In the last article, I discussed the minor and major default scenarios and that a major scenario could turn into a dealbreaker as the delegate (appointed by the trustee shell company representing the Sukuk investors) may opt to exercise the put option to wriggle out of the failed Sukuk transaction.

It is all fine to put the Sukuk asset to be purchased by the obligor and to use the sale proceeds to redeem for the Sukuk investors, in addition to payment of the profit (if any). However, what if the obligor is unable to purchase the Sukuk asset owing to financial constraints?

Well, the question arises if the obligor was in a position to purchase the Sukuk asset, why would it default in the first place? This not only invites the investors’ annoyance but also ruins its market reputation and damages the likelihood to issue new Sukuk.

There can be two situations where the obligor may get into a financial crunch. Either it is due to unfavorable market conditions or if something went terribly wrong due to no fault of the obligor or if the obligor has been willfully neglectful and as a result jeopardized the investors’ interest.

I have explained the first scenario in article 167 as to how Shariah principles may come into play and protect the obligor in an adverse situation where the circumstances went beyond the obligor’s control due to no fault of it. Here, if the Sukuk investors decide to exercise the purchase undertaking, the chances are the obligor may seek the Shariah scholars’ opinion and is able to thwart the investors’ attempt to force it to buy the Sukuk asset.

You need to understand that Islamic finance is all about fair play and you cannot use any arm-twisting techniques here. The ground rules are all clearly defined and properly laid out. As such, if the obligor has been prudent in investing the Sukuk proceeds and an unforeseen situation arises where the obligor could not meet any of its financial obligations, the investors will have to be patient, allowing more time to the obligor to manage the affairs umtil such time that it is able to successfully redeem the Sukuk.

But what if the obligor has been negligent and as a result the Sukuk investors are made to suffer? Certainly, the Shariah principles fully support the investors and the obligor is dealt with firmly. An example may be a defaulted Sukuk Ijarah facility where a real estate asset has been purchased by the Sukuk investors from the obligor and leased to it. The first option for the Sukuk investors shall be to exercise the put option and ask the obligor to pay the exercise price within a certain number of days.

In case the obligor is unable to arrange the amount, the Sukuk investors do have the option to sell the Sukuk asset in the market and claim any shortfall in the exercise price from the obligor. But this swift route can only be adopted by the Sukuk investors if the registered title to the asset is held in the name of the trustee shell company.

In almost all Sukuk Ijarah transactions, the registered title is held with the obligor who signs the deed of trust or title agency agreement, declaring that it is holding the title in trust for the trustee shell company (representing the Sukuk investors) and that it shall act upon the instruction to transfer the title to the trustee shell company or to a third party buyer of the Sukuk asset.

If in such a situation, the Sukuk investors would not like to wait and want to proceed to sell the Sukuk asset in the open market, they may have to seek assistance from legal channels toward obtaining a court order attaching the asset to the Sukuk amount and allowing it to be sold and use the proceeds to redeem for the investors.

Critics say that such a long-drawn process may put the investors off from investing in any future Sukuk Ijarah transactions. My response to them is that at least the investors of a defaulted Sukuk transaction do have an asset to fall back on in case of need, irrespective of it being an asset-based or asset-backed transaction. To the contrary, the buyers of a conventional bond hold nothing in case of a default since the bond is a clean lending instrument. There may be a delay in the recovery of the invested amount by the Sukukholders but nevertheless, they will be able to eventually receive it. So which option is better? Make your own decision.

I recall a Sukuk Ijarah transaction I was advising on where an interesting situation was deliberated on how to cover the period from the date of serving the exercise notice to the obligor by the delegate until the receipt of the redemption amount, which may usually take a few days. The question was based on the interpretation that the lease term is deemed to be terminated upon serving the exercise notice to the obligor and hence the Sukuk investors may be deprived of the lease rent earing for such a period. I will come back to discuss this point but I dare you to suggest the solution.

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].