In my opinion, I have provided enough ammunition to investors against the originator (obligor) to be able to safeguard their capital injection in Sukuk transactions.
Now, let me explain what happens if an event of default occurs. There is no formal classification as such, but for readers’ easy understanding, I would like to divide the Sukuk default into minor and major, or lighter and serious — for the choice of better words.
Minor or lighter defaults: these relate to informative or administrative milestones missed by the originator or breach of any of the representation, warranties and covenants by it. For illustrative purposes, this could include not providing the required financial information on time.
If such a default occurs, the delegate (explained earlier in this space) shall raise the red flag to investors and write to the originator to comply with the requirement within a certain predefined number of days. Most probably, the requirement is fulfilled by the originator and the situation is regularized.
However, if the irregularity persists, the matter is put to the investors’ meeting and upon obtaining the quorum and the majority decision, the exemption is granted to the originator so as not to put the Sukuk transaction into jeopardy for a lighter default whereby the investors may be deprived of the return and eventual redemption in the normal course.
By quorum and majority, I mean the presence of the Sukuk investors representing three-quarters (or any other agreed number) of the face value of the Sukuk amount in the meeting howsoever held, either in person or virtual or by circulation. This is irrespective of the number of investors, which means if even one investor holds the certificates which aggregate to three-quarters of the Sukuk face value (and not market value), its consent to grant waiver shall be deemed appropriate despite the contesting opinion by the other minority investors, even if they are in the thousands.
Based on the majority consent, the delegate who calls and convenes such a meeting shall then issue an extraordinary resolution to abolish the default for once or on a regular basis, depending on the nature of the request.
Major or serious defaults: the primary major default is not meeting with any of the financial commitments on time, and the continuation of default for a certain number of predefined business days, usually between seven and 10 business days when the banks are operating in the relevant jurisdiction. The financial default could be for the payment of a periodic profit to Sukuk investors or the redemption amount (also called the dissolution amount).
If such an event occurs, the delegate shall inform the Sukukholders in writing, seeking their guidance whether to continue with the Sukuk transaction despite such a default or call it a day. If the written winding-up request is received by the delegate from the Sukukholders constituting, say at least one-fifth of the aggregate face amount of the Sukuk certificates outstanding at the time of such a default, the delegate shall give notice of dissolution of the Sukuk transaction to the originator (obligor). This is to be noted that the figure of one-fifth is not based on any Shariah doctrine but a modern-day administrative measure to which the Shariah scholars do not have any comment or reservation.
Once the dissolution amount (or redemption proceed) is paid by the originator, all Sukuk certificates shall stand redeemed and canceled and the trust between the trustee shell company and the Sukuk investors shall also stand dissolved. The dissolution amount is comprised of the outstanding face value of the Sukuk plus any due and undistributed profit.
Here, I would like to point out that based on my review of many Sukuk prospectuses, the word ‘accrued’ is used to denote the return to investors. As far as the Sukuk Ijarah is concerned, I agree that the term accrued fits well since the usufruct in Ijarah is consumed second by second, minute by minute, day by day and so on. Therefore, as the lessee is consuming the usufruct, the return to the lessor (and hence to the Sukuk investors) is actually accruing in the real sense.
Nevertheless, in the case of investment-based Sukuk, which are Mudarabah, Musharakah and Wakalah, it will be inappropriate to use this term since the return to Sukukholders shall be comprised of the profit generated by the underlying asset or project which remains unknown barring an indication in the business plan submitted by the originator (obligor). As such, the return to the investment-based Sukuk investors cannot be considered to be ‘accrued’ similar to interest-bearing bonds or Sukuk Ijarah.
Once the Sukuk certificates are redeemed, the ownership in terms of the underlying Sukuk asset, whether asset (Ijarah) or investment-based (Mudarabah, Musharakah and Wakalah), shall be transferred to the originator (obligor).
The correct way of doing it is to treat the redemption amount as the sale proceeds by the trustee shell company (representing the Sukuk investors) to the obligor and it should be adequately documented through a separate agreement evidencing such a transfer. This is because as per Shariah principles, there can be no automatic transfer of ownership and that it must be documented.
The purpose of this educative series and the article is not to hurt any religious or commercial sentiments either consciously or even unwittingly.
Next week: Discussion on the events of default in a Sukuk transaction shall continue.