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Marcus Ashworth is a Bloomberg Gadfly columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.

There is brinkmanship, and then there is Dana Gas. Not repaying your debt has been seen before -- but demanding previous payments back from investors is a new one.

Dana Gas PJSC is an independent natural gas supplier from Sharjah, one of the smaller sheikhdoms in the United Arab Emirates. It produces most of its energy from the Kurdish region of Iraq as well as Egypt. With a market capitalization of about $1.5 billion it may not be a major player, but it has certainly learnt how to play hardball in legal wranglings over its sukuk securities.

Its dispute with investors including Blackrock Inc. and Goldman Sachs Group Inc. is now making its way through the English courts -- the latest wrinkle is due on Monday -- and trading suggests bond holders are banking on common sense prevailing. 

Down But Not Out
Investors are pricing the recovery rate close to previously suggested workout plans
Source: Bloomberg

There's perhaps some wisdom to this, given the outcome of a previous attempt not to pay a different type of sukuk: in 2010, Kuwaiti company Investment Dar attempted this, but then rolled over soon after the English courts got involved. To have this happen once is unfortunate, but this second occurrence is worrying for investors. 

This time around, a broader problem has already taken hold, with one small issuer potentially ruining the whole market for everyone. Regardless of what happens next, Dana's gone so far down the road of using religious rulings to avoid its debt repayments the affair could easily scare international investors away from the sector, possibly for good.

The fallout can be seen in the new issue market. While sovereign sales are carrying on -- Saudi Arabia and Bahrain issued sukuks this month -- the broader corporate and financials market in the Middle East has been effectively shuttered awaiting resolution of this dispute.

Sukuk are complex financial structures that require -- ongoing, in Dana's case -- approval from religious scholars. They don't pay interest, which is banned under Islamic law. They offer something else instead, such as profit participation payments or rent.

In June Dana obtained a ruling from an Islamic court that two of its outstanding international Mudarabah Sukuk bonds, with a combined face value of $700 million, were non-compliant with Shariah law. But here is the rub: if the bond is not compliant now then it was never compliant, and no profit participation payments should ever have been made. So Dana is now claiming most the money it paid out to holders of the bonds should be returned. Punchy.

Bondholders objected, but Dana has rejected a common sense solution. A counter-offer from a group representing 70 percent of holders, including Blackrock and Goldman, suggested an immediate payment of half of the $700 million face amount outstanding and the due date for the balance extended for three years. 

Instead the investors are finding themselves defending their cause in an English court, with the added twist that Dana won't be appearing due to restrictions placed on it by a Sharjah court in the U.A.E. A ruling in London on Friday addressed some conflicts about the company's participation and the timing, and now the case will proceed on Monday. It is still a far from straightforward affair. After the trial starts it will be stayed until Oct. 12, to allow court proceedings in Sharjah to conclude -- these concern the legitimacy of the injunction against Dana, along with questions on the earlier Shariah-compliance ruling. 

The irony in all of this is that that Dana’s stock price has doubled since around the end of May, because it has successfully pursued the Kurdistan Regional Government over failure to develop oil and gas assets. The profits could yet start flowing. It has now set its legal sights on Egypt as well as partners in its equity joint ventures.

Not An Equity Problem
Dana's success in pursuing compensation for their energy rights from Kurdish region of Iraq has doubled the share price
Source: Bloomberg

However, even if the case resolves into an arrangement that roughly satisfies all sides, the damage has been done to one corner of the $350 billion global sukuk market. Though the corporate, non-sovereign universe is a small slice of this pie (not least because it mostly concerns only issuers outside of Malaysia), its the one global players are eyeing for growth. The U.K. is part of the push: not only has Britain issued a sukuk, it plans to increase the size of the security in 2019. Big beasts such as Blackrock and Goldman are by no means under pressure to suffer the types of antics Dana is now trying, they can just ignore the whole sector.

The affair highlights the importance of creating a centralized Shariah court for the Gulf Cooperation Council countries that would have definite and final authority on sukuk structures. Future investors would rightly demand this level of comfort.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Marcus Ashworth in London at mashworth4@bloomberg.net

To contact the editor responsible for this story:
Jennifer Ryan at jryan13@bloomberg.net