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Treatment of Islamic Financial Transactions in Dispute Resolution:

Legal Certainty vs. Adherence to Shari’a Principles

I. Introduction

Islamic finance, as the name implies, is financial intermediation accomplished in a


manner that is firmly rooted in Shari’a principles1. However, it appears that the role of
Shari’a principles in Islamic Financial Transactions [“IFT”] is often diminished
during the dispute resolution process, especially if the dispute is brought within the
ambit of Civil Courts, because Civil Courts represent a non-Islamic legal
environment2 that is not bound by Shari’a principles. This inflexibility in the Court’s
approach to the application of Shari’a principles undermines the sanctity of IFTs and
is often contrary to the intentions of the contracting parties who entered the IFT on the
understanding that it would remain Shari’a-compliant throughout its lifespan.

This poses a challenge for the continued growth of the Islamic finance industry
because a precondition to sustainable development in any financial industry is the
provision of an effective regulatory framework3, including an avenue for legal redress
for IFTs that balances legal certainty and an adherence to Shari’a principles.

Thus, this paper will first examine the current approach of Civil Courts in its
treatment of IFTs which emphasizes doctrinal certainty. This paper will then evaluate
possible solutions to cure the imbalance between legal certainty and the adherence to
Shari’a principles in resolving IFT disputes.

II. Current Approach of Civil Courts

In financial transactions in particular, contractual certainty is a paramount


consideration that is highly prized by contractual counterparties and lawyers alike as
it promotes investor confidence and predictability of outcome. However, it is
1
Nadar, Aisha. “Islamic Finance : Potential Implications for Dispute Resolution” (2009) Arbitration, Vol. 75,
issue 3, p. 296-308.
2
Kilian Balz , “A Murābaḥa Transaction in an English Court: The London High Court of 13th February 2002
Islamic Investment Company of the Gulf (Bahamas) Ltd. v. Symphony Gems N.V. & Ors” Kilian Balz (2004)
Vol. 11, No. 1 pp. 117-134
3
Dahlia El-Hawary, Wafik Grais and Zamir Iqbal, “Regulating Islamic Financial Institutions: The Nature of the
Regulated”, (March 2004) World Bank Policy Research Working Paper 3227
submitted that the current approach of Civil Courts in dealing with IFT disputes
seems to stress legal certainty and the doctrine of freedom of contract, whilst
dismissing Shari’a principles because the lack of recognized Shari’a law is deemed to
add doctrinal ambiguity to proceedings.

A. Application of Syariah Principles

In the seminal case of Beximco4, Potter LJ expressed the importance of maintaining


certainty in English law because it is a law “adopted internationally as the governing
law for banking and commercial contracts”5, thus it is “not open to doubt or
disputation on the basis of religious or philosophical principle”6. In adjudicating over
the disputed validity of a Murabaha agreement, that included a governing clause
stating that “Subject to the principles of the Glorious Shari’a, this agreement shall be
governed by and construed in accordance with the laws of England7", the Court held
that the defendant’s obligations under the IFT were to be decided according to
English law.

The Court declined to apply Shari’a law as it would add “doubt or disputation” to the
proceedings for various reasons. Firstly, the Court was bound by the Rome
Convention on the Law Applicable to Contractual Obligations8, which makes it clear
that there is no provision for the application of a non-national system of law such as
Shari’a law9.

Secondly, Potter LJ agreed with the lower Courts that the words in the governing law
clause simply reflected the religious principles by which the bank held itself out as
doing business, and were not contractual terms for which either party could rely on to
“trump”10 the application of English law.

Additionally, Potter LJ, also rejected the application of any Shari’a principles because

4
Shamil Bank of Bahrain EC v Beximco Pharmaceuticals Ltd and others [2004] EWCA Civ 19 [“Beximco”]
5
ibid at [54]
6
ibid
7
Supra, Note 3 at [1]
8
which by section 2(1) of the Contracts (Applicable Law) Act 1990, has the force of law in the United Kingdom
9
Rome Convention on the Law Applicable to Contractual Obligations, Art 3(1) read with Art 1(1)
10
Supra, note 4
doctrinal unsoundness would be introduced if Civil Court judges had to determine the
“true”11 principles Shari’a and the “strictness in which such principles should be
interpreted and applied12”. This is because most of the classical Islamic law on
financial transactions is not contained as "rules" in the Qur'an and Sunnah but is based
on the divergent views of historically established mazzhabs. Thus Shari’a law does
not refer to a defined body of laws, but to a vague broad expression13.

In conclusion, Beximco is authority that a Civil Court was not suited to ascertain and
determine highly controversial principles of a religious based law”14. The general tone
of Beximco showed that courts prefer to leave the issue of Shari’a-compliance to
banks to monitor according to their “own perception of Islamic principles of law in an
international banking context through their Sharia Commitees.15”

Judging from subsequent cases16 that applied the holding in Beximco, any attempt to
compel Civil Courts to apply generalized and unqualified Shari’a principles in
governing law clauses is foreclosed. This puts litigants, who choose to enter into IFT
based on the assurance that they were Shari’a-compliant, in a vulnerable position
because if a dispute arises, Courts will neither determine nor apply the principles of
Shari’a.

B. Freedom of Contract

Since Civil Courts decline to apply shari’a principles, most IFT disputes are resolved
by Civil Courts using Common Law freedom of contract. This is unsatisfactory
because it does not uphold the contractual sanctity of Shari’a contracts, as initially
perceived by contractual parties.

11
[2003] 2 All ER (Comm) 849 at [37]
12
ibid
13
ibid
14
supra, note 3 at [40]
15
supra note 3, at [41]
16
Musawi v RE International (UK) Ltd [2007] EWHC 2981 (Ch); [2008] 1 All E.R. (Comm) 607, Halpern v
Halpern [2007] EWCA Civ 291
Islamic contract law has a set of mandatory rules that must be observed for the
transaction to be acceptable in Shari’a, such as the proscriptions on gharar, riba or
trading in prohibited items like alcohol. Therefore, in Islamic law, there exist certain
mandates that serve to constrain parties’ freedom of contract. Thus, Islamic contract
law is to some extent incompatible with the Common Law contract law, with its
emphasis on the doctrine of freedom of contract, whereby Courts promote contractual
certainty by honoring virtually any genuine commercial agreement having lawful
purposes.

This is evinced by the Court’s approach Symphony Gems17, which was about the
disputed validity of a Murabaha agreement. While Tomlinson J agreed with expert
evidence that the contract did not “have the essential characteristics of a Murabaha
contract”, he went on to state that this was irrelevant as he would “simply construe it
according to its terms as an English law contract” in accordance with prevalent
commercial practice, barring the need to make a finding regarding the validity of the
murabaha agreement according to Shari’a-principles. This was contradictory to the
intentions of both parties who stated explicitly in the recitals of their agreement that
they wish to deal with each other “in accordance with the Islamic Shari’a”.

Thus, applying this approach, Civil Courts will still uphold IFT that have significantly
contravened the mandatory rules of Shari’a as long as it is deemed to be a genuine
commercial agreement having lawful purposes, allowing parties to evade Islamic law.
This tendency to bring IFTs within the established commercial contractual framework
of freedom of contract, rather than treating them differently from other commercial
financial agreements, is detrimental in upholding the sanctity of IFTs that must
remain shari’a- compliant.

III. Solutions

17
Islamic Investment Company of the Gulf(Bahamas) Ltd v. Symphony Gems N.V. & Ors [2001] Folio 1226
[“Symphony Gems”]
Due to inflexibility of Civil Courts in applying Shari’a principles, a solution must be
found for parties to find legal redress that upholds the shari’a-sanctity of IFTs without
compromising legal certainty.

A. Incorporation

Given that Courts apply the doctrine of Common Law freedom of contract, the most
practical solution is to incorporate the specific “black letter” Shari’a principles by
way of express terms in contracts to solve the problem of the definability of Shari’a
for the Civil Courts. The effectiveness of this solution was alluded to by Potter LJ in
Beximco, where he stated that “ [I]f the Shari’a law proviso were sufficient to
incorporate the principles of Shari’a law into the parties' agreement, the defendants
would have been likely to succeed18.” The extent to which this is possible, however,
requires further judicial clarification. It appears that a proviso to incorporation is that
there must be sufficient certainty and clarity19 of the provisions, which may prove to
be onerous on lawyers since the current state in which divergent opinions of Islamic
law is documented does not facilitate the doctrine of incorporation.

Moreover, it may be repugnant to the strict adherence of some parties to Islamic


principles, as it seeks to reduce the large and divergent body of Islamic
jurisprudence20 to a mere set of forms or standards of practice, negating centuries of
the application of the doctrine of Ikhtilaf21. Additionally, since most banks arguably
tend to avoid the assumption of commercial risks under the financing agreement,
rather than aiming at a true reconstruction of traditional Islamic legal principles, it is
questionable whether financial institutions are likely to incorporate neutral Shari’a
principles into contracts if doing so would undermine their risk-management

18
supra note 3, at
19
Richard Bamforth, “International Arbitration news: Can parties choose a religious or other non-national law to
govern>their contract?”, (17 March 2008), online: Olswang <http://www.olswang.com/newsarticle.asp?
sid=858&aid=715&de=&mid=?>
20
Nima Mersadi Tabari “Islamic finance and the modern world: the legal principles governing Islamic finance in
international trade” (2010) The UEA Law School Working Paper

21
ibid
objectives.

B. Expert Determination

Because Civil Court judges clearly lack the expertise to understand the intricacies and
uncertainties of Islamic finance, it has been suggested that there is a need to
complement civil proceedings with expert determination22.

This is the approach taken in Malaysia23, where the Central Bank of Malaysia Act
2009 (CBMA) was gazetted just months after a landmark Court of Appeal case24
overturned a High Court judgment25 declaring the Bai Bithaman-Ajil contract
contradictory to principles of Shari’a because it not acceptable to all of the recognized
mazhabs26. Consequently, the 3-bench Court of Appeal criticized the lower Court for
taking upon themselves to declare whether a IFT is Shari’a-compliant because “a
Civil Court judge may not be sufficiently equipped to deal with matters which need
consideration by jurists who are properly qualified in the field of Islamic
jurisprudence”27

The CBMA was thus enacted to remedy the inadequacy of Civil Courts in applying
Shari’a laws. Section 56 of the CBMA makes it mandatory for any Court or arbitrator
to take into consideration any published rulings of the Shari’a Advisory Councilor
(SAC) to refer to the SAC for its ruling where any question concerning a Shari’a
matter arises in any proceedings relating to Islamic financial business which shall be
binding . The legislative effect of such provisions was indubitably to ensure the

22
Mohd Illiyias Syed Ibrahim “Islamic dispute resolution: the need to complement litigation with expert
determination”, online: Asia Legal Business Online < http://asia.legalbusinessonline.com/law-firms/islamic-
finance-dispute-resolution-the-need-to-complement-litigation-with-expert-determination/898/25248>

23
In Malaysia, Civil Courts have jurisidiction over Islamic finance cases, andnot Syariah Courts. This is due to
the fact that the Civil Courts’ jurisdiction laid down in List 1 (Federal List), of the 9th Schedule of Federal
Constitution includes civil, criminal procedures, contracts, lex mercatoria (inclusive
of banking and financial laws), arbitration, the administration of justice, etc.
24
Bank Islam Malaysia Bhd v Lim Kok Hoe Unreported March 31, 2009 (CA (Mal))
25
Arab-Malaysian Finance Bhd v Taman Ihsan Jaya Sdn Bhd [2008] 5 M.L.J. 631 HC.
26
Siti Faridah Abdul Jabbar, “Adjudication of disputes relating to Islamic financial contracts in non-Shari'a
Courts: BIMB v Lim Kok Hoe”. (2010) 31 (3) Company Lawyer 94-96
27
Citing with approval the decision of Suriyadi J. (as he then was) in Arab-Malaysian Merchant Bank Bhd
compulsory and correct adherence of Shari’a principle in IFT disputes.

However, whilst this approach guarantees shari’a-adherence, it creates other problems


which undoubtedly affects its practicality of application in Malaysia and also its
transferability to other jurisdictions

Firstly, compulsory reference to the SAC may be construed as an abdication of the


Court’s judicial functions. The current amendment has recognized the level of the
SAC to be at parity with that of a civil judge28 because not only is the appointment
process substantially the same29, the SAC is now seen as the sole arbiter in all IFT
disputes because Civil Court judges and arbitrators are forced to refer and adhere to
decisions made by them. It remains doubtful whether such a system can be adopted in
other civil jurisdictions because it can be seen as allowing the legislature to usurp the
powers of the judiciary, since the court must abdicate its role by submitting to
decisions of lesser bodies or tribunals such as SACs.

Secondly, there is still a need to harmonize the processes of any SAC rulings across
the globe30. It is uncertain whether the Court is obliged to follow any rulings made by
any SAC in cases which involves international litigants. The international bank or
local bank may adopt certain rulings which may be contrary to the practice in the
Court’s jurisdiction. It would be difficult to ascertain which ruling the Court should
follow if SAC rulings differ in different jurisdictions. Therefore the absence of
standardisation of a framework to assist the market and Courts may lead to
uncertainty in any Court-sanctioned SAC scheme, which may result in Courts
reverting to the norms of international trade which disregard Shari’ah principles and
values31, defeating the purpose of domestic legislation..

28
Hakimah Yacob, “The New Central Bank of Malaysia Act 2009 (Act 701): Enhancing the Integrity and Role of
the Syariah Advisory Council (SAC) in Islamic Finance”, International Shari’ah Research Academy for Islamic
Finance (ISRA) Research Paper (no:6/2010) at 11
29
Refer to Article 122B of the Federal Constitution: “The Chief Justice of the Federal Court, the President
of the Court of Appeal and the Chief Judges of the High Court…shall be appointed by the Yang Di
Pertuan Agong, acting on the advice of the Prime Minister, after consulting the Conference of Rulers.” And
section 53(1) of the Central Bank of Malaysia Act 2009 which states that the Yang di-Pertuan Agong may, on the
advice of the Minister, after consultation with the Bank, appoint as members of the Shari’ah Advisory Council
persons who are qualified in the Shari’a or who have knowledge or experience in the Shari’a and in banking,
finance, law or such other related disciplines.

30
ibid
31
Supra Note 40 at 26
C. Arbitration

Given the proven inadequacies of the Civil Courts, which craves stability and abhors
uncertainty, in adjudication over IFT disputes, it is submitted that the best solution is
to bring dispute resolution out of the ambit of Civil Courts altogether using
arbitration.

The fundamental features of arbitration as a practice are fourfold: an alternative to


Civil Court; final and binding determination of parties' rights and obligations; a
private mechanism for dispute resolution; selected and controlled by the parties32.

That such inherent features of arbitration make it a more efficacious method to


further, rather than defeat, the commercial purpose of IFTs is evinced by juxtaposing
the outcomes reached by the English Court in Beximco with the different result
reached in the factually-similar arbitration case of Sanghi33 34.

In Sanghi, there was a choice of law clause that provided for any dispute to be
“governed by the Laws of England except to the extent it may conflict with Islamic
Shari'a, which shall prevail.35” The decision of the arbitrator, a lawyer cum expert in
Islamic law, gave effect to the parties' will to be governed by English law36, except
where this would conflict with Shari’a, by awarding principal and the profit claims,
but disallowing additional damages claims because, although compliant with English
law, these would conflict with Shari’a principles37.
32
Julian Lew, Loukas Mistelis and Stefan Kroll, Comparative International Commercial Arbitration (The
Netherlands: Kluwer Law International, 2003), p.9.

33
Sanghi Polyesters (India [2000] 1 Lloyd's Rep. 480 ; [2001] C.L.C. 748 [“Sanghi”]
34
Aisha Nadar, “Islamic Finance and Dispute Resolution: Part 1” (2009) Arab Law Quarterly 23 2009 1-29

35
ibid at 750.
36
Similar outcome in Musawi v R E International (UK) Ltd & Others [2007] EWHC 2981, where the Court
acknowledged the fact that s. 46(1)(b) of the 1996 Act entitled the parties to the arbitration to require the ayatollah
arbitrator to apply Shari’a law to the resolution of their dispute
37
Supra, note 25
Legal certainty in arbitration is ensured because most arbitration agreements provide
for recognized arbitration rules like KLRCA38 which specify the framework for
arbitration processes and procedures. KLRCA’s Rules for Islamic Banking Services
Arbitration closely mirror UNCITRAL39 Arbitration rules, with certain modifications
made only to meet the unique needs of Islamic finance where the dispute arises from
the Shari’a aspects of the transaction.

Some critics have stated that that arbitration still requires mutual acceptance of the
scope and strictness of the Shari’a principles to be applied40. However, given that
arbitration is premised on the freewill of the parties, the proper selection of arbitrators
or members of the arbitration tribunal will solve this problem. It is the arbitrator who
will both adjudicate and provide expert determination in the application of the
appropriate Shari’a principles when ascertaining whether IFT is legally valid, as
evinced by the arbitrator’s role in Sanghi.

Other critics have stated that awards handed down by arbitrators are enforced through
the Civil Courts, which may give rise to enforcement problems in cross-border
disputes if those awards are incompatible with domestic civil law principles.
However, this is unlikely, since signatories of Arbitration Conventions are bound to
honor arbitration awards, but for a few exceptions, such as by proving that it is
contrary to public policy41.

Thus, it seems that the inherent features of arbitration provide for more flexibility in
the application of Shari’a principles, rendering decision that are in line with the
intentions of parties and ensuring the sanctity of IFTs is upheld. Additionally, legal
certainty is not compromised because expert arbitrators are able to ensure correct
application of civil and shari’a laws in tandem, without compromising either.

38
“Kuala Lumpur Regional Center for Arbitration “
39
The United Nations Commission on International Trade Law
40
Mohamed Ismail Mohamed Shariff “Specific issues in Islamic dispute resolution”, (May 2009) Arbitration,
Vol. 75, Number 2
41
Article V 2(b) of the New York Convention provides for an exception allowing contracting States to refuse to
recognise an award where it would be contrary to the public policy
IV. Conclusion

It is submitted that the arguments are equally valid on both sides: they revolve around
the concerns about legal certainty on the one hand and the desire not to compromise
the essential compliance of the contract with the Shari'ah on the other.

However, it seems that progress in Civil Courts has proven difficult to advance
without consensus and consistency of opinion amongst the Shari’a authorities. In
fact, the best way to attain a balance between both competing considerations currently
seems to be to resolve IFT disputes privately via arbitration. However, perhaps in the
(probably distant) future, the emergence of globally recognized principles of Shari’a
would be easier for disputes to be resolved with objective legal clarity in Civil Courts.

(2496 words)

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