Student editor Esther Agbaje (HLS ’17) suggests that sukuk (commonly called Islamic bonds) are insufficient to handle bankruptcy in financial systems operating with respect to Islamic law, or sharīʿa compliance. Banks and other financial institutions or municipalities that issue sukuk intend for these instrument to organize debt and therefore to be insulated from default. This idea seeks to implement the Islamic law financial principle of profit/loss sharing, designed to limit exposure to default by making both parties invested in the success of the venture. Thus, the Accounting and Auditing Organization for Islamic Financial Institutions – the premier regulatory authority in the Gulf for financial institutions engaged in Islamic finance – defines sukuk as “not debts from the issuer,” but as “fractional proportional interests in underlying assets, usufructs, services, projects or investment activities.” Using sukuk for sharīʿa-compliant financing, the East Cameron Gas Company defaulted in 2008. With this example, Agbaje argues that sukuk offer an imperfect means of organizing debt or debt-organization schemes, the latter of which can often fail. In short, the East Cameron Company failed to pay its sukuk holders, investors that had loaned money to the company. In the end, a Chapter 11 (U.S. Bankruptcy Code) reorganization reset things by “transform[ing] the sukuk holdings into preferred stock options,” leaving the sukuk scheme Islamic in name only. If sukuk is not protected from default, then it stands to reason that other debt structures within Islamic finance are likely to be susceptible to failure using sukuk. The logical conclusion, Agbaje argues, is that countries that want to rely on Islamic financial instruments still need to develop (or borrow) bankruptcy codes to both support Islamic finance principles and to standardized regulations for handling loan defaults in cases of insolvency.
Islamic financial literatures discusses debt default often in the context of sukuk. Sukuk is called an Islamic bond, but this is not a perfect translation or analogy. According to the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), sukuk “are not debts from the issuer, they are fractional proportional interests in underlying assets, usufructs, services, projects or investment activities.” Financial institutions or municipalities that issue sukuk arrange them to be insulated from default. This plays on the Islamic law financial principle of profit/loss sharing, which is designed to limit exposure to default because both parties are interested in the success (and liable for the failure) of the venture. This setup refers to the ideal situation.
But sukuk, like other debt arrangements, can fail. Those failures should strongly encourage Islamic financial regulators to develop an Islamic bankruptcy regime for the modern world. This post highlights an instance of a sukuk default and briefly explores whether conventional bankruptcy law can serve as a model for an Islamic bankruptcy regime. In the end, I include that lessons from the U.S. bankruptcy laws could be a starting point to developing Islamic bankruptcy codes that embody Islamic principles concerning debt repayment.
Sukuk defaults are not new. Several have occurred on offerings from the U.S., Dubai, and Saudi Arabia. But a recent sukuk default is believed to be the first known example of a sukuk default in the United States. In 2006, East Cameron Gas Company offered a sukuk holdings arrangement as an alternative debt structure to mimic the structures that have met with success in countries with Islamic financial systems. East Cameron’s success was short-lived. By 2008 the company defaulted on its sukuk payments to investors. East Cameron filed for bankruptcy and a Chapter 11 reorganization under U.S. law. In the end, the Bankruptcy Court restructured East Cameron in a way that transformed the sukuk holdings into preferred stock options in the newly formed company after the reorganization. The outcome of the bankruptcy proceedings was to reorganize the debt offering in a way that removed the Islamic financial aspects of the security offering. This scenario presented a failure of sukuk financial structuring in instance of default, because of Islamic law’s lack of robust bankruptcy laws.
If the goal of Islamic law in finance is to provide a way for Muslims to live their whole lives according to a moral code by using an “ethical finance” model, Islamic law financial regulations should extend to instances when financial ventures crumble and go bankrupt. While sukuk are complex debt structures, they are still based on the profit/loss sharing structure that underlies other Islamic financial debt arrangements, such as muḍāraba. Sukuk defaults and the number of cases concerning debt collection that come before courts prove false any underlying sense that Islamic financial arrangements are insulated from default. Regulators will have to seriously consider an Islamic bankruptcy regime at all levels of investment and loans.
Other countries can provide models of bankruptcy codes on which the authorities in Muslim majority countries can build. In modern conventional bankruptcy codes, countries are either pro-creditor, meaning that the law prefers the creditor in debt repayment, or pro-debtor, meaning that the law allows for the consideration of the debtor’s circumstances and an opportunity to for the debtor to discharge his debts. Both of those sentiments are present in the texts of classical Islamic law, except for the discharge of debt. The U.S. Bankruptcy code, which was reformed in 1978, is a hybrid approach that focuses on liquidation, debt repayment, and company reorganization. The purposes of these measures are to ensure repayment of debts as far as possible, but also to discharge or reduce some debts and allow the debtor a second chance.
Of the existing models, both pro-creditor arrangement and hybrid arrangements could align with the precepts of classical Islamic finance laws. Pro-creditor models more readily lend themselves to a foundation for an Islamic bankruptcy regime because of the focus on the repayment of debts. The U.S. model, which allows for reorganization, could be useful in developing the concept of paying debt over time, in tune with classical Islamic precepts.
Using this type of mixed system as a basis for an Islamic law bankrupt regime could still attract foreign investors to Muslim majority countries just as sukuk structures attracted foreign investors looking for alternatives to classical financing that would attract companies doing business in the Middle East or with respect to Islamic law. Moreover, an Islamic bankruptcy code could provide more options to the debtor for repayment and restructuring, while eventually removing the stigma of debt. This arrangement could be an appropriate extension and application of classical Islamic law if Islamic law experts who acts as guides sharīʿa-compliant finance are willing to interpret the law in that direction.
 Kamal Abdelkarim Hassan and Muhamad Kholid, Bankruptcy Resolution and Investor Protection in Sukuk Markets, in Islamic Finance: Instruments and Markets 101 (Bloomsbury Information, Ltd., 2010).
 Maha-Hanaan Balala, Islamic Finance and Law: Theory and Practice in a Globalized World 147 (2011).
 Ibrahim Warde, The Relevance of Contemporary Islamic Finance, 2 Berk. J. Middle E. & Islamic L. 159, 166 (2009).
 Hassan and Kholid, Bankruptcy Resolution, at 105. These sukuk defaults include the U.S. East Cameron Gas Company, Investment Dar in Dubai, and Golden Belt 1 in Saudi Arabia.
 Michael J.T. McMillen, An Introduction to Shariʿah Considerations in Bankruptcy and Insolvency Contexts and Islamic Finance’s First Bankruptcy (East Cameron), 2 n. 4 (June 17, 2012), available at http://ssrn.com/abstract=1826246.
 In re East Cameron Partners, L.P., 2008 Bankr. LEXIS 3918 (Bankr. W.D. La. Dec. 12, 2008); 11 U.S.C.A. § Ch. 11 (West).
 Michael J.T. McMillen, An Introduction to Shariʿah Considerations in Bankruptcy and Insolvency Contexts and Islamic Finance’s First Bankruptcy (East Cameron), 25-28 (2012), available at http://ssrn.com/abstract=1826246 or http://dx.doi.org/10.2139/ssrn.1826246.
 McMillen, Shariʿah Considerations in Bankruptcy and Insolvency Contexts, at 25-28.
 Warde, Relevance of Contemporary Islamic Finance, at 169.
 Warde, Relevance of Contemporary Islamic Finance, at 166. Warde briefly explains the concept of muḍāraba. “The mudaraba (or commenda partnership) is an association between the rabb-el-maal (financier) and the mudarib (entrepreneur) where profits and losses are shared based on an agreed-upon ratio.”
 See Esther Agbaje, “Building an Islamic Bankruptcy Regime from Dispute Resolution in Malaysia.” [What is this? If a SHARIAsource post, it needs to be linked.]
 Sonali Abeyratne, Corporate Insolvency in Malaysia, INSOL Int. Insolv. Rev. 177, 178 (2000).
 McMillen, Shariʿah Considerations in Bankruptcy and Insolvency Contexts, at 7-9.
 McMillen, Shariʿah Considerations in Bankruptcy and Insolvency Contexts, at 3.
 Title 11 of the United States Code .
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