It is almost three years since Dubai caused panic in financial markets by announcing plans to renegotiate the payment of about $25bn of debt held by Dubai World, a government-owned conglomerate. The emirate’s restructuring saga remains far from over and is now taking on new twists.

In early September, three banks, the UK’s Royal Bank of Scotland (RBS), South Africa’s Standard Bank and Germany’s Commerzbank, launched a joint legal action against Dubai Holding subsidiary Dubai Group, after talks to restructure about $10bn of debt failed.

It is the highest-profile case yet of a creditor trying to force Dubai into a repayment and represents an unprecedented move for any bank with so many key relationships in the emirate at stake. It is also a reflection of the hardening approach of both the government and its creditors, after the relatively amicable negotiations around previous restructurings of the emirate’s $110bn debt pile.

Complicated debt case

In previous negotiations, creditors have avoided launching legal action, instead seeking repayment to maintain relationships and ensure a flow of new business beyond the emirate’s current debt troubles. Clearly for some banks that rationale is now wearing thin, as opportunities to develop new business remain infrequent and are hotly contested.

Unlike previous cases, the restructuring of Dubai Group has dragged on for the past two years. The much larger Dubai World restructuring was wrapped up in about a year, while three other potentially troublesome debts were refinanced earlier this year.

Dubai Group’s case has been complicated by the various other restructurings under way at parent company Dubai Holding, the investment vehicle of Sheikh Mohammed bin Rashid al-Maktoum, the emirate’s ruler. The fear was that any concessions or legal rights granted to Dubai Group creditors could trigger legal complications in other restructurings, or lead creditors in other negotiations to demand similar treatment.

If Dubai Group fails to bring the three banks back on board, both sides face an uncertain battle

Several other significant differences in the process have also made creditors wary. In January, the government walked away from the restructuring talks, leaving Dubai Group to work out a deal without the benefit of state financial aid or a government guarantee of repayment. Since agreeing to a large bailout of Dubai World and its subsidiary, Nakheel, as part of those restructurings, the emirate’s government has become increasingly reluctant to extend financial support to other overleveraged firms as they wrestle with their debt piles.

The three banks behind the legal action are understood to have favoured a five-year repayment term, with a guarantee they would be repaid at the end of that term. They wanted the agreement to say that even if Dubai Group had been unable to sell off some of its assets, mostly small stakes in financial companies, they would still be repaid.

Another problem the three banks faced with the deal was the terms of the restructuring agreement on offer. Unsecured creditors, such as RBS, were being offered repayment over 12 years, well beyond the five-to-eight-year repayment plans agreed as part of the Dubai World debt deal.

“The other unsecured lenders are still considering the deal on offer,” says one source involved in the restructuring. “At least some of them are close to accepting it, if they haven’t already.”

Local banks with closer ties to the government are keen to draw a line under the problems and a longer repayment period could mean they book fewer provisions.

Dubai Group’s debt is split across roughly $4bn of intercompany loans with its parent, and $6bn of bank debt. Of the bank debt, RBS had been co-chair of the steering committee representing unsecured or only partially secured creditors. Secured creditors, whose loans are backed by specific assets of the company, are understood to have been offered a much shorter repayment term.

Significant debt restructuring test

Sources close to the situation say the three banks launched legal action as a last resort and are still open to reaching a consensual agreement. However, a fourth creditor, Egypt’s Commercial International Bank, is also opposed to the deal currently proposed by Dubai Group. The company says 35 banks are still working on a settlement and that it believes “this deal is in the best interests of all parties”.

If Dubai Group fails to bring the three banks back on board, both sides face an uncertain battle. Even if the banks succeed in getting a judgement against Dubai Group in the UK court where the legal action has been filed, it is questionable whether it could be enforced in Dubai. Whatever happens now, the three banks could long be tainted by the decision to begin legal proceedings.

The next few months will be a significant test of both the creditors’ and the government’s tougher new negotiating strategy.

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