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How Sukuk and Bond defaults differ – The role of the Trustee and the Purchase undertaking agreement
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today 11 May 2014 GMT

The structure of a Sukuk makes enforcing investor rights in the event of a default different from a conventional Bond.



The structure of a Sukuk makes enforcing investor rights in the event of a default different from a conventional Bond.


The modified role of the Trustee


Whilst similarities between Sukuk and Bonds are numerous, in the case of a missed payment or default, the role and power of a Trustee are considerably different in a Sukuk structure from that in a bond.


In the event of a conventional bond default, the Trustee of the bond acting on behalf of bondholders can sue the issuer for the missing interest.


In the case of a Sukuk default, the challenges the Sukuk certificate holders face are that in a Sukuk structure, the Trustee is the issuer and a special purpose vehicle (SPV). Hence, it is pointless suing the Issuer, as it would be no more than a shell company in an offshore jurisdiction such as Cayman Islands setup for the sole purpose of declaring a trust and holding the assets of a Sukuk issuance. Its directors would be nominal (typically from a local law firm) and in the event of a default, this SPV would have no interest in enforcing against the underlying issuer to pay the missed rental payment.


To address this problem, in a Sukuk structure the SPV delegates all of its trustee functions, except the core holding of the asset to a professional Trustee, so we end up with the same type of Trustee as used in conventional bonds who then polices the issuance to maturity.


Collapsing a Bond vs. the Purchase Undertaking Agreement


In the case of a serious event resulting in the underlying issuer missing (or likely to miss) a number of payments, the treatment of bond and Sukuk holder varies.


In a bond rather than sue for each missed interest payment, the bondholders have a contractual right to be put out of their misery and collapse the entire bond with the intention of getting missing interest payments and their capital back.


In a Sukuk, certificate holders have no such right, as they cannot sue the Obligor (underlying issuer) because there is no contractual agreement in place between Obligor and certificate holders. The certificate holders can sue the SPV, but the SPV as part of its set-up would be structured so that it is bankruptcy remote in that its only obligation would be to pay to holders what it has received, so if the Obligor does not pay the rent to the SPV, the SPV has no obligation to pay the holders.


In order to provide equality in comparison to bondholders, Sukuk holders whilst not having the right to collapse the Sukuk as per conventional bonds, do have a contractual right to force the Obligor to buy back the assets in the event of the Obligor failing to meet any of its obligations. This right is written into the Purchase undertaking agreement, which is one of the contractual documents forming the Sukuk.


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