Dr. Abu Umar Faruq Ahmad, Adjunct Professor of Islamic Economics and Finance, Guidance College, Huston, Texas, USA; & Chairman, Shariah Supervisory Board of Islamic Cooperative Finance Australia Ltd., Sydney, Australia, in the International Webinar Series of the Iranian Association of Islamic Finance, which was held on 8 Feb. 2022, delivered a lecture on Post Default Sukuk Restructuring of Islamic Financial Institutions.
His lecture is as follows:

SHARIAH-COMPLIANCE REQUIREMENTS FOR SUKUK
a) Any profits derived from these funding arrangements must be derived from commercial risk-taking and trading only
b) The assets or businesses underlying the Sukuk must be Shariah-compliant and therefore, cannot be related, for example, to the production or sale of alcohol or pork and so on
c) All rights and obligations relating to an investment certificate must be transparent and clear
d) The value and pricing on underlying assets of Sukuk must follow the Shariah rulings
•Therefore, the Sukuk yield is the most important principle that distinguishes it from conventional bonds

RESTRUCTURING: MEANING, OBJECTIVES AND CAUSES
•Restructuring is a method of rearranging the payments made by a borrower to a lender –especially in the event of liquidation, distressed debt, bankruptcy, insolvency, reorganization, restructuring and workout markets
•For business firm it is used to imply a considerable adjustment made to the debt, operations or structure of the relevant firm
•The key objectives of restructuring are:
a)to offer a debtor more latitude, in form and time, to settle his current debt obligations
b)to consider the value of their assets and the potential for profitability of their business enterprise

THE CAUSES FOR SUKUK DEFAULT
1)Failure to pay on time as agreed upon
•If the Sukuk issuer intending to generate cash flow or raise capital fails to make a timely payment as agreed upon, then it leads to a possibility of default on that issue
2)Lack of strict regulations supportive of avoiding Sukuk defaults
•Unlike the Middle Eastern countries, Malaysia has strict laws and regulations to protect the Sukuk market to default, although bonds and Sukuk are equally governed by similar standards, guidelines, and laws

The non-maintenance of structural integrities in structuring Sukuk
•Similar to bonds the relationship between the originator/obligor and Sukuk holders is that of creditor and debtor, supported by provisions such as repurchase undertaking of the underlying assets
•The non-maintenance of structural integrities in structuring Sukuk is responsible for some Sukuk default cases
•These integrities normally consist of requirements that an element of risk is shared between the business enterprises and the financiers, and that financings be backed by real assets

Mimicking conventional bonds
•For example, incorporation of the debt-like structure of conventional bonds to Sukuk through the inclusion of income and capital guarantees in the structures
•This inclusion ensures that a particular failure to make a periodic payment on time or to redeem the principal amount on the due date would show up the way of default
The debt structure of these Sukuk provided both Sukukholders and issuers with the desired structure that replicates the risk of default in bonds

Additional risks associated with Sukukbonds
•For example, the experience of Sukuk defaults in GCC countries in 2009 and 2010 revealed to the investors the additional risks associated with Sukukas a result of the unproven structures used to accomplish Shariah compliance
•Investors exploring their investments in Sukuk found no significant difference in what the economic outcome provided in comparison with bonds
•They realized that the untested structures created an extra layer of risks with few benefits for purposes of portfolio diversification

The presence of ambiguity and confusion
•It is found the enforcement of Sukuk contracts and their insolvency in the case of default in some of the Sukuk cases were shrouded in a veil of ambiguity
•For example, Although Nakheel Sukukof Dubai are said to be a Shariah-compliant product, they are governed by English law
•There was the matter of the physical asset underpinning Nakheel Sukuk valued in 2006 at $4 billion, but it was proved that the underlying asset was worth considerably less
•In this Sukuk, the enforceability was also a matter since, under Dubai law, no debt owed by the ruler can be recovered by taking possession of the government’s assets

Breach of Contract
•Sukuk default may take place when there is a breach by Sukuk issuer of its fiduciary responsibilities concerning the original terms of the agreement between the Sukuk issuer and Sukuk holders
•Sukuk defaults can also happen when the obligor fails in fulfilling their financial obligations as indicated in the contractual agreement
•8) Sukuk Structuring
•The diversity of Sukuk structures necessitates alternative restructuring options
•For example:The structures of debt-based Sukuk provide the rights to the Sukuk holders to receive the payment for a debt from the issuer. However, direct access to the asset is not available in ijarah, Mudarabah, &Musharakah Sukuk, because in these Sukuk the recourse is limited to the Sukuk originator & the issuer

THE BENEFITS OF SUKUK RESTRUCTURING
•In debt-based Sukuk (e.g., Murabahahand Istisna` Sukuk) it provide the rights to the Sukukholders to receive the payment for debt from the issuer on a pre-agreed interval time
•In asset-based Sukuk (in which the investors have limited recourse to assets)it provides the rights to the Sukukholders to claim both the asset and the returns generated from the asset
•In Sukuk Ijarah, Sukuk Mudarabahand Sukuk Musharakah defaults the recourse is only limited to the Sukuk originator and the issuer, not to the underlying assets
•Unlike the asset-based Sukuk,the asset-backed Sukuk provide the Sukuk holders the right to claim only from the asset and not from the Sukuk issuer

SHARIAH CONSIDERATIONS IN RESTRUCTURING SUKUK
•The basic Shariah principles that may be taken into consideration in this regard are:
1)Restructured in a way that creates the same economic outcome as conventional bonds while maintaining the compliance with the Shariah
2)Sukuk restructuring transactions must not include the elements of Shariah prohibitions
•For example, Sukukcertificate holders can only profit from the performance of any underlying asset
•Under no circumstances, interest-bearing payments should be exchanged during a restructuring

The prohibition of investing in products and services that are not-Shariah compliant
•Thus, while restructuring, there can neither be any investments in haram industries, which include:
•prostitution, gambling, lotteries, drugs, weapons of mass destruction, nor can there be any involvement in manufacturing tobacco products, pork or alcohol, or in providing pornographic activities

4) The need for getting the approval of Shari’ahAdvisory Board for new financial products
5)The overall guiding precept that if a debtor is in financial distress that often leads him to bankruptcy, he should be granted a grace period (respite, postponement) until it is easier for him to repay the debt
•This is based on the Qur’anic verse (2:280) that affirms:
•“One who faces hardship in paying his debts must be given time until his financial condition improves. Would that you knew that waiving such a loan as charity would be better for you!”

THE KEY SHARIAH CHALLENGES IN RESTRUCTURING SUKUK
1) The absence of specific guidance from scripture and legal scholarship
•The classical literature mainly focuses on insolvency and restructuring for the obligations of natural legal persons
•In such instances, the final remedy is typically debt forgiveness
•A major issue in relying on traditional scholarship is that, in contrast to contemporary conceptions of the limited liability company, project companies or SPVs with a distinct legal personality from its shareholders, they were limited to real persons
•Thus, classical Shariah scholarship provides limited guidance on matters of ultimate liabilities in default

The preference for the parties to amicably resolve disputes through just and fair means (al-Sulh)
•There are two major implications of this dispute resolution principle
•a) Parties are provided flexibility to determine their resolutions that best address their circumstances through fair negotiations, as long as they do not contravene other Shariah rules
•b) there are fewer concretized scaffolds for debt restructuring because the parties may settle on any number of solutions
•Thus, for contemporary purposes, we find limited pre-structured debt-restructuring mechanisms as opposed to a general principle for Islamic dispute resolution mechanism

FINDINGS AND CONCLUDING REMARKS
•Sukuk necessitate rescheduling with their variety of structures, and refinancing in the event of defaults and liquidation
•The key reason for a Sukuk default is the inability of the Sukuk issuer to be unable to pay the Sukukholders their returns as agreed and the varying rights of Sukukholders irrespective of ‘asset-based’ or an ‘asset-backed’ Sukuk
•Sukuk must adhere to the basic principles of Shariah to be protected in the event of defaults and liquidation
•The basic Shariah principles must be maintained while restructuring in a way that creates the same economic output as conventional bonds
•Restructuring the Sukuk transactions in all stages cannot include the elements of Shariah prohibitions

•If the debtor is in financial distress that often leads him to bankruptcy, he should be granted more time until he is able to repay the debt
•Granting an additional time does not mean that the debt is waived; rather it is still an obligation that is owed, until the debtor is able to pay it back
•Serious questions remain regarding Sukuk’s treatment in default
•With some exceptions, including those referred to above, Sukuk remain largely untested
•The mega Sukuk defaults in GCC and Malaysia have put a damper on new Sukuk issuance
•Restructuring and new issues may end up in the conventional market unless regions keen on issuing sukuk domestically address prevailing legal concerns
•Until then a lack of confidence may cause investors to consider other jurisdictions with more robust frameworks.