Islamic Finance, English Law and UK Courts

Can UK Law govern Islamic contracts? Typically, the vast majority of internationally traded contracts are drafted so as to say that English Law applies. But how can English Law apply and Shariah Law apply at once?

This is not particularly new, but many in the Islamic Finance Community are not aware of the implications. In Shamil Bank of Bahrin v Beximco Pharma and Others, the defendants argued that the financing agreements in a Murabaha contract were governed by English Law but only if they were consistent with the principles of Shariah. Moreover, the contract was so worded to provide that it was 'subject to the principles of the Glorious Sharia'a'.

But the court cited standard practices (Rome Convention on the Law Applicable to Contractual Obligations 1980), there could be no two separate systems of law governing a contract. Consequently, the judge held that even if the plaintiff (Shamil Bank) acted in contradiction of the Shariah and this may have contributed to the defendants subsequent default, it was no matter for English courts to decide and that they must decide only in accordance with English Law. (See Shari'a Compliance and the Shamil Bank Litigation for more details).

In a separate case with relatively similar circumstances, Islamic Investment Company of the Gulf (Bahamas) Ltd. V. Symphony Gems N.V. & Others (see Killian Balz, reference below), the defendants argued that the Islamic Bank did not adhere to the Shariah and that requisite deliveries of commodities which were required were not made, rendering the Murabaha agreement (or rather the 'markup' portion) entirely Ribawi. While the matters were the subject of serious deliberation (did failure to deliver the goods amount to a genuine contractual default? Was it truly a contract of 'sale' under English Law or was it a financing scheme? These and more subtleties are discussed in Balz's paper).

Again the English court decided in favour of the bank, claiming no expertise to decide matters of Shariah. In both cases, contravention of Shariah was considered insufficient evidence to decided in favour of defendants or was deemed undecidable by English courts. The courts decided that English Law Only applied. And, in both cases, defendents, presumably expecting to act in an Islamically legitimated manner (i.e., why did they even bother entering into these more expensive and burdnsome financing arrangements unless it actually meant something to them from a moral point of view), were compelled by the courts to act in a very non-Islamic fashion.


Mahmoud El Gamal, in his essay, the Incoherence of Contract-Based Islamic Financial Jurisprudence in the Age of Financial Engineering argues that this points to (one of the many) failings of the use of Contract Law alone as a means of enforcement and regulation of Islamic Finance. He also cites the many cases of Islamic banks who point to similarities between Islamic and conventional contracts as a reason for their seeking quick approval from regulatory authorities. How can a murabaha be merely a financing arrangement just like an interest-bearing loan in the eyes of the regulator, and yet this same arrangement is expected to be treated as trade, not riba, by the courts? In order to prevent hiyal/ruses, in order to prevent this sort of forcing "shariah compliant" into conventional pigeon holes, we should seek the establishment of strong bodies of regulation and the empowerment of appropriate regulatory institutions.

(This is not to say that Islamic countries are not without their idiosyncracies, as we saw recently with the Malaysian High Court decision declaring BBA non-compliant and the subsequent 31 March 2009 Appeals Court reversal in the case of Affin Bank Bhd vs Zulfikli Abdullah and Others.)

Although El Gamal is correct in thinking that contract-based Islamic Finance does have the (very high) likelihood of being incoherent, there are possible solutions to this, and it may be plausible if not somewhat onerous, through contract. For instance, it could be spelled out that if the bank does not take ownership for the underlying commodity, asking the client to be their agent that the bank (not complying with Shariah) is in default. While this is clearly not a mere sale, being a sale and an agency arrangement, and trade finance, etc, it can be impressed on the courts through appropriate wording (i.e., to give it a look and feel quite different from an interest-bearing loan) that any lack of adherence to the detail of the contact is truly a default. Again, all eventualities must be entirely spelled out to make it "more" likely to adhere.

Certainly the most appropriate way forward is to have a governing body of regulation such as is the case in Malaysia or Bahrain, so that all eventualities are covered by legislation and courts are compelled to uphold the Law or to have some other means of dispute resolution (see for instance, Islamic finance dispute resolution : The need to complement litigation with expert determination or Islamic finance and the Square Mile where there is some discussion of the plausibility of Shariah-friendly arbitration under English Law).

Is this all timely? Not really. The only recent set of rulings were in the very Islamic jurisdiction of Malaysia, which ruled that BBA was not in fact a sale, later overturning it. It does go to show that even when there is a body of law specifically devoted to Islamic Finance, it is not without its glitches. But at the very least, unlike the cases decided by English Courts, it is likely that in an Islamic jurisidiction, consideration to the actual subtleties of Shariah will be given, and the overall coherence of Islamic Finance will be a subject of considerable discussion (see e.g., Dr Zeti Akhtar Akhtar Aziz: Legal & Shariah issues in the Islamic financial services industry )

References

Shamil Bank of Bahrain EC v Beximco Pharma Ltd and Others [2004] EWCA Civ 19. Court of Appeals [2004] All ER 1072

Bälz, Killian, A Murbaha Transaction in An English Court - The London High Court of 13th February 2002 in Islamic Investment Company of the Gulf (Bahamas) Ltd. V. Symphony Gems N.V. & Ors Islamic Law and Society, Volume 11, Number 1, 2004 , pp. 117-134(18), DOI: 10.1163/156851904772841435

Islamic Finance, English Law and UK Courts