Minnesota Litigator spoke recently with Eric Nilsson, a Minnesota lawyer 35 years of experience in bank-related law. (For Eric’s contact information, click here.) Most recently, he’s taken on a highly specialized and extraordinarily complicated task, the reconciliation of U.S. commercial lending law and Sharia-compliant financial transactions for Muslim clients.
As he discusses, he has found the work complex, intellectually fascinating, and, also, important in our current cultural climate in which our country confronts powerful and insidious head-winds of anti-Muslim xenophobia.
Minnesota Litigator (“ML”): Eric, for starters, why don’t you tell our readers how you got to where you are today.
Eric Nilsson: I joined Briggs and Morgan and I spent a year in litigation handling commercial disputes. My secondt year was in the real estate department handling conveyancing and finance. At the end of that second year, the chair of the banking group at Briggs and Morgan asked me if I’d like to serve as a “loaner lawyer” to First Bank to work in their real estate work-out division.
At that point I didn’t even know what a work-out was, but I thought it sounded like an interesting opportunity. For the next year, I worked full-time at the bank, though I remained an associate at the firm. My job was to work out a portfolio of defaulted real estate loans and the sale of OREO, that is, property that was taken back through for closure or deeds in lieu of foreclosure. After a year at the bank, I returned to Briggs and Morgan, this time to the commercial or banking department and worked on asset based loans and a variety of loan transactions, but also workouts, on behalf of lenders.
A couple of years later, First Bank—by that time, First St. Paul and First Minneapolis had consolidated— hired me back to work again in the real estate work out division. A year and a half later, I was recruited by the commercial department of Oppenheimer Wolff & Donnelly to work on loan transactions and loan work-outs and some litigation. After several years at Oppenheimer, I had an opportunity to transfer to Norwest Bank (later Wells Fargo) and manage the default group in their corporate trust department.
That entailed administering indenture trusteeships of defaulted bonds and involved both real estate and non-real estate matters across the country. In 2000 I opened my own law practice, initially representing primarily Wells Fargo. Bank clients would refer customers to me, and in time my practice expanded to representation of other community banks and a host of different business types, but all with a focus on finance, real estate, and litigation associated with those two areas, all of which brings me to the present where I’m still engaged in that practice.
Recently I was approached by an Islamic group. They needed what would be termed a conventional commercial construction loan for the construction of a mosque on some real estate that this entity, a non-profit, owned. The requirement was that the loan transaction be Sharia compliant, more specifically that the terms of this transaction comply with or observe Quranic directions and prohibitions. The leading one is the prohibition against paying interest.
The conventional lending part was very familiar to me. For the Sharia side, however, I had to roll up my sleeves and figure it out… Although I’d had some exposure to Sharia finance in the past, I had not had to acquire a deep understanding. With this latest assignment, I really had to learn it. That necessity launched me on a fascinating and hugely rewarding intellectual experience — trying to understand Islamic finance and its ramifications in the context of a conventional, commercial real estate.
My study started with reviewing accessible materials on the internet. I found a number of law review articles and white papers by experts in this area. I also delved into some textbooks on the subject that are quite dense, quite sophisticated, and the big problem I was encountering was how to address issues that are pretty central to any domestic context— by that I mean transactions in America and specifically Minnesota— absolute requirements that any regulated lender, i.e., a bank, is going to require in connection with any construction loan, any real estate loan.
Specifically, in construction lending here in the United States and specifically Minnesota, the core issue, legal issue, and structural issue is how to ensure that the lender’s collateral position is going to be prime and enforceable against all other parties, particularly potential mechanics lien claimants. That’s the central issue in a construction loan. Of course, there are legion of other issues associated with any loan, but that is the central issue. One has to solve for that problem. How does one ensure, from the lender’s perspective, that they’re going to wind up with a first lien position?
A mortgage. Start with a mortgage concept because that’s the vehicle, the legal vehicle, by which a lender can prevail over mechanics liens. Plenty of sub-issues are associated with that. How do you prevent a mechanics lien from running around that mortgage somehow and gaining priority? How does the bank ensure that it has protection? Ultimately, the bank is going to turn to a title insurer for protection.
The title insurer then examines and analyzes the situation and basically dictates from a host of perspectives what is going to be required before the title company can give the bank coverage over mechanics liens. That’s the analytical starting point, if you will — to achieve protection against mechanics liens by way of a mortgage.
The next question is, what obligation is the mortgage going to secure? That’s where it gets really interesting. Normally, it’s the fee interest that is mortgaged. That is what we all consider the ownership, the simple ownership of the property. It’s that interest that gets mortgaged to the bank.
That’s all well and good, except then you turn to what does the mortgage obligation secure and normally it secures an interest bearing note. There’s the rub, because a Sharia compliant borrower cannot be executing an interest bearing note. It cannot borrow on an interest bearing basis. Now you have to back up and ask, where is title going to reside then and where is this obligation going to reside, this interest bearing obligation, if it’s prohibited under Sharia law?
ML: I had imagined that one could solve this problem simply by using some kind of euphemism for “interest.”
Eric Nilsson: Some people have taken that approach. But to be truly Sharia compliant, you need to do more that change the name of “interest.” The underlying concept is that the Quran prohibits “making money on money.” In brief, you need to work with the concept of rent, coupled with buy-back provisions, as an alternative to interest, but this in turn requires devising an ownership structure that challenges basic methods of collateralizing a construction loan and addressing mechanic’s liens. You also have to worry about additional transactional costs, mainly in the form of conveyancing taxes.
There are other prohibitions that you have to take into account in structuring these transactions. For example, to provide for rent, which, as I’ve described, is the alternative to interest, you have to create a lease under which rent is paid. But under Sharia law, cost of maintenance must the responsibility of the lessor, not the lessee.
Back to your basic question of, “Can’t we just change the name?” I’ve actually had the good fortune of getting acquainted with one of the world’s leading legal experts in this area, Michael McMillan, who teaches at the University of Pennsylvania Law School. He’s spend a couple of decades developing the architecture that dovetails conventional real estate finance with Sharia law. His work provides valuable insights into how deals should and can be structured.
I’ve also reverse engineered actual Islamic financings that I’ve been able to identify—here in Minnesota and in California. I examined title, obtained copies of recorded documents and reviewed the structures that had been devised. They took various forms and departed significantly from the architecture devised by Professor McMillan. The one challenge of adopting that architecture, however, is cost. A large-size, for-profit deal could support it. A modest loan transaction to a non-profit entity — that is, a mosque — cannot.
At one extreme, I found no apparent compliance with Sharia law. In other words, what I found of record was a “rip it off the tablet” conventional mortgage form securing an interest bearing note. At the other end of the spectrum, no apparent real estate collateral what-so-ever was in the mix. From that, I could only deduce that there had been no outside financing for that particular mosque. I expect the acquisition of the property and any improvements to it were funded completely by pledges — a cash deal in effect. No lending required. Those were the extremes.
In the middle, I found attempts to structure things that would be Sharia compliant. What I could not figure out about these deals, however, was how they could address that central issue of mechanics liens, particularly in a construction loan setting. Where this has left me is devising a structure that is informed by Professor McMillan’s architecture but that is also tailored to accommodate the cost considerations that I have to observe. Through my experience as a real estate finance lawyer, I know what I have to “solve for” on the bank and title company front. Through my study of Sharia finance, I am learning what I have to “solve for” on the Islamic side. .
ML: Here your clients are investors or people who want to build a mosque. Is that right?
Eric Nilsson: That’s correct.
ML: Who decides when something is Sharia compliant?
Eric Nilsson: That’s a very interesting question. First of all, in Islam, unlike for example Catholicism, there is no head Imam. There is no Pope in whom resides the ultimate authority on anything. Authority is rather dispersed. What’s developed is the notion of Sharia boards and there are many of them all over the place. It depends on your context, your jurisdiction. In Saudi Arabia, for example, there’s an official Sharia board. It’s considered like a Supreme Court. It’s not one individual. It’s a board. You have that interesting element. There’s not unified agreement as to how the Quran should be interpreted.
ML: Do your clients have a board they must get the construction transaction approved for Sharia compliance?
Eric Nilsson: They have a corporate board but not a Sharia board per se. However, they do have a resident scholar to whom they defer. This individual, with whom I’ve had a lot of fascinating exchanges, is the expert within this group. His opinions can vary from the opinions of other scholars and other boards within the local Islamic community and within the national and within the international communities. It’s not a black and white analysis. That’s one challenge.
Another concept is that, and again, there’s no unity with respect to the force of this concept. It’s been expressed to me, I think by a more liberal end of this spectrum, that this compliance with Sharia law is not an absolute necessity. I don’t want to overstate this, but basically, if you as an entity or as individual, find yourself in circumstances in which there is no alternative to breaching certain prohibitions then you’re allowed to do so. That might explain why I found an Islamic entity that had entered directly into what was by all appearances a conventional, interest-bearing loan.
Given that, all those forgoing considerations, I’ve had to construct something the best I can. I’ve had to solve for a number of issues much like one presented with a Rubix cube. Example, mechanics lien, which I just mentioned or mentioned previously, that’s central issue. How does one solve for mechanics liens in a construction loans setting? Number two, how does one address the state deed tax, because one element of the architecture that’s been devised to basically bifurcate the loan between conventional bank loan and Sharia compliance, and the other side, is to create a middle entity, an SPV, or special purpose vehicle.
ML: A middle man?
Eric Nilsson: Yeah, a middle man. That entails the transfer of title from the current fee owner which is the mosque, which a 501(c)(3) entity (a non-profit), a conveyance from that entity to the special purpose vehicle. Query: what does that suggest in the way of state deed tax and what’s the consideration going to be? Is it nominal, in which case there would be no deed tax? Eventually, once the construction is completed, title has to revert back in some fashion to the original grantor, to the mosque.
ML: Can’t the SPV be controlled by the mosque?
Eric Nilsson: That raises a question. In my opinion, this gets to shades of grey. In a perfect world, that SPV would be owned and managed by an entity or individuals completely separate from the Islamic organization. That’s the best model. But it can also be problematic, from the perspective of say the board of a mosque, which doesn’t want to accede control and authority.
The problem is to try to explain limitations on SPV authority and so forth to a group of, basically, volunteers associated with a non-profit. That’s a big task. These people are very intelligent, very well educated, but they’re not familiar with real estate law, finance law, so on, so forth, or LLC organizational law. I have had to explain how this SPV would work.
I’m still in the crafting stage of , but I think what I’m going to wind up with is a hybrid structure that I think is an improvement on the structures that I’ve seen of record but is not entirely consistent with what I think is the perfect architecture.
ML: How long have you been working on this?
Eric Nilsson: I met my people for the first time shortly before the election, so going on six weeks.
ML: I know it’s probably difficult, maybe impossible to predict, but do you have a sense of when you think you will have a framework in place and allow this transaction to go forward?
Eric Nilsson: My goal is January.
ML: How close are you?
Eric Nilsson: I think we’re a week away probably, not given the holidays. A week to 10 days away from agreement among all the players on the basic global structure.
ML: When you say all the players, do you mean the bank on the one hand and what I’ll call the investors on the other hand?
Eric Nilsson: I’d say the bank, the title company, and the ultimate beneficiary of the project.
ML: Good luck.
Eric Nilsson: Thank you. I’ve invested huge amount of time in this effort. Only a fraction of which will be compensated. I consider it a huge gain for me personally in a couple of respects. One, it’s just gratifying intellectual curiosity. I think from a broader perspective, if I can develop expertise in this area, and be of value both to conventional lenders as well as to Islamic borrowers, then I think I will have served a larger purpose that Professor McMillan has served. I’ll give you just a couple of anecdotes.
Mr. McMillan explained to me that he’s been accused on a couple occasions over the last number of years of helping finance Islamic terrorists, which is complete nonsense. He’s done nothing of the sort. He’s received death threats. He’s been maligned publicly by extreme anti-Muslim pundits. His reaction is, “I have a public duty actually to help this element of our community, our financial community, or economic community, and our social community, to accommodate them with respect to Islamic finance or complying with Sharia law.” I find that inspiring.
Additionally, one of my clients, one of the group, told me just anecdotally how his kids reacted to the election. It was abject fear. I feel a connection with these people. As I said, they’re very well educated, very intelligent. They’re major contributors to our community on a whole bunch of levels. They’re an asset to our community. I want to do my part in accommodating that asset, which I think is going to grow in the years ahead. If we as a society are halfway smart about it, we’ll allow that, we’ll accommodate that growth.
By learning this area of finance, and being of service in it, I think I can help counter some of the reaction, the adverse and negative reaction, to the growing Muslim segment within our community. That’s what really motivates me.
[Previous Minnesota Litigator Profiles: Roshan Rajkumar, products liability defense, Liz Kramer, Arbitration Maven/Author of Arbitration Nation, Bob Lear, Residential Real Estate Appraiser/Expert Witness, Tim Nolan, Lawyer/poet, Laurie Vasicheck, 25 year veteran of the Minneapolis office of the EEOC, Jake Holdreith, an IP litigator for “drug dealers” (better known as pharmaceutical companies), Pam VanderWiel, lawyer for Minnesota municipalities, Bill Dossett, Executive Director of Minnesota’s Nice Ride bike-sharing program, Christina Snow, lender/servicer real estate and foreclosure lawyer, Clayton Halunen, plaintiffs’ employment lawyer, consumer rights lawyer, Stephen L. Smith, straddling a civil and a criminal litigation practice (and later appointed to the Ramsey County District Court bench), Kevin Dunlevy, Minnesota real property authority, Vildan Teske, consumer rights class action litigation and service members class actions, Jim Behrenbrinker, civil rights/excessive force cases, Eric Cooperstein, “ethics maven“, Mike Flom, Gray Plant’s General Counsel, Phil Gainsley, veteran solo civil litigator, John Halpern, collections, Elliot Olsen, foodborne illness litigation, Dave Potter, railroad industry litigator, Katherine Mackinnon, ERISA plaintiff’s lawyer, Kristine Boylan, international IP/Complex Litigation lawyer,Karin Ciano, free-lance “federal sherpa,” Jerry Alcazar, products liability defense.]