The Gulf Cooperation Council (“GCC”) countries, including the United Arab Emirates (“UAE”) and specifically the emirate of Dubai, have witnessed a dramatic increase in the number of regional parties interested in financing corporate and real estate acquisitions and infrastructure projects on a Shariah compliant and non-recourse basis.
Generally speaking, non-recourse financings (conventional or otherwise), other than in the context of infrastructure projects, continue to be highly unusual in the GCC, as most financings are backed by personal or corporate guarantees from creditworthy borrowers or their ultimate parent or shareholders. Borrowers who wish to structure a financing in a Shariah compliant manner not only seek to finance their investments in ways that do not involve the payment of interest/riba, but also look to abide by other underlying Shariah requirements. Achieving non-recourse, Shariah compliant financing will obviously add another level of complexity to the transaction.
In addition to the relatively new trend of turning to Shariah compliant financing on a non-recourse basis, regional borrowers are increasingly turning to lenders outside of the region to source their funding. Such foreign lenders normally secure their loans with a full and robust security package that is over and above what regional borrowers are accustomed to providing to financiers. Furthermore, the laws of the GCC are not designed to accommodate the security package typically expected by foreign lenders.
In order to structure a financing in Dubai (outside the separate legal regime of the Dubai International Financial Center), it is critical for parties to have a basic understanding of the Shariah as applied in Dubai. While the UAE is a civil code jurisdiction, Islamic Shariah is embedded in many provisions of law. For instance, Article 7 of the UAE Constitution provides that Islamic Shariah is “a source” for legislation. Article 2 of the UAE Federal Law 5 of 1985 (“the Civil Code”) provides that the principles of fiqh are to be utilized in understanding the underpinnings of the provisions of the Civil Code.
Article 27 of the same Code provides that the provisions of a governing law cannot be applied if they are contrary to Islamic Shariah, public order or the morals of the UAE. However, similar to other jurisdictions in the region, interest provisions are enforceable in the UAE. The Federal Supreme Court and the Dubai Court of Cassation have upheld Article 76 of Federal Law 18 of 1993 (the “Commercial Code”) enforcing interest provisions in financing agreements.
The number of Islamic banks in the UAE has gone from two to at least eight in the last three years. Federal Law No 6 of 1985 permits Islamic banks to invest in companies and projects and engage in financial, commercial and investment banking activities. The growth in the number of financial institutions that have either been converted from conventional banks or created from scratch in the UAE is a testament to the growth of Shariah compliant financings in the UAE.
This article will provide a brief overview of some of the issues lenders need to consider when structuring Shariah compliant financings on a non-recourse basis in Dubai.
A number of challenges exist in structuring a non-recourse financing (conventional or Shariah compliant) in Dubai, particularly the concept of “security” and the means of “perfecting” and enforcing security interests in Dubai, which often differs from those of most western jurisdictions. Under the Shariah, a security interest may be perfected only through possession. Thus, a pledge of an object (e.g. a vehicle or jewelry) as security for a loan will be recognized so long as the lender maintains possession of the object. This becomes difficult with respect to certain types of property that are the object of financings, including immovable property such as real estate or fixtures on the land.
We note that the term for pledge (rahn) is used interchangeably for both real property (mortgages) and personal property. Also, we note that rahns (e.g. business mortgages) that require the recognition of the notary public will normally require a UAE financier to be the lender of record, which creates issues for foreign lenders.
Financiers normally wish to obtain a rahn of the real estate, movable property of the borrower and/or the facility to be constructed for use by the borrower. Below is a brief discussion of each type of asset:
• Real estate/immovables
Unlike some surrounding jurisdictions, the UAE does have a central registry for the recordation of real estate title deeds with the UAE lands department. In connection with the sale of real property, the lands department charges a fee over a certain percentage of the value of the property. If the property is in one of the designated freehold areas in which foreign ownership is permitted, the developer usually charges a transfer fee to transfer the title deed. This becomes an issue when using the Ijarah structure.
In an Ijarah financing, the ownership of the real estate is transferred in the name of the financier. This will result in significant fees, which will again be charged when the real estate is transferred back in the name of the lessee under the Ijarah. Due to the significant fees, the financier sometimes simply accepts a contractual right as the owner of the concerned real estate without registering its ownership with the lands department or the concerned developer.
It is also possible for a local financial institution to record a mortgage with the lands department, which charges a fee based on the value of the property.
In a non-recourse financing, the financiers normally wish to take a mortgage over all the movables that belong to the concerned borrower. In Dubai, there is no general register for pledges over movables. Certain governmental departments, however, will permit a registration of such rahn. For example, the General Civil Aviation Authority has in the past provided an undertaking to deregister an aircraft upon request by the financier upon an event of default. It is unclear, however, if such rahn would actually be effective in practice.
In general, Article 165 of the Commercial Code requires that the subject of the pledge must be placed in joint possession of the pledgor and pledgee in such a manner that the pledgor cannot dispose of the assets without the pledgee’s knowledge.
Article 1487 of the Civil Code provides that a pledge of movable assets shall not be effective against third parties unless it is recorded in writing on a fixed date and states the amount of the secured debt, the asset pledged and the fact of the transfer of the possession of the pledged asset to the pledge.
• Pledge of interests in a UAE LLC
A UAE LLC, the corporate form most often utilized for joint-venture entities in Dubai, does not issue share certificates. This has presented difficulties in raising non-recourse financing for UAE LLCs to the extent that there are no share certificates of the project company that can be pledged to the lenders. The problem arises from the requirement under the Shariah principle that any security interest, in order to be valid, must be reduced to actual or constructive possession of the subject of the rahn given.
In the absence of a share certificate that can be physically delivered to the lenders or even annotated, the pledge of interests in a UAE LLC is not enforceable under local law. Accordingly, there is no generally effective direct means by which shareholders may pledge their interests in a UAE LLC to a lender or any other party.
To get around this, lenders will often require sponsors to form special purpose vehicles or SPVs in offshore jurisdictions (e.g. the Cayman Islands) to serve as the actual shareholders in the UAE project company, as the shares of such SPVs may be more readily pledged to the lenders as additional security for the financing provided. The lenders can then take security over the second-tier shares, the shares of the offshore companies established by the borrowers to hold their shares in the project company. However, this solution is of limited effect since an offshore company will only be able to own 49% of a UAE LLC. Therefore, lenders also often require a power of attorney from each of the shareholders of the UAE LLC (discussed below) to exercise step-in rights.
• Business mortgages
The Commercial Code permits the creation of a rahn over a business and its assets in favor of a financier. The Code requires such rahn to be executed before a notary public and registered in the Commercial Register. Registration includes registration at the Commercial Registration Section of the Dubai Department of Economic Development and publication of such in the local Arabic language press. Upon an event of default, the financier may not exercise self-help (regardless of any provision to the contrary in the rahn agreement).
Instead, the financier as the mortgagor, may, after eight days’ notice, apply to a local court for the sale of the assets subject to the rahn in a public auction. Note the real estate where the business is conducted is not deemed to be part of the business. A separate mortgage to secure any interest in real estate must be registered with the lands department.
• Bank accounts
In general, the concept of floating charges is not recognized in Dubai. An identifiable asset, such as a fixed deposit, is required. It may be argued that the amount pledged is the amount standing in such account on the date of enforcement, but we are unaware of a consistent precedent that supports this view. Therefore, financiers normally require that certain project accounts be maintained in an account in a jurisdiction in which the lenders can take a floating charge over the account (e.g. England or New York). For example, lenders will likely require that proceeds generated from offshore off-take agreements or rents in connection with the real estate that is the subject matter of the financing be deposited directly into certain offshore accounts subject to such floating charges.
However, this mechanism is often impractical where onshore counterparties are reluctant to pay into an offshore account. In these instances, financiers have employed “cash sweep” mechanisms to move cash from an onshore account of the borrower to an offshore account subject to a floating charge. This can be accomplished by creating a segregated onshore account and contracting with the deposit bank to permit a representative of the lender to manage or direct disbursements from the onshore account.
Offshore financiers will typically also require set-off rights with respect to accounts held with them. The rights of banks in Dubai to set off are generally broad. Financiers must ensure that such rights are provided for in the finance documentation. In the absence of such agreement, financiers may arguably require a court order before exercising any claimed set-off rights.
• After-acquired property
Assets, or marhoun, under the Shariah must be something that can be validly sold. Therefore, any marhoun subject to a rahn must: (i) be in existence at time of execution of the rahn; (ii) have a quantifiable value; and (iii) be saleable and deliverable. The definition of marhoun creates a problem in terms of after-acquired property. This can be addressed in a financing through regular updates of the schedule of marhoun/assets in the security agreement prior to each draw on a facility to ensure that the concerned marhoun is covered by the security agreement.
We have developed a form of security agreement for the region that utilizes the rahn-adl structure, in which the adl is akin to the western concept of a trustee over the assets. This is supported by a “deed of possession” in which the schedules to the concerned security agreement are duplicated (and, as with the security agreement, updated regularly), thus creating a form of “constructive possession” of the assets and subjecting them to a rahn. Each type of asset in a financing needs to be analyzed and a determination made as to the best method under local law to subject such asset(s) to a rahn. While the rahn-adl concept has not been tested before local courts, to our knowledge, such structure has been utilized in other non-recourse financings in the region.
b. Assignment of contract proceeds
It is possible to assign contract proceeds and other intangible rights under Islamic Shariah as applied in Dubai, subject, however, to the caveat that it is not possible to “perfect” such assignments through recordation with a central registry. Instead, borrowers in Dubai are often asked to assign specific contract proceeds, with an acknowledgment from the payor that the assignment shall remain in effect until the assignee consents to any transfer or termination of the assignment.
Under Shariah precepts as applied in Dubai, however, unilateral assignments are not effective. In order to create an effective assignment of a contract of the relevant project company and/or contractual obligations of counterparties thereto, such counterparties must be given notice of the assignment and must consent to the assignment. Thus, an assignment to the lender(s) of amounts owed to the borrower must include a written consent of such assignment by the payor(s) in order to improve the enforceability of such assignment.
We note that some local commentators believe that as per Article 1130 of the Civil Code, it is not possible to have such assignment effective against third parties (e.g. a liquidator) unless there is a “date certain” for the assignment. Such commentators believe a date certain is not achievable in Dubai unless the signatures on such assignment are recognized by a local notary public and such date becoming the “date certain” of the assignment.
Other local commentators, however, believe it is sufficient to simply provide written notice to the original payor to make the assignment effective. We note that the notary public has refused to notarize assignments in relation to real estate transactions in Dubai.
c. Power of attorney
Financiers in Dubai often rely on a wakalah or a power of attorney given to a designee of the lenders in order to exercise certain “step-in rights” in an event of default scenario. However, it is critical to note that powers of attorney in Dubai are revocable, even if the power of attorney is characterized on its face and in the security documents as an “irrevocable” power of attorney.
In order to protect against the revocation of a power of attorney granting step-in rights, lenders often include a liquidated damages provision in the concerned security agreement that is triggered upon premature revocation. In our experience, liquidated damages have been enforced by the local courts as long as the sum approximates the actual damages and are not drafted as excessive financial penalties for non-performance.
Financiers in the UAE often rely on post-dated checks for additional security. The UAE Penal Code makes it a criminal offense to issue a check without sufficient funds. The arrest of the drawer for “bouncing” a check is a strong deterrent against default. Also, as payment of a check may only be stopped upon a court order, banks regularly utilize post-dated checks as another means of security.
• Issues in relation to governmental or quasi-governmental entity
The doctrine of sovereign immunity applies in Dubai. Pursuant to a 23rd September, 1972 order of the ruler of Dubai and a subsequent 4th July, 1992 order of the ruler of Dubai (collectively, the “immunity orders”), the Dubai government, including its departments and any other governmental corporations or bodies, cannot be sued without the prior consent of the ruler of Dubai, and its properties cannot be attached or seized.
It does not appear that, under Dubai law, a Dubai governmental entity would have the authority to give a prospective, blanket waiver of sovereign immunity in a contract or otherwise without the express prior consent of the ruler of Dubai. Thus, the issue of sovereign immunity should be considered in the event a Dubai governmental entity is the borrower or a guarantor.
• Enforcement of a foreign arbitral award or judgment against the project company
Offshore lenders will likely be concerned about the ability to enforce a foreign judgment or arbitral award against an entity in Dubai. It should be noted that as per the UAE Civil Procedure Code, almost any matter involving a UAE national or a foreigner resident in the UAE gives the local courts jurisdiction.
While the UAE recently acceded to the New York Convention on the Enforcement of Foreign Arbitral Awards, it is unclear to what extent such arbitral awards are enforceable without having to re-litigate the merits of the matter in a local court. We note that arbitral awards rendered in France have been enforced in Abu Dhabi on the basis of a reciprocal treaty between the UAE and France.
The willingness of lenders to provide Shariah compliant financing with longer tenures, pricing that is competitive with conventional banks, and the growing number of lenders and lawyers who understand and are able to utilize a number of different Shari’ah compliant structures have made this type of financing attractive.
While there are a number of challenges in structuring a non-recourse financing, particularly on a Shariah compliant basis, local and international lenders and legal counsel have developed methods to work within the boundaries of local law to successfully structure non-recourse financing of corporate and real estate acquisitions and infrastructure projects in Dubai on a Shariah compliant basis.
Jawad Ali (
) is a partner based in the Dubai and London offices of King & Spalding LLP while Nabil A Issa (
) is a senior associate based in its Dubai and affiliated Riyadh offices. They can be contacted by telephone at +971 4305 0004/9, respectively.