to the debtor so that it can arrange payment of the amount to the creditor. Or, as the Holy Quran says: “It is better for you if the debt is forgiven altogether.”

There is no limit in Shariah as to how much time should be granted by the creditor and it is left to both parties to discuss and agree. Even if the debtor relapses into default on the extended timeline, and if it is again due to no fault of it, the creditor may further extend the repayment period without increasing the amount until such time that the debtor recovers fully and is out of the woods.

This Shariah approach is 100% pro-business since I had myself witnessed the unnecessary collapse of entities during my conventional banking days owing to extreme rigidity demonstrated by the staff (including me) due to the bank’s remedial management policies.

Looking back, had the conventional bank I worked for given some concession and relaxation to the borrowers who were in the midst of a market storm due to no fault of theirs, the businesses developed by them with untiring efforts for decades would not have seen the padlocks on their shutters.

The purpose of this educative series and the article is not to hurt any religious or commercial sentiments either consciously or even unwittingly.

Sohail Zubairi is an Islamic finance specialist and AAOIFI-certified Shariah advisor and auditor. He can be contacted at [email protected].

Next week: Discussion on the events of default in a Sukuk transaction shall continue.