An example of the risk to international investors from local country legal regimes

A key requirement for a successful economy is reliable, relatively inexpensive, and rapid, enforcement of commercial contracts. If you cannot rely on contracts with strangers, you will limit yourself to doing business only with people you know well, which reduces the overall efficiency of the economy and limits its growth.

Sadly the courts of many countries cannot be relied upon when it comes to enforcing contracts, particularly when foreigners are seeking to enforce contracts against local country residents. All too often, courts in such countries rule in favour of their nationals.

The case of Dana Gas and its sukuk default illustrates this very well. In my view, there are no real issues regarding Shariah compliance in this case. However what it does show is that if the sukuk investors had to rely upon the law and courts of the UAE, they would got a very raw deal. However, because the key contracts were written under English law, the UK courts have disposed of the issue robustly and expeditiously.

I wrote about this case in my January 2018 "Letter from Amin" column in Islamic Finance News. You can read it below.

"International investors are right to be wary of local country legal systems"

All commercial contracts carry the risk that your counterparty may be unable, or unwilling, to perform their obligations. Accordingly, every country needs a legal system which enables the enforcement of contractual claims. As I mentioned in my July 2017 column, the World Bank in its annual “Doing Business: Measuring Regulatory Quality and Efficiency” has a section on enforcing contracts, and gives a score for every country covered in the survey.

One key concern with international investment is that local country law may favour the counterparty located in that country, either because the international investor may know less about local law, or because local law may be designed to favour nationals of that country, or because the country’s courts choose to favour nationals.

Accordingly, international investors typically choose to have commercial contracts drawn up under the law of a reliable jurisdiction, avoiding local law wherever possible. The most commonly used is English law, even for commercial arrangements that have nothing to do with the UK, because English law is well-developed and English courts have a deserved reputation for legal competence and impartiality.

Sometimes local law cannot be excluded entirely; for example, transferring land located within a country normally requires a local law instrument. In such cases, common legal practice is to split the legal documentation, with local law being used for those parts where it is mandatory, and the preferred foreign law being used for the rest of the legal documentation.

The case of Dana Gas PJSC (“Dana Gas”) v Dana Gas Sukuk Limited (“DGSL”) illustrates the issues very well.

Very briefly, DGSL raised money from international investors by issuing sukuk. The money so raised was invested by DGSL in a mudarabah agreement with Dana Gas, written under UAE law.

DGSL and Dana Gas also entered into a purchase undertaking, written under English law. The purchase undertaking required Dana Gas to make specified payments to DGSL in various circumstances (basically default) and upon those payments being made required DGSL to enter into a sale contract with Dana Gas to sell its interest in the mudarabah back to Dana Gas, the consideration being the payments just made by Dana Gas.

Dana Gas did default. It appears to have had financial problems, but also contended that it had legal advice that the commercial arrangements were not Shariah compliant, even though Dana Gas had accepted them as Shariah compliant when entering into them. Under UAE law, the UAE mudarabah agreement would not be enforceable if not Shariah compliant, and the UAE sale contract to sell the mudarabah assets back to Dana Gas would then also not be valid.

Under UAE law, DGSL and the sukuk investors would have been sunk, having to litigate in the UAE courts about whether the commercial arrangements were or were not Shariah compliant. However, they were saved by the purchase undertaking being under English law.

On 17 November 2017 the UK High Court decided the case. The citation is [2017] EWHC 2928 (Comm). The judge held that the enforceability of Dana Gas’s obligation to pay DGSL under the purchase undertaking was unconditional, and not contingent upon the Shariah compliance of the UAE mudarabah agreement, or the Shariah compliance of the subsequent UAE sale contract.

As I wrote in July, to grow Islamic finance, we need to minimize contractual uncertainty. That requires countries such as the UAE to improve their legal system to eliminate claims of Shariah non-compliance when they are essentially retrospective. Meanwhile, well advised international investors should continue to avoid local law wherever possible.