* Exposure includes Cyprus Popular Bank *
Three banks have begun legal proceedings against an investment vehicle owned by Dubai's ruler in an unprecedented move to secure repayment of loans in the Gulf state that could delay a wider deal on restructuring $10 billion of debt.
Royal Bank of Scotland said on Thursday it had launched the action against Dubai Group with German lender Commerzbank and South Africa's Standard Bank.
The banks began the proceedings in a London court last Thursday. The move breaks with the precedent in previous restructuring cases involving Dubai state-linked firms which avoided courts due to the United Arab Emirates' untested insolvency regime.
Dubai Group, a unit of Dubai Holding, the investment arm of Sheikh Mohammed bin Rashid al-Maktoum, was hit hard by the global financial crisis in 2008 due to excessive use of leverage in its investments and a sharp decline in asset values.
Since missing interest payments on two loan facilities in 2010, it has been locked in talks with its lenders to extend repayment deadlines. It wants time for asset values to recover before making sales in order to pay back its debts.
Hopes of a deal this year, though, could be jeopardised by the legal action.
"Arbitration could be two years and we don't want to see the destruction of shareholder value just because these banks have thrown their toys in the corner," said one source with knowledge of the situation.
Others, however, said the move could be a negotiating tactic by the three banks - all of which are unsecured creditors - aimed at getting a better deal from Dubai Group.
The government walked away from debt talks in January, dashing any hope creditors had of state support.
RBS said it was forced to act after several concessions offered to Dubai Group failed to secure a solution.
Given the complexity, and the lack of precedent, it would take a lot of time to work through the case but the three could secure a favourable outcome, according to one Gulf-based lawyer.
The case would have to overcome a number of hurdles to reach that point, including a rare challenge to the structure behind the Islamic financing facility which the three banks provided, which could have wide-ranging implications for Islamic banking.
And if they secure a positive outcome from arbitration, the three banks would be unable to secure assets locally - UAE law prohibits foreign ownership of land, while businesses outside free zones must be majority-owned by a local partner - meaning they would have to pursue assets in other jurisdictions.
"A favourable judgment in a UK court opens the prospect for the attachment of Dubai Group's international assets, pitting them against the other consenting banks," said Ahmad Alanani, a senior executive at investment bank Exotix in Dubai.
The filing comes at a time when others banks involved in the restructuring are considering a proposal, put to them before the summer, which would see debt extensions ranging from 3.5 to 12 years.
The 12-year extension is the main concern for the three unsecured banks, as extending cash for so long is uneconomical.
"Over 35 banks are working towards an agreement and a global term sheet is now being considered by bank credit committees, a number of which have indicated their support," Dubai Group said in a statement. "We believe that we can reach a consensual agreement with our creditors."
Dubai Group is in talks with a number of parties about selling its 45% stake in Lafarge Emirates Cement, sources told Reuters on Thursday.
Its financial assets include stakes in Egypt's EFG Hermes and Cyprus Popular Bank, formerly Marfin, whose recapitalisation forced Cyprus to seek a bailout.
Of the $10 billion total debt, $6 billion is owed to banks and the remaining $4 billion is classed as inter-company loans.
SNR Denton is representing the banks, two sources familiar with the matter said. Clifford Chance is acting for Dubai Group.
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