Legal Documentation. Islamic Finance Seminar. Abdul Jabbar, Dato Dr Nik Norzrul Thani & Megat Hizaini Hassan Tuesday, 13 September 2005

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1 Islamic Finance Seminar Legal Documentation Abdul Jabbar, Dato Dr Nik Norzrul Thani & Megat Hizaini Hassan Tuesday, 13 September

2 Principles In Drafting Documentation 1.Experience of Drafting Conventional Bonds a Useful Tool The aims and objectives of Islamic bonds are similar to conventional bonds ie the raising of funds by the issuer through issuance of debt papers Legal framework governing the issuance of Islamic bonds, from the guidelines issued by the authorities to the decision to be made by the courts, are all similar to conventional bonds Therefore a lawyer intending to draft the legal documents for an Islamic bonds issuance need not throw away his experience in handling conventional bonds documentation, instead he should find it as a useful tool 2

3 Principles In Drafting Documentation 2 2.Understand the Shariah Principles A lawyer is not entitled to claim himself as an expert in Islamic bonds documentation without sound understanding of the Shariah principles used in Islamic bonds that can meet the expectation of Shariah advisors. Besides the prohibition against interest or usury, Islamic bond transactions must also be free from dubiousness (gharar), gambling (maisir), and oppression (zulm). Lawyer should also grasp the concepts of permissible (halal), prohibited (haram), recommended (afdhal) and discouraged (makruh) in order to meet the expectation of the Shariah advisors. 3

4 Structure Of Common Documentation One has to bear in mind that the documentation required would depend on the nature of the facility granted In Malaysia, while the common forms of Islamic bonds issued are Bai Bithaman Ajil Islamic Debt Securities (BaIDS) and Murabahah Underwritten Notes Issuance Facilities (MUNIF), the market has also seen Islamic bond issuance based on the principles of qardhul hasan, istisna musharakah and ijarah The certificates issued from these transactions are called Sukuk al-ijarah, Sukuk al-musharakah or Shahadah al-dayn and these certificates can be traded in the secondary market 4

5 Structure Of Common Documentation 2 1. Documentation used for any Islamic Bond Issuance (i) Facility Agreement In principle it is the master agreement Recitals will portray the scenario and history of the facility. Definitions clause will give the whole picture of the facility as it highlights inter alia the agreements executed, security granted, the description of the parties Although Islamic bonds issuance may be structured as a sale and purchase or leasing or partnership transaction (as the case may be), the drafting of the documents in some countries would still reflect its legal status as a financing facility 5

6 Structure Of Common Documentation 3 1. Documentation used for any Islamic Bond Issuance (cont d) (ii) Trust Deed Trustee must be qualified to act as a trustee corporation Main role of the trustee is to act on behalf and for the interest of holders of the Islamic bonds Trustee shall upon instructions of the bondholders declare an event of default Other provisions - relating to removal of the trustee by the bondholders; appointment of new trustee; meeting of bondholders 6

7 Structure Of Common Documentation 4 1. Documentation used for any Islamic Bond Issuance (cont d) (iii)depository and Paying Agency Agreement Allows issuer to appoint an agent for the purpose of issuing or registering and lodging securities into the agency and for automating the payment of profit and maturity proceeds The depository shall hold the Global Certificates in its custody for and on behalf of the trustee and the bondholders until the maturity date Inter alia provides for appointment of the depository and paying agent, obligation of the issuer and trustee, obligation of the depository with regards to payment of profit, payment of the principal amount trading of the certificates; etc 7

8 Structure Of Common Documentation 5 2. Documentation peculiar for BaIDS, MUNIF, Istisna Bonds and Salam Bonds (i) Asset Purchase Agreement Warranties on the asset are excluded; no provisions for physical delivery of the asset Purchase price would reflect the amount of financing required by the issuer Most of the agreements drafted would provide the reason of the issuer requiring the financing which could be for example refinancing of its existing facilities. However the Shariah does not require the purposes of the sale to be mentioned in the contract 8

9 Structure Of Common Documentation 6 2. Documentation peculiar for BaIDS, MUNIF, Istisna Bonds and Salam Bonds (cont d) (ii) Asset Sale Agreement Once the agreement to sell is concluded, the sale price would become a debt owed to the primary subscribers The sale price stipulated in this agreement reflects the face value of the Islamic bond Once the sale price is paid, the Islamic bond would be considered as redeemed by the issuer. Issuer may repurchase any part of the Islamic bond prior to the maturity date and cancel the relevant bond certificates 9

10 Structure Of Common Documentation 7 3. Documentation peculiar for Sukuk al-ijarah Asset Lease Agreement / Al-Ijarah Muntahiah Bit-tamlik Agreement Asset Purchase Agreement providing for the purchase of the asset by the primary subscribers from the issuer must be entered first Under the Asset Lease Agreement / Al-Ijarah Muntahiah Bittamlik Agreement the primary subscribers lease back the asset to the issuer. This agreement will inter alia sets out the lease period and the rental payment structure Subscribers must take the ownership of the asset throughout the tenure of the Sukuk in order to be entitled to lease its enjoyment (manfa ah) to the issuer 10

11 Structure Of Common Documentation 8 4. Documentation peculiar for Musyarakah or Mudarabah Notes Partnership / Participation / Subscription Agreement Constitutes the partnership or joint venture between the issuer and the subscribers Contains inter alia the pre-determined profit-sharing ratio, profit distribution mechanism and dissolution of the partnership / joint venture Need not necessarily be backed by an underlying asset. However the subscribers may lose capital investment As mitigation, issuer may provide collaterals as security and the profit-sharing ratio would usually be heavily favouring the subscribers 11

12 Types Of Clauses In Documentation 1. To serve the requirements of the Legal Framework No specific Shariah principle to be applied in relation to the appointment and actions of the depository and paying agent and the trustee. Clauses such as representation and warranties, conditions precedents and events of default are standard contents derived from conventional practices and are acceptable as long as they does not contravene any Shariah principles 12

13 Types Of Clauses In Documentation 2 2. To serve the requirements of the Shariah Far from standardised and depends on proficiency of lawyer on relevant Shariah principles. Eg: (i) Non-payment of interest necessary to remove any doubt that the facility has any elements of interest (ii) Muqasah (rebate) permits the granting of rebate to the issuer if they never default in their payment obligations (iii) Verdict of the Shariah Advisors binds all parties to abide by the verdict given by the Shariah Advisors on the Shariahcompliance of the issuance (iv) Letter of Hibah in a transaction whereby the issuer uses an asset owned by a third party 13

14 Litigation & Arbitration In IBF 1) Litigation Under the AMLA, the Shariah Court has jurisdiction over family law matters only. Issues relating to IBF matters would therefore be decided by the civil courts Reported cases showed that the civil courts were inclined to decide IBF disputes strictly based on civil laws and procedures without considering the Islamic dimension of IBF documents 14

15 Litigation & Arbitration In IBF In Malaysia, issues relating to litigation have been addressed at the structural level: i) dedicated High Court judges to preside on matters relating to IBF ii) Law Review Committee established to review the common law-based domestic legislation to assimilate the Shariah principles iii) the amendment to the Central Bank of Malaysia Act 1958 ( CBMA ) which provide for the establishment of a Shariah Advisory Council ( SAC ) at the Central Bank as the sole authority and reference on all Shariah matters pertaining to IBF Singapore will also need to address these issues 15

16 Litigation & Arbitration In IBF 2) Arbitration Has not really taken off as a dispute resolution method for IBF May be due to the general views of Shariah scholars that voluntary arbitration or tahkim is recognised only with restrictions under the Shariah It is also considered as an inferior system for the settlement of disputes in substitute for the officiallyorganised judiciary or qada' 16

17 Litigation & Arbitration In IBF The increase of cross-border IBF transactions may push for greater demands of arbitration There are many arbitration centres that can facilitate IBF arbitration in Muslim countries such as KL, Abu Dhabi, Dubai, Rabat, Cairo and Manama 17

18 Issues And Challenges 1.Global Acceptance of Islamic Bonds Structure Prevailing perception amongst Middle East Shariah scholars is that the contract of bai al- inah and bai al-dayn is too similar to usury-based financing Malaysia initiated issuance of global Sukuk based on ijarah followed by Bahrain, Qatar and Islamic Development Bank Establishment of International Islamic Financial Market (IIFM) and International Islamic Rating Agency (IIRA) indicate that there will be more global Islamic bonds issuance to come Issuers intending to tap international funds may use Sukuk - Lawyers must improve drafting skills to reach international standards and meet expectations of the international players 18

19 Issues And Challenges 2 2.Standardisation of Documents Islamic Financial Services Board (IFSB) has taken initiatives to standardise the documents used in Islamic banking and finance Lack of standard documentation causes different documentation to be used for the same concepts and would lead to different interpretation Standardised documents would eliminate risk of poor drafting and non-compliance with Shariah principle due to ignorance 19

20 Rajah & Tann Contact Details Rajah & Tann 4 Battery Road #26-01 Bank of China Building Singapore Republic of Singapore Tel : Fax : Website : eoasis: eoasis@rajahtann.com Abdul Jabbar, Partner DID : Fax : abdul.jabbar@rajahtann.com 20

21 . Contact Details 19th Floor Menara Milenium Jalan Damanlela Pusat Bandar Damansara Kuala Lumpur Malaysia Tel : Fax : Dato Dr Nik Norzrul Thani, Partner DID Megat Hizaini Hassan, Senior Associate DID

22 Thank You 22

23 Question & Answer Session 23