Islamic financial institutions who provisionally decide to provide Commodity Murabaha financing to their Customers will, as with conventional counterparts, require the Customer to satisfy the Bank of certain rudiments before the funds can be dispatched (be that the strength of its financial standing and/or the robustness of the property being secured as collateral).
These are known as conditions precedent (the CPs) and are often contained in a schedule to the Master Murabaha Agreement (the MMA). As the Bank's decision to fund hinges on the satisfaction of these CPs (which will form part of the Bank's credit approval), what constitutes a CP and the exact wording of these CPs will often be a point of negotiation between the parties.
Once the CPs have been agreed, most will be satisfied between the Customer and the Bank. However, issues may arise when CPs are required to be satisfied by a third party, a common example being the requirement of an insurance broker's letter.
An insurance broker's letter provides evidentiary confirmation that a Bank's insurance requirements have or will be met on completion of the transaction. The Bank will want to know that the property, being the underlying collateral that supports their financing, will be protected from destruction, damage, or any other events that could affect the property's value or income stream. The Bank will also want to be named as co-insured and first loss payee on the policy and, accordingly, delivery of an insurance broker's letter from the Customer's insurance broker is a market standard CP on structured real estate financing transactions.
This sounds simple enough, but contention and protracted negotiations often arise:
- If the broker is adamant on using its own house form of letter, or demands various changes to the Loan Market Association's standard form.
- When the Bank seeks to request positive confirmations on certain details of the policy, such as cover, limitations and exclusions, all of which, in order to confirm, may require due diligence from the broker, as well as some degree of judgment.
- On issues of liability, caps on liability and reliance (for example, some Banks will insist on the letter benefiting their successors, but some brokers may challenge this in order to avoid a widened scope of liability).
The issues above may be unavoidable, but to ensure that these issues do not cause delays, the Customer must manage the parties appropriately and as early as possible in order that the right parties are communicating to one another at the earliest instance. This could mean putting the insurance broker in touch with the Bank's solicitors, or vice versa, as soon as possible.
Separately, there are certain circumstances where it isn’t possible to satisfy a condition within a given timeframe. In these situations, the Bank may decide to either:
- Waive the condition as a CP (this is however uncommon and may only be applicable to minor CPs so as not to fall foul of the Bank's credit approval conditions for the transaction).
- Make the CP a condition subsequent (CS).
Essentially, a CS will require the Customer to satisfy the condition within a specific period after the transaction completes. If the Customer is unable to meet the deadline then this breach will be treated as an Event of Default. Neither party will want to face this consequence and therefore CSs are only agreed in practice if there is a real possibility that the Customer will be able to deliver on that condition within the specified time period.
Strategically, CSs should be treated with caution from the Bank's perspective as in the event the condition is not satisfied then the Bank will have already advanced the facility and will therefore need to commit time and expense associated with investigating the breach and, to the extent appropriate, reserving its rights.
To conclude, while common issues outlined above can be resolved through pragmatic transaction management, the terms sheet issued by the Bank is perhaps the most appropriate document to clarify early on the terms and conditions of the facility to ensure the Customer is well-informed about what is expected of them to reach a successful close.