Islamic banking disputes in English courts.... chapter 2 of my dissertation

salam,

below is the draft for my 2nd chapter. put it here in case sth happened to my Imac. at least, got a back up here. for some reasons, the blog did not include the referencing I have for each points. friendly warning, this is heavy reading. for those interested to know about how English courts will deal with Islamic banking disputes. will they apply Shariah law or otherwise. Happy reading!...

Chapter 2: Critical analysis on Islamic banking under English law

Introduction

The second chapter of the dissertation will focus on critical analysis of the Islamic banking transactions in the UK. The aim of this chapter is to examine the legal principles, which was established by English court based on their judgments on Islamic banking disputes. There have not been any reported local cases as the sector is still relatively new in the UK. However, the English courts have dealt with three international Islamic banking disputes where English law was chosen as the governing law. The three main cases are Islamic Investment Company of the Gulf (Bahamas) Ltd. v Symphony Gems NV & Ors, Shamil Bank of Bahrain v Beximco Pharmaceuticals Limited and Others and the recent case of Investment Dar Co KSCC v Blom Developments Bank Sal.

Islamic banking cases in the English courts

To start with, there are several reasons on why the Islamic banking contracts are often constructed with reference to the English law. This is because of international respect for English judges and their decisions and most importantly, the fact that the wide interpretation of the freedom of contract principle under English law will enable transactions to be structured according to Shariah principle. In fact, there is no requirement in Islam to designate Shariah law as the governing law of a financial contract. The contractual freedom is recognised as long as the contract adhere with Islamic rules and principles.

Besides, due to the presumed high degree of certainty that English law provides for commercial disputes, it is common for Islamic banks using English law as the governing law of their Islamic transactions agreements such as Murabaha, which will be illustrated by these two cases; Islamic Investment Company of the Gulf (Bahamas) Ltd. v Symphony Gems NV & Ors, Shamil Bank of Bahrain v Beximco Pharmaceuticals Limited and Others

Islamic Investment Company of the Gulf (Bahamas) Ltd. v Symphony Gems NV & Ors

In the first case, the Bahamas-based Islamic Investment Company entered a Murabaha (cost plus financing) agreement to supply valuable gems to Symphony Gems (SG) - the defendant company, which was incorporated in Belgium. Murabaha works through the bank buys the goods for the customer and re-sells them to the customer on a deferred basis, adding an agreed profit margin. The customer then pays the sale price for the goods over instalments, effectively obtaining credit without paying interest. The mark-up represents the bank's profit margin, but this is a reward for risk, not merely for providing finance, as the bank owns the goods until the resale occurs.

The issue in this case concerns with the amount of the balance due. Under the term of the contracts, both parties agreed that ‘this agreement and each purchase agreement shall be governed by, and shall be construed in accordance with, English law’ and ‘… the courts of England shall have exclusive jurisdiction to hear and determine any suit …’. In short, as stated on the terms of the contract, ‘the agreement and each purchase agreement made pursuant thereto shall be governed by and shall be construed in accordance with English law’. Having said that, the agreement also clearly stated that ‘the purchaser wishes to deal with the seller for the purpose of purchasing supplies under this agreement in accordance with the Islamic Shariah’.

As a result, the court was confronted on three issues namely to determine the affect of Murabaha agreement on the risk of a failure to deliver, the illegality of the transactions and the application of the ultra vires doctrine. Firstly, with regards to the application of the Murabaha agreement, the defendant argued that its payment default was due to an alleged delivery failure by the supplier. According to Murabaha principle, the seller must not get paid until the supplies have reached their destination (the defendant company SG). This will justify the bank’s margin of profits, as the failure to deliver will be borne by the bank.

However, the judge, Mr Justice Tomlinson viewed the agreement as a normal trade financing transaction where the risk of failure to deliver was borne by the purchaser. The judge’s view was supported by the term in the contract, which stated that the payment by the purchaser, SG, should take place ‘… in all cases notwithstanding any defect, deficiency or any loss or any other breach of any supply contract … by the supplier’. In addition, the clause 4.4 stated that ‘…such payment shall not be conditional upon the happening of any event …’. Thus, the decision was justified because ‘… it is a contract governed by English law…’ and ‘… must simply be construe it according to its term as an English law contract’. Conversely, if the court were to consider Islamic law in the court, under Murabaha principle, the term releasing the bank from its responsibility will not be accepted.

The second issue is based on the principles of illegality on the ground that the contract contradicted with the rules of Islamic law. However, based on the report from two experts, Dr. Yahya Al-Samaan and Dr. Martin Lau, the court was informed of the non-Islamic nature of the Murabaha agreement. Dr. Yahya for instance, after examining the nature and the terms of the contract, concluded that ‘… the agreement in issue does not have the essential characteristics of a Morabaha contract’. Nevertheless, despite this, the court will decline the illegality defence because the English law has been chosen to govern the agreement without any restrictions or limitation. In short, after considering illegality doctrine found in Sethia case - referring to English law, the court found that ‘the defendants do not have arguable defence of illegality’.

The final issue in this case is the claim of the ultra vires doctrine. The Murabaha agreement contained the condition that ‘…such payment shall not be conditional upon the happening of any event …’. In other word, the bank was guaranteed the payment regardless of any circumstances – which clearly contradicts with Shariah law principle that requires parties to share risk in order to gain profit. Moreover, the condition also conflicted with the claimant’s Memorandum of Association, which stated that ‘“to carry out in a manner which is consistent with Islamic laws, rules, principles and traditions…”

However, the Company Act of Bahamas, where the bank was established, protected the good faith of third parties from any limitations in the bank’s memorandum. In fact, the court concluded that having reviewed the documents provided and considered the applicable Bahamian law, found that ‘at the time the Morabaha Agreement was executed by the claimant, the company was no longer subject to the ultra vires doctrine… unless it can be proved that the claimant was aware that the contract was ultra vires its objects’. Furthermore, the English court has always been reluctant to apply the ultra vires doctrine because it has been considered as a ‘technical rule’ that could undermine the unique financial standing of London in international markets. The court also worried for the fact that parties, by abusing this doctrine, would use it to avoid their contractual responsibilities and could impact upon the interests of international commerce.

To summarise, although the agreement in this case stipulated that it was governed by English law subject to compliance with Shariah principles, the court clearly stated that only English law was capable of being the governing law of a contract. This is because the parties agreed to use the English law on the agreement subject to Shariah principles. However, the court would only determine the validity of the contract under the exclusive jurisdiction of English law and it was not for the court to determine the validity of the contract under Shariah principles. Arguably, even if the court were to consider the contract under the Shariah, the contract is still not voidable because of the non- Islamic nature of the Murabaha agreement. Thus, English law shall be chosen to govern the contract.

Shamil Bank of Bahrain v Beximco Pharmaceuticals Limited and Others

In the second case, the lender was the Shamil Bank of Bahrain (the Bank), which holds itself out as applying Islamic principles in the course of its banking business. In common with many Islamic banks, it has a Religious Supervisory Board comprising Shariah scholars, who specialise in Islamic jurisprudence. The Religious Supervisory Board reviews all of the Bank's investments and other business activities to determine whether or not these comply with Shariah.

Beximco Pharmaceuticals Ltd and the other borrowers (together the Borrowers) were Bangladeshi companies involved in the manufacture, export and import of pharmaceuticals to and from Bangladesh.

In 1995 the Bank agreed to provide the Borrowers with a working capital facility. So as not to offend against the prohibition under Shariah of the charging of interest (Riba) the financing took the form of Murabaha contracts under which interest was not payable but with the Bank utilising other techniques to extract profit.

Similar with the previous case, the dispute arises due to the default in payment by the defendants and after the occurrence of various termination events under the agreements, the Bank issued formal court proceedings and made an application to the Court for summary judgment. As part of the terms of the agreement, the parties decided that ‘jurisdiction over any legal action or proceedings arising out of or in connection with this agreement’ and the parties’ choice of law was stated in the following way:

"Subject to the principles of glorious Sharia'a, this agreement shall be governed by and construed in accordance with the laws of England."

In short, the parties had stated that in a choice of law clause that the English law would apply to their contract subject tot the principles of Shariah. As a result, the main issue in this case, is the difficulties imposed on the English court where it is instructed by the parties to consider Islamic law principles. The question before the Court raised by the Borrowers' defence was whether on a true construction of the governing law clause, the finance agreements were enforceable only if they were valid and enforceable both in accordance with the principles of Shariah and in accordance with English law.

The Borrowers' also argued that the effect of the governing law clause was to select English law as the governing law but at the same time stipulating as a condition precedent that the contract would be enforceable only if consistent with the principles of Shariah. While the Borrowers acknowledged that the application of Shariah gave rise to disputes between different jurists as to the content of Shariah itself, they argued that it was uncontroversial that Shariah prohibited interest being charged on loans. As a consequence these Murabaha agreements were invalid and unenforceable because they were in truth disguised loans charging at interest declare it void.

The courts ruled that the governing law could not be the Shariah because of two reasons. Firstly, even if Shariah law were to be considered in the contract, English law will still be chosen as a governing law because there could not be two separate systems of law governing the agreements. Then, the parties themselves had not chosen the Shariah law as the governing law because it was not the law of a country and there was no provision for the application of a non-national system of law. Furthermore, the wording of Article 5 of the Rome Convention impliedly exclude the choice of law other than the law of state, which in this case, Shariah law seems to be understood as a set of general rules and principles, will definitely be excluded by the Convention from being the governing law.

In addition, Mr Justice Morrison stated that:

‘… It cannot have been the intention of the parties that it would ask this secular court to determine principles of law derived from religious writings on matters of great controversy...’

Thus, in order for the court to decide a Shariah law issue in this case, it needs to have ‘its own view of the position under the Sharia’a law’. However, the task will be difficult, if not impossible, for a secular court that lacks of required knowledge to apply Islamic law, as Lord Justice Potter observed in his significant speech in the decision of the Court of Appeal in the case, ‘most of the classical Islamic law on financial transactions is not contained as “rules” or “law” in the Qur’an and Sunnah but is based on the often divergent views held by established schools of law formed in a period roughly between 700 and 850 CE’. As a result, many of the commercial issues are still quite debatable as it is made up of ‘conflicting pronouncements’.

To sum up, in both cases, the results would have been totally different if the court had considered Shariah law principles in both agreements. The latter case shows that court can dismiss the Shariah law to govern the disputed contract due to the difficulty in applying Islamic law by a secular court. Having said that, although the court chose not to recognise the Shariah as an independent body of law capable of governing the relationships between parties, there are few important concessions such as the court recognised that Shariah principles may be relevant to the intentions of parties when entering the contract and the court may have regards to expert evidence from Shariah scholars for advices regarding commercial disputes involving Shariah principles.

Investment Dar Co KSCC v Blom Developments Bank Sal

In the last case, a Lebanese bank, Blom Developments Bank SAL (Blom), provided The Investment Dar Company KSCC (TID) (a Kuwaiti company) with funding totaling approximately US$10million (the Principal Amount) through a wakala (or agency) based deposit / investment structure. The wakala was structured as a 'master' arrangement under which Blom as muwakkil (or depositor) would, from time to time, deposit funds with TID as wakeel (or agent). TID instigated each of these investments through 'investment offers' (i.e. funding requests). TID was required to invest those funds in a pre-agreed manner, and any such investment was to be in accordance with Shari'a.

The intention behind this arrangement was that TID would ultimately return the Principal Amount along with an expected amount of profit based upon an anticipated profit rate for each investment transaction (the Expected Profit). The documentation was drafted so as to create – using a series of complicated contractual provisions – an unconditional obligation on TID to pay the Expected Profit and to return the Principal Amount when required, irrespective of the performance of the investments themselves. This was what Blom expected to receive, subject to non-performance by TID. Similar with the previous two cases, it is quite common for governing cross-border Islamic finance transactions by using English law. Then, TID failed to pay the Expected Profit and to return the Principal Amount at the end of the investment period, which resulted in Blom brought a summary judgment application in the English courts.

Blom’s application was based on two claims which are TID had acted in breach of the terms wakala arrangements and TID held Blom’s funds on trust for Blom. On the contrary, TID argued that is should not pay the Blom a fixed return on deposits invested with it insofar as its constitutional documents prevent it from engaging in forbidden activities and the wakala arrangements did not comply with the Shariah. Then, TID argued that they did not have the proper legal capacity at the outset to enter into the wakala (or agency) arrangements – and that such arrangements went beyond the corporate power and authority of TID and should therefore be considered ultra vires.

Ironically, the TID Shariah board had approved the transaction and even attempted to persuade an English judge that it did not do its job properly. Eventually, the court refused to try the case according to the Shariah as the contract expressly designated English law as the governing law of the contract.

Having said that, some commentators argue that this case can be distinguished from the Shamil bank litigation. In the former case, the Court refused to take into account Shariah principles on the basis that English law should determine on the issue of enforceability. In this case however, the Court expands their view by saying that the decision of the Court also rests upon an analysis of capacity and authority. Thus, they argued that it is necessary to consider the relevant Kuwaiti laws as they apply to TID and to consider underlying issue of Shariah compliance in order to determine whether TID had proper legal capacity.

Conclusion

In conclusion, with the UK positioning itself for the anticipated worldwide growth in Islamic finance, it is increasingly important to understand how secular English laws and regulations will be applied to Shariah-compliant products and services. These three cases illustrated how difficult it is for English courts to deal with disputes involving Islamic law principles due to several issues such as the sophisticated nature of Islamic law and the absence of any recognised body or agency that the court can consult in relation to Islamic finance principles. Arguably, the Court decision for sole reference on English law for governing the contracts involving Islamic commercial disputes is ‘pragmatic solution for now’. It is suggested that the contracts used by Islamic banks can be incorporated into the English law without the need for Islamic law to be part of English law. For instance, the FSA plans on Islamic mortgage requirements to be recognised under English law as Home Purchase Plans. Although the regulation has tried to cater all Islamic finance requirements, the Home Purchase Plan transaction is still part a part of conventional banking regulation, which means in case of disputes the English courts will be applying UK banking regulation, taking into account of Islamic finance conditions – rather than applying Islamic law itself.

Bibliography

Books:

M. Kabir Hassan and Mervyn K. Lewis, Islamic Finance (1st edn, Edward Elgar Publishing Limited, Glos, 2007)

Chris Skinner, The Future of Banking in Globalised World (1st edn, John Wiley & Sons Ltd, West Sussex, 2007)

Saiful Azhar Rosly, Critical Issues on Islamic Banking and Financial Markets (1st edn, AuthorHouse, Indiana, 2005)

Mike Buckel and John Thompson, The UK Financial System; theory and practice (3rd edn, Manchester University Press, Manchester, 2004)

Ibrahim Warde, Islamic Finance in the Global Economy (1st edn, Edinburgh University Press, Wiltshire, 2007)

Cases:

Islamic Investment Company of the Gulf (Bahamas) Ltd. v Symphony Gems NV & Ors (2002) WL 346969 (QBD (Comm Ct))

Shamil Bank of Bahrain v Beximco Pharmaceuticals Limited and Others (2003) EWHC 2118 (Comm)

Investment Dar Co KSCC v Blom Developments Bank Sal (2009) EWHC 3545 (Ch)

Journals:

Jonathan Ercanbrack, ‘The regulation of Islamic finance in the United Kingdom’ (2011) Ecclesiastical Law Journal 69

Nima Mersadi Tabari, ‘Islamic finance and the modern world: the legal principles governing Islamic finance in international trade’ (2010) Company Lawyer 249

Siti Faridah Abdul Jabbar, ‘Adjudication of disputes relating to Islamic financial contracts in non-Sharia courts: BIMB v Lim Kok Hoe’ (2010) Company Lawyer 94

Abdul Karim Aldohni, ‘the challenge of Islamic banking disputes in the English courts: the applied law’ (2009) 6 JIBFL 350

Atif Hanif, ‘Islamic finance – an overview’ (2008) International Energy Law Review 9

Karim Djaraouane, Churi Joseph Serhal, ‘Choice of governing law in Islamic finance agreements’ (2009) International Business Law Journal 115

Antony Hainsworth, ‘Retakaful, regulation and risk: developing the Islamic insurance market in the UK’ (2009) 4 Journal of International Banking and Financial Law 193

Anthony Hainsworth, ‘Islamic financial institutions and Islamic finance: a new division in the Butterworths Encyclopedia of Banking Law’ (2008) 9 Journal of International Banking and Financial Law 495

Antony Hainsworth, ‘New letters of the law’ (2008) 158 New Law Journal 1382

Qudeer Latif, ‘Islamic Finance’ (2006) 1 Journal of International Banking and Financial Law 10

Richard Iferenta, John Bain and Kelly Eland, ‘An Introduction to Islamic Banking’ (2005) Tax Journal, Issue 808, 24

Rodney Wilson, ‘The issue of interest and the Islamic financing alternatives’ (1997) Journal of International Banking Law 23

Publications and Articles:

Graham Lovett, ‘Islamic finance: when will an English court consider Shari'a compliance?’ (2010) <> accessed 21 February 2011

Andrew Cunningham, ‘Role of sharia boards needs modernisation’ Financial Times (London 21 April 2010) accessed 21 Feb 2011

Dan Waters, ‘Home reversions and Islamic mortgages get new consumer protections’ (2006) FSA/PN041/2006 accessed 21 February 2011

Shibeer Ahmed, ‘Shariah law in the English Courts’ (2004) <> accessed on 21 February 2011

FSA, ‘Islamic Banking in the UK’ (2006) Briefing Note BN016/06 <> accessed 5 November 2010

Emily B. and Bhasker S., ‘The steady rise of Islamic finance’ BBC News (London 23 September 2009) <> accessed 27 November 2010

HM Treasury, ‘A Regulatory Impact Assessment for the 2006, Alternative Finance Products’ (2006) accessed 15 November 2010

HM Treasury, ‘The development of Islamic finance in the UK: the Government's perspective’ (2008) <> accessed 27 November 2010

UK Trade and Investment, ‘The City: UK Excellence in Islamic Finance’ (2007) URN 07/1657 <> accessed 27 November 2010

Michael A., Ali M., Robert H., Arshadur R., and Ali R., FSA, ‘Islamic Finance in the UK: Regulation and Challenges’ (2007) accessed 5 November 2010

Farmida B., ‘The Election Briefing: Islamic finance’ (2010) < lang="en-gb&page="> accessed 27 November 2010


Others:

Islamic Finance Council UK (IFC) accessed 27 November 2010

The Alternative Finance Arrangements (Community Investment Tax Relief) Order 2008, section 98 Finance Act 2006