When an Islamic Finance dispute goes before a judge in England or New York, by default, the transaction by default turns into a conventional transaction. The judge declares Shari’a law to be invalid due to the conflict of laws and applies the common law and principles of conventional finance or misapplies Shari’a to the Islamic Finance transaction. A few cases adjudicated in non-Islamic courts discussed below demonstrate this point.
BEXIMCO
In Beximco Pharmaceuticals Ltd, Bangladesh Export Import Co. Ltd., Mr Ahmed Sohail Fasiur Rahman, Beximco (Holdings) Ltd. v.
Shamil Bank of Bahrain E.C. [2004] EWCA Civ 19, the defendant Beximco Pharmaceuticals Ltd. and the other borrowers entered into a murabahah agreement with the plaintiff. The defendants defaulted and after a series of various termination events under the agreements, the plaintiff finally brought the case to court and made an application for summary judgement. The defendants argued that the murabahah agreements were invalid and unenforceable because they were in actuality disguised loans charging interest (Asutay and Hasan, 2011: 56).
According to the Appeal Case, the Court ruled that an Islamic Finance contract could not be governed by Shari’a law in the UK. Even if so specified in the contract, the judge further ruled, in fact, that Shari’a law is not a recognizable form of law containing principles of law capable of governing a commercial dispute in the UK. Lord Justice Potter stated in Paragraph 2 of the judgment, ‘It is not in dispute that the principles of the glorious Shari’a referred to are the principles described by the defendants’ expert, Mr Justice (retd) Khalil- Ur-Rehman Khan as: “the law laid down by the Qu’ran, which is the Holy Book of Islam and the Sunnah (the sayings, teachings and actions of Prophet Mohammad (pbuh). These are the principal sources of the Shari’a. The Sunnah is the most important source of the Islamic faith after the Qu’ran and refers essentially to the Prophet’s example as indicated by the practice of the faith. The only way to know the Sunnah is through the collection of hadith, which consist of reports about the sayings, deeds, and reactions of the Prophet.”’ Lord Justice Potter, in this judgment, recognizes the definition of Shari’a law stated by Mr. Justice Khalil-Ur- Rehman Khan, however, stated that Shari’a law, which in his opinion is more of a religion than law, could not apply to a commercial banking transaction in the UK.
The Judge declined to construe the wording of the clause as a choice of Shari’a law as the governing law for the following reasons. First, Article 3.1 of the Rome Convention (which by s.2 (1) of the Contracts (Applicable Law) Act 1990 has the force of law in the United Kingdom. It contemplates that a contract ‘… shall be governed by the law chosen by the parties’ and Article 1.1 of the Rome Convention makes it clear that the reference to the parties choice of law to govern a contract is a reference to the law of a country. Lord Justice Potter further argued that the reference to a choice of a ‘foreign law’ in Article 3.3 suggests that the Convention as a whole only contemplates and sanctions the choice of the law of a country: c.f. Dicey and Morris on The Conflict of Laws (13th ed.) vol. 2 at 32-079 (p.1223) and Briggs: The Conflict of Laws at p. 159.’ Lord Justice Potter stated that Shari’a law is not a national system of law and is classified as a non-national system of law such as ‘lex mercatoria’ or ‘general principles of law’ and therefore cannot apply to a commercial transaction in the UK. Colon (2011:425) states that even though the Rome Convention has been replaced by Regulation (EC) No. 593/2008 of the European Parliament and the Council of 17 June 2008 on the Law Applicable to Contractual Obligations (Rome I), the conflict of law rules remain the same.
In this appeal case, English law was confirmed as the governing law and it was further confirmed that English law does not recognize Shari’a law as a valid source of law to govern a commercial contract. Furthermore, even if Shari’a law were recognized under English law, under the conflict of law rules applicable in England and Wales, according to this judgment and the new Rome I, English law would prevail as the governing law must be the law of a State.
Colon (2011:425) points out that according to Beximco, under English law a murabaha agreement may be treated the same as an interest-bearing loan, which ironically was part of the initial claim that based on the governing law clause, the murabaha agreements were invalid and unenforceable because they were in truth disguised loans charging interest (Asutay and Hasan, 2011: 56). In fact, the adjudication of the dispute by an English court guarantees turning the murabaha agreements into loans charging interest. Beximco interpreted the contract in light of the commercial goals that it served to accomplish, as English law requires (Colon 2011:426) and in line with the common law, interpretational approach as explained by Asutay and Hasan. This strict approach decimated the Islamic finance transaction (2011:431).
BLOM BANK
The term wakalah literally means ‘preservation.’ For instance, in verse [Qu’ran 3:173]: “They said: ‘for us, Allah suffices, and He is the best Disposer of affairs [the best wakil]” The Prophet (pbuh) was also urged in [Qu’ran 73:9] to take Allah (swt), the only true God, as his preserver and protector (wakil). The term is also used to mean delegation of one’s affairs to another. Thus, Allah is also described as the best one to whom one must delegate one’s affairs: “For those who put their trust (mutawakkilun) should put their trust on Allah,” my Lord, and your Lord” [Qu’ran 11:56] (Zuhayli 2007:632).
In the case of Investment Dar Co KSCC v Blom Developments Bank Sal [2009] EWHC 3545 (Ch) High Court of Justice Chancery Division, Investment Dar (TID) was an investment company registered in Kuwait and the Blom Development Bank (BDB) was a bank incorporated in Lebanon. A wakalah investment agreement was entered into between the two parties governed by English law (Asutay and Hasan, 2011: 57). The agreement provided that Blom deposit a certain amount of money with TID, appointing TID as its wakil (agent) to manage the money as an investment (ISRA 2012:758). When TID defaulted on payments under the wakalah agreement, BDB sued TID in the High Court of England and applied for summary judgment on the grounds of default in payment (claim in contract) and the deposits held in trust (claim in equity) (Asutay and Hasan, 2011: 57). The master found that there was an arguable defence to the contractual claim, but not to the trust claim due to a misunderstanding of Shari’a and the application of common law to an Islamic finance transaction.
In this appeal case, English law was confirmed as the governing law and it was further confirmed that English law does not recognize Shari’a law as a valid source of law to govern a commercial contract. Furthermore, even if Shari’a law were recognized under English law, under the conflict of law rules applicable in England and Wales, according to this judgment and the new Rome I, English law would prevail as the governing law must be the law of a State.
Colon (2011:425) points out that according to Beximco, under English law a murabaha agreement may be treated the same as an interest-bearing loan, which ironically was part of the initial claim that based on the governing law clause, the murabaha agreements were invalid and unenforceable because they were in truth disguised loans charging interest (Asutay and Hasan, 2011: 56). In fact, the adjudication of the dispute by an English court guarantees turning the murabaha agreements into loans charging interest. Beximco interpreted the contract in light of the commercial goals that it served to accomplish, as English law requires (Colon 2011:426) and in line with the common law, interpretational approach as explained by Asutay and Hasan. This strict approach decimated the Islamic finance transaction (2011:431).
TID raised the defence of ultra vires (Asutay and Hasan, 2011: 57). TID argued that the wakalah agreement, which was approved by its own Shari’a board, did not comply with the Shari’a and was therefore void and against TID’s constitutional documents (Asutay and Hasan, 2011: 57 and ISRA 2012:758). Although within the wakalah arrangement some issues of Shari’a non-compliance arose, since the contract was approved by the TID Shari’a Board and constituted a binding contract in both common and Islamic law with valid offer and acceptance. Thus, TID should have been held to the terms of the contract.
In terms of Islamic law, the Hanafis stipulated a valid offer and acceptance as the cornerstones of the agency contract. While the Hanafis restricted the contracts cornerstones to offer and acceptance or actions implying acceptance, the other jurists enumerated four cornerstones: (i) principal, (ii) agent, (iii) object of the agency contract, and (iv) the contract language (Zuhayli 2007: 632). If the compensation is a ji’alah, whereby the task and the time period are not explicitly stated in the contract, then the majority of jurists agree that the contract is non-binding on the parties. However, the Malikis ruled that the contract was, in this case, binding on the principal once the agent begins working. If the compensation renders the contract an ijarah, then the Hanafis and most Malikis ruled that the agency contract is thus binding. In contrast, the Shafis and Hanbalis ruled that the contract was still not binding in this case (Zuhayli 2007: 683). In this instance, according to the Hanafis, the contract had valid offer and acceptance with principal and an agent consenting to the terms of the contract and initiating investment activity in the form of a wakalah. In addition, the wakalah contract appears to be an ijarah and thus valid and binding according to the Hanafis and Malikis. According to the AAOIFI Shari’a standard No. 23 (4/3) and as occurred in this case, ‘when agency is paid, involves the rights of others, when the agent commences tasks that cannot be discontinued or phased out without causing injury to him or to the principal, and or when the principal or the agent undertakes not to revoke the contract within a certain period, it falls under the Shari’a rulings on Ijarah and is binding’ (2004:416). The judge ignored the valid and binding contract and the original contractual intent of the parties, applied western trust law to the wakalah arrangement, and unjustly ruled that TID was only liable to pay Blom the principle amount.
In the concerned wakalah arrangement, at the end of every wakalah period, TID was obligated to pay 5% profit to Blom. The issue arose when TID defaulted on payments of Blom’s principal and the agreed profits. Blom claimed that TID should pay it the principal deposit plus the contractually agreed 5% profit. However, TID argued that the agreement was not Shari’a- compliant, being an agreement for deposit taking with interest, and therefore null, being ultra vires and beyond its legal capacity to conform. The Judge concurred and stated, ‘I agree…that where one finds, as one does in this master wakalah contract, a device to enable …the payment of interest under another guise, that is at least an indirect practice of a non-Shari’a compliant activity.’ Due to the constraints faced by the Islamic banking industry in terms of risk management, the reality of operating in a conventional system, and the need to compete, it is difficult to adhere to true Shari’a banking at this moment in time. It may be argued that in fact all Islamic banking products are devices to enable the payment of interest in another guise.
According to the AAOIFI Shari’a Standard No. 5(2/2/2) on Guarantees, ‘it is not permissible to combine agency and personal guarantees in one contract at the same time (i.e. the same party acting as agent on the one hand and acting as guarantor on the other hand), because such a combination conflicts with the nature of these contracts. In addition, a guarantee given by a party acting as an agent in respect of an investment, turns the transaction into an interest-based loan since the capital of the investment is guaranteed in addition to the proceeds of the investment (i.e. as though the investment agent had taken a loan and repaid it with an additional sum, which is tantamount to riba).’ In this case, TID, as agent, also guaranteed Blom a 5% return. However, even if the wakalah agreement in question really was a loan with interest in disguise or a similar contraption, due to the fact that this agreement was approved by the TID Shari’a board, TID should be held to the terms of the contract. TID should not be allowed to suddenly claim that the transaction is non-Shari’a compliant in order to evade its contractual obligations to Blom Bank.
Jurists agree that an agent’s possession is one of trust, analogous to deposits and similar to possessions (Zuhayli 2007: 675). This ruling follows from the fact that the agent would possess goods as a legal representative of the principal (who is the owner). Thus, his possession is similar (but not the same) to that of a depository, following its rules for trust and guarantee (Zuhayli 2007: 675). Under Shari’a, TID was holding the 5% profit on trust for Blom as agent for principal even if the guarantee combined with agency is thought by some to have turned the wakalah into a deposit-taking with interest or to have simulated an interest-bearing loan.
Although under Shari’a, TID was technically only supposed to receive an agency fee, in this wakalah arrangement, TID was contractually to receive an agency fee plus all return above 5%, thus bearing risk of loss. In a proper wakalah arrangement, the principal bears all risk of loss and profit, while the agent only receives an agency fee. According to the AAOIFI Shari’a Standard No. 21(4/2/c), ‘…the amount payable as remuneration for agency should be known, whether in lump sum or as a share of a specific amount of income. It may also be defined in terms of an amount of income to be known in the future, as when remuneration is linked to an indicator that may be quoted at the beginnings of different intervals of time. However, it is not permissible to leave remuneration for agency undetermined and allow the agent to take an unspecified share from the entitlements of principal’ (2004: 415). In this arrangement, the agent was to take an unspecified share from the entitlements of the principal, being any amount of return above 5%. These Shari’a issues were totally ignored by the judge. In this transaction, the judge misapplied Shari’a law, ignored the reality of the Islamic finance and banking industry, and then judged the contracts in relation to Western trust law, unfairly ruling that Blom was only entitled to the principal amount.
The judge ordered an interim payment to be paid to Blom based on the fact that the contract was null and void (no trust) and that the transaction was ultra vires (non-Shari’a compliant). The judge should have ruled that Blom was entitled to the deposit amount plus any profit made up to a limit of 5% (if profit was made) rather than just the deposit amount. TID ultimately withdrew the case (Asutay and Hasan, 2011: 57).
BANK ISLAM MALAYSIA BERHARD
In Bank Islam Malaysia Bhd v Azhar Osman & Other Cases [2010] 5 CLJ 54 [2010] 1 LNS 251, the court ruled that in relation to ibra or rebate for an early settlement of a financing facility, the court may infer an implied term from evidence and from commercial business practice that the parties to a contract intended to include the rebate in the contract (ISRA 2012:752). The term ibra literally means removal and acquittal from something. In Islamic jurisprudence, the term refers to one party dropping another’s liability towards him (i.e. dropping the debtor’s liability for a debt) (Zuhayli 2007: 237). Zuhayli (2007:237) states that most jurists agree that absolution of debts is legally recommended. Zuhayli explains that this was the stated opinion of Al-Khatib Al- Shirbini, who said that the rulings for absolution were much laxer than those for guarantee because of the charitable nature of the former, as evidenced by the dropping of the creditor’s right. The charitable nature of the contract is manifest regardless of whether or not the debtor is in a financial bind, as the verse states, ‘If the debtor is in a difficulty, grant him time till it is easy for him to repay. But if you remit it by way of charity, that is best for you if you only knew’ [Qu’ran 2:280] (Zuhayli 2007: 238).
“The legal documentation used by Islamic banks should have addressed the peculiarity of the Islamic banking transaction, instead of adopting a cut and paste approach of the conventional banking documents. Therefore, not only is it necessary to have standardized dispute resolution contracts, but all Islamic finance contracts should be issued in a standardized format by the International Islamic Financial Market or IIFM.”
Bai Bithaman Ajil (“BBA”) is an agreement whereby a bank buys an asset or property and sells the said asset or property to a customer at an agreed-defined price, which the customer has to pay on a deferred basis or by periodic instalments. The sale will include a profit margin (Thani, Abdullah, Hasan 2003:38).
The common perception is that this is simply a straightforward charging of interest disguised as a sale. However, nothing in Islamic law dictates how the price for such a sale is determined: it is simply determined by what the parties have agreed upon. Therefore, nothing prevents the seller from linking the sale price to the period of time for which credit is extended (Thani, Abdullah, Hasan 2003:39).
It was unsuccessfully contended on behalf of the plaintiff that in a BBA contract, the bank had a legal right to claim for the full sale price as stipulated in the property sale agreement (“PSA”), regardless of a premature termination. Counsel for the plaintiff argued firstly that the defendant had agreed to the amount of sale price and was under a legal obligation to pay the full sale price. This argument was premised on the underlying presumption that a BBA contract is a sale transaction and not a loan transaction. Counsel for the plaintiff argued that since it is a sale agreement, the sale price does not change. Secondly, the plaintiff argued that the court was bound by the decision of the Court of Appeal in Lim Kok Hoe, which upheld and acknowledged the obligation to pay the full sale price under the PSA.
The judge disagreed that the court was bound by the decision in Lim Kok Hoe. The judge explained, ‘Whilst it is true that the Court of Appeal in Lim Kok Hoe held that a BBA contract differs in a way differs from conventional banking because it is a sale transaction, it cannot, however, be regarded as a sale transaction simpliciter.’ The judge elaborated ‘the BBA contract is secured by a charge and concession as ibra is given as a matter of practice to all premature terminations.’ The judge stated, ‘Further, it is not a simple sale because even if the bank does not make payment of the full purchase price under BBA, the bank would still be entitled to claim the amount already paid.’ The judge said, ‘Whereas in a simple sale if the first leg of the transaction fails, the bank’s right to the amount paid will not ipso facto accrue since the sale was never completed.’ The judge questioned, ‘Why a bank should insist on payment of the full sale price and thereafter as a matter of practice grant a rebate to the customer simply to show that it is a sale transaction may have its purpose, but to place the customer in such a precarious position is quite something else, particularly when such grant is at the bank’s absolute discretion.’ The judge asserted, ‘From the practice of the bank it is clear that the insistence on enforcing payment of the full sale price appears to be merely an attempt to adhere to written text, but I doubt if such appearance achieve its purpose.’ The judge based her reasoning on commercial business practice and explained, ‘This is because, despite the written term of the agreement, the bank, in reality, does not enforce payment of the full sale price upon a premature termination. It always grants rebate or ibrar based on ‘unearned profit.”’
The judge further stated that granting an order for the full sale price in order for sale application would defeat the requirements of s.
266(1) of the NLC, which is designed to protect the charger, whose property is about to be sold at an auction (ISRA 2012: 752). The judge ruled that, “The bank should not be allowed to enrich itself with an amount, which is not due while at the same time taking cognizance of the customer’s right to redeem his property.” Therefore, where the BBA contract is silent on the issue of rebate or the quantum of the rebate, by implied term, commercial business practice, and compliance with Malaysian law, the judge held that “the bank must grant a rebate and such rebate shall be the amount of unearned profit as practiced by Islamic banks.”
The judge pointed out in this case, “The legal documentation used by Islamic banks should have addressed the peculiarity of the Islamic banking transaction, instead of adopting a cut and paste approach of the conventional banking documents” as this would have made her job of Islamic finance dispute adjudication easier. Therefore, not only is it necessary to have standardized dispute resolution contracts, but all Islamic finance contracts should be issued in a standardized format by the International Islamic Financial Market or (“IIFM”).
THE THREE CASES ANALYZED
The three cases assessed including Beximco, Blom Bank, and Bank Islam Malaysia Berhard reveal the detrimental effects of using English or common law and litigation to adjudicate Islamic finance disputes and the advantages of applying Shari’a and commercial business practices. Beximco illustrates how selecting English law as the governing law for an Islamic finance contract may invalidate the application of Shari’a to the dispute as Shari’a is not recognized as a valid source of law for governing commercial transactions in the UK and is not seen as a national law in relation to Rome I. Blom Bank reveals how the misapplication of Shari’a by a UK judge may be detrimental to the effective adjudication of the Islamic finance dispute. Bank Islam Malaysia Berhard reveals the benefits of applying Shari’a and commercial business practice to the dispute resolution process in order to properly adjudicate an Islamic finance transaction.
