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:
- 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.
- 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:
- Investment Agency Agreement
- Istisna Agreement
- Ijarah Mawsufa Fi al-Dhimmah Agreement
- Purchase Undertaking
The conventional structure will typically entail the following contracts:
- Syndicate Agency Agreement
- Syndicate Term Loan Agreement
- 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,
- Mortgage Deed
- Hypothecation Agreement
- Lien
- 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.
- 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.
- 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 way- out, 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.
- 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.
- 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.
