Finance & Banking

ISSUES AND CHALLENGES OF MIXED SYNDICATIONS SULEMAN MUHAMMAD ALI HEAD OF PRODUCTS AND SEGMENTS,ISLAMIC BANK, OMAN

Loan syndication is the loan process involving
multiple lenders in funding a single project. This
usually happens when the borrower requires
a loan that is too large for a single lender to
provide or when the loan is outside the scope
of a lender’s risk exposure levels.

Mixed syndications involve one syndication
financing with two underlying structures, one is
Islamic and the other conventional. The terms
and conditions such as profit rates, security
packages, payment intervals etc. for both the
syndicates need to be the same. The legal
documentation of such a transaction requires
two sets of documentation, Islamic as well as
conventional, albeit having the same terms and
conditions.

A typical mixed syndicate transaction involves the following documentation set:

  1. Common Terms Agreement:
    The Common Terms Agreement or CTA is signed by all
    parties of the syndicate that is, the Islamic financiers, the
    conventional financiers and the customers. It sets out
    common definitions to be used in both sets of documents.
    Detailed information of the terms and conditions of the
    financing is also included, but not limited to the security
    structure, the financing rate, covenants, the amount
    of financing, events of default, conditions precedent,
    terms of enforcement, etc. The purpose is to outline the
    transaction along with its details and various other legal
    documentation that will be executed pursuant to and
    subject to the terms of the CTA.
  1. Transaction Documents:
    These include the documents, which are required to
    execute the actual financial transaction of the two
    structures in the syndicate. For instance, an Istisna cum
    Ijarah transaction under the Islamic structure and a
    loan transaction under the conventional structure will
    typically involve the following contracts:
    a) Investment Agency Agreement
    b) Istisna Agreement
    c) Ijarah Mawsufa Fi al-Dhimmah Agreement
    d) Purchase Undertaking

The conventional structure will typically entail the following contracts:
a) Syndicate Agency Agreement
b) Syndicate Term Loan Agreement

  1. Security Documents:
    These are the documents signed between the financiers
    and the customer to create the security in favour of the
    financiers. These are one set of documents, executed
    by both conventional and syndicate financiers. Since
    the security is the same, the same set of security
    documents are signed by both types of syndicate
    financiers. Typically, the following types of
    agreements are signed for this purpose,
    a) Mortgage Deed
    b) Hypothecation Agreement
    c) Lien
  1. Other documents:
    Other documents such as Security Trust Deed or
    Intercreditor agency agreement may be signed by all
    conventional and Islamic syndicate financiers depending
    on the requirements of the transaction. The purpose of
    such agreements is to appoint one agent bank, which
    shall deal with the customer in terms of communication,
    enforcement, receiving of payments, distributing
    payments to all financiers, termination, or act as the
    security trustee for upholding the security for the
    benefit of all participating banks.

Technical issues in Mixed Syndications
The use of joint documentations, and terms and conditions
in transactions involving mixed syndicated loans give rise to
tricky issues, which needs to be resolved while entering into
such transactions.
i) The use of CTA

The use of CTA has some major referencing issues given the
basic Shari’a requirement of contracts that says, ‘two contracts
cannot be executed within one contract’ or that ‘one contract
cannot be made conditional to the other contract’. The CTA
outlines the transactions including the terms and conditions
under which each subsequent contract shall be executed and
implemented. For instance, in case of an istisna structure,
the CTA will mention the terms under which the asset
is constructed through an Istisna agreement, its
subsequent lease through the ijarah contract,
and the use of Purchase Undertaking at the
end of the term and in cases of events of
default enforcement.

The common understanding is that the CTA being in the form
of an MOU or a general outline of terms covering all contracts
does not cause the issue of ‘contracts in contracts’ on its
own. However, the problem arises when all the subsequent
agreements are executed as per the terms and conditions of
the CTA in general as a whole. For instance, when the ijarah
agreement is signed it refers to the terms of the CTA, which
includes the enforcement clauses referring to the Purchase
Undertaking requiring the customer to purchase the leased
asset in case of an Event of Default or at maturity. This defeats
the purpose of having a separate Purchase Undertaking from
the lease agreement that was done originally to keep the
lease contract and the sale contract separate at maturity and
not conditional to one another, as is the case in conventional
lease contracts.

Does the Lease Agreement and the Purchase Undertaking
referring to CTA results in the issue of ‘contracts in contract’?
This depends on the language used to refer to the CTA. In
some instances, as a solution, the reference is limited to
particular sections of the CTA, which supposedly does not
link it to other sections of the CTA and hence does not make
the lease conditional to sale. However, in most syndicate
transactions there is a general reference to the whole of
the CTA. Whether this results in the issue of contracts in
contract, or whether the restrictive referencing resolves this
issue requires further review, research and collaboration
between Shari’a scholars and law experts.

ii) Sharing of security
Under the above-mentioned mechanism of mixed
syndications, Islamic banks have to share security with
conventional banks and sign the same security documents.
In most of the cases, the conventional security documents
contain non-compliant clauses, for instance, liquidated
damages, which would result in interest payments in case the
customer does not settle on time. Hence, Islamic banks need
to be extra cautious when executing such documentation.
However, it can be resolved by carving out Islamic banks
from such clauses or limiting these clauses for conventional
syndicate partners only and making a separate charity clause
for Islamic banks. This would still lead to Islamic banks signing
an agreement, which is recording the client’s obligation to
make interest payments. Hence, for this purpose as a wayout, scholars have suggested writing a disclaimer clause
stating that ‘any mention of interest payments in this
agreement does not relate to Islamic banks and such interest
payment shall not be made to Islamic banks.

iii) Cross Default
Syndication agreements normally have cross-default clauses
in the event of termination and default. This means that in
the case that the customer defaults the payment of interest
to a conventional bank in the syndicate, the whole syndicate
facility will issue a notice of termination to terminate the facility and go for settlement or enforcement. This means
that the Islamic syndicate partners would also have to
terminate their part of the syndicate even though there may
be no default by the client under the Islamic structure or
documentation. Cancelling a Shari’a-compliant facility due to
this reason does not seem appropriate. However, such issues
have been allowed based on the necessity for the Islamic
financial industry to grow to a point where they are able to
arrange Islamic syndications on their own.

iv) Underlying Assets as Shared Security
The above two issues become more drastic when the
underlying assets used for the Islamic structure are part of
the security package. This means that the project assets, real
estate, plants etc. owned and leased by Islamic banks under
the Islamic syndicate structure are part of the mortgaged
assets shared between the Islamic and conventional
syndicate financiers. This would result in a scenario that in
case of a default in the conventional part of the syndicate,
Islamic banks would have to liquidate their owned leased
assets as well to make the outstanding interest payments
on the conventional facility, even though there may be no
default on the Islamic part of the syndicate.

The above issues are tolerated in mixed syndications to allow
Islamic banks to grow and not reject an attractive financing
opportunity with certain conditions. However, these issues
should not be ignored and need to be tackled from an
operational and Shari’a perspective.

Ideally, Islamic syndication finance should not include any
conventional bank because of various Shari’a issues, which
are mentioned above. However, due to the small size of
Islamic banks as compared to conventional banks in many
jurisdictions, it is not possible for Islamic banks to make
syndication of a group of Islamic banks to carry out the
funding on their own. Deciding not to finance would mean
losing an opportunity to fund an attractive project and
hampering the overall growth of Islamic banking.

As a solution, Islamic banks have the option to involve
conventional banks in such syndications while ensuring that
the underlying transaction involves an Islamic structure for
all participants of the syndicate including the conventional
banks. However, in most cases either the conventional banks
do not agree to such an arrangement or they are restricted
by regulations to do any form of Islamic banking business
without appropriate licensing from the regulators, which in
turn leaves the participants with only one option that is to
have mixed syndications having Islamic and conventional
legs.

The author is the Head of Products and Segments at an Islamic
Bank in Oman. He has been involved in the structuring of
various sukuk issues and syndications. He may be contacted at
sulemanmuhammadali@gmail.com. The views expressed by the
author are personal.

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