Dubai World’s unraveling could prove a critical test for the rapidly growing Islamic finance sector, and Dubai’s murky judicial system. A significant chunk of Dubai’s debt is in the form of Sharia-compliant bonds, the New York Times explains. These increasingly popular instruments forbid lenders from collecting interest, instead putting them in a partner-like relationship with the borrower. There have been few major defaults on them, leaving courts little precedent in arbitrating them.
Holders of Sharia-compliant bonds intend to argue that they hold the more secure position, and should be paid out before banks, a reverse of the traditional bankruptcy hierarchy. Of course, first they’ll need to get government permission to sue the government-run company, and even if they get it, Dubai law protects government assets from creditors. Dubai’s courts are run by the ruling family, and lawyers say their decisions are erratic. (More Sharia law stories.)
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