Combining Conventional and Islamic Real Estate Finance Techniques: How to Get the Deal Done A publication of Winter issue 2014 sponsored by CRE Finance World Winter 2014 67 acceleration. However, Islamic financiers may regard it as important that the payment waterfalls dealing with the process of payment are kept separate in the Islamic compliant and conventional finance documentation and only cross-referenced in the intercreditor agreement. This is to avoid the possibility of the payment of interest to the conventional lenders tainting the Islamic compliant element. If the claims of the financiers on the Islamic compliant financing structure rank pari passu with those of the financiers on the conventional facility, the intercreditor arrangements are usually relatively straightforward. However, issues can arise in determining the intercreditor voting entitlements if the Islamic compliant financing structure comprises staged advances of money to the borrower and the conventional financing structure advances all the money to the borrower at the beginning of the deal. Title to Security Although there is not a general prohibition on the taking of security under Islamic law, some scholars object to the English law concept of a general pledge (or floating charge) on the basis that the assets that are the subject of the relevant security interest are not specifically identifiable. This can raise intercreditor issues because the conventional lenders may want as extensive a security package as possible. Islamic financiers may want to take security over a specific pool of assets that can be readily identifiable. One of the key principles of Islamic finance is that of certainty. If so then the assets of the obligors will need to be allocated between the different types of financiers for security purposes. Some documents, such as purchase undertakings in Islamic finance structures, create proprietary or contractual interests in favor of the Islamic financiers. Often the purchase undertakings cannot be mortgaged. The ability of the Islamic financiers to exercise their rights under a purchase undertaking will usually be triggered by an event of default. However, how and when those rights are exercised will need to be co-ordinated with the exercise of the rights of the conventional lenders. A security agent may hold the security interests under the intercreditor arrangements for the benefit of both the conventional lenders and the Islamic financiers. A conventional lender will not own assets, but will have security interests granted in its favor. However, depending on the Islamic facility (such as an ijara or musharaka), an Islamic financier may have title to certain assets. In an ijara financing it will own the leased asset and in a musharaka financing it will own an equity interest in the partnership or joint venture. Where assets are in the name of the Islamic financier: • An intercreditor arrangement should set out the agreement to share any proceeds on disposal of the project or any assets on an event of default. • Depending on the applicable law, it may be possible for the Islamic financier to grant a security interest in favor of the security agent as long as the monetary obligation being secured can be determined. • If a special purpose vehicle is used, the SPV could grant the security interest to the security agent so that any title transfer to the Islamic financier would be subject to that security interest. • If the asset that the Islamic financier owns is merely a contractual interest (which may be done so that registration fees are not incurred on the transfer), the obligor (in whose name the legal title remains) could grant the security interest to the security agent. Enforcement In certain types of Islamic financing, on a default, the amount claimed will include a profit element that is calculated over the full finance period. In contrast, with a conventional financing, the amount of interest is that which has accrued up to the occurrence of an event of default. The conventional lenders may, therefore, feel that the Islamic financiers’ pro rata entitlement to a share in any enforcement proceeds (based on amounts outstanding) means that they benefit more than the conventional lenders. A sharing mechanism must therefore be documented in the intercreditor agreement if equality is the commercial deal. The typical approach in relation to enforcement proceeds is that they are held by a designated security agent and applied in discharging the amounts outstanding under the conventional facility and the Islamic compliant financing in accordance with a pre-determined order of priority set out in the intercreditor agreement. In some co-financing transactions, Islamic financiers may require that the portion of the enforcement proceeds earmarked for the Islamic compliant structure be held in a separate account so as not to be tainted by the proceeds that are to be used to repay the conventional facility. Issues can arise when the enforcement proceeds include an element of interest (for example, interest accrued on cash balances in an account of the security agent or interest on a sum awarded by a court judgment). Financiers that are Islamic compliant may be unable to share in these amounts, in which case, they may require an equalization payment mechanism to uphold the principle of equal treatment.
CRE Finance World, Winter 2014
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