THE APPLICATION OF ISLAMIC FINANCE PRINCIPLES UNDER ENGLISH AND DIFC LAW DIFC AND ENGLISH UNDER PRINCIPLES FINANCE ISLAMIC OF APPLICATION THE Key points Neither the English nor the DIFC courts can directly apply Sharia principles, because the Feature proper law of a contract is required to be the law of a country. An arbitral tribunal in England or the DIFC can directly apply Sharia principles, even as a non-national system of law, under the relevant UK and DIFC statutes. The English courts canindirectly apply religious law, for example: where specific provisions are incorporated into an agreement; where the parties choose a national law based on religious law; where it is used as an aid to construction; or where a justiciable issue of fact arises as a condition of the existence of a right. In practice, Sharia principles are indirectly applied in deciding whether an agreement was ultra vires a party under the law of its seat.
Author Rupert Reed QC The application of Islamic finance principles under English and DIFC law
Neither the English nor the DIFC courts can directly apply Sharia principles. In this Consequences of direct article, Rupert Reed QC considers the ways in which the English and the DIFC courts application of Sharia can apply Islamic law indirectly. principles The judgment at first instance inHalpern suggests that an express agreement of Introduction subject to limited exceptions, parties can Sharia as the applicable law may have the The total amounts of Islamic financial only provide for the application of the law effect of making the contract unenforceable: nassets have grown exponentially of a country or jurisdiction as the applicable [2006] EWHC 1728 (Comm) [50]. in spite of the global financial crisis. An or “proper” law of their agreement: Art 1 However, the Court of Appeal (CA) increasing number of Islamic finance (IF) RC. The applicable law, under Art 10 RC, disagreed, taking the view that it would instruments are being negotiated and is that which will govern interpretation, then be for the applicable law to decide the written in the “new” IF centres of London performance, the consequences of extent to which the agreement impliedly and Dubai, including its financial “free breach, and various ways of extinguishing incorporated the relevant religious law as zone”, the Dubai International Finance obligations and prescribing and limiting part of the contract: Halpern [36]. Centre (DIFC), which has codified actions. Issues such as the validity of the commercial and financial law based on contract will therefore be ascertained by Direct application of Sharia English and other common law principles. reference to the substantive law of the principles in arbitration Many of those instruments contain English relevant country. The direct application of Sharia principles and DIFC jurisdiction and choice of law The parties therefore cannot provide was similarly excluded in arbitration, until a provisions. for the application of a “non-national” tribunal was permitted, under s 46(1)(b) of Neither the English nor the DIFC system of law, such as Islamic or any other the Arbitration Act 1996, to decide a dispute courts can apply Islamic law directly, but religious law: Shamil Bank of Bahrain EC “in accordance with such other considerations both can apply it indirectly in circumstances v Beximco Pharmaceuticals Ltd [2003] as are agreed by them or determined by the where they recognise it as being “relevant”. EWHC 2128 (Comm) [27], [35]; [2004] tribunal”. Arbitral disputes are of course The English courts have shown themselves 1 WLR 1784 [48]; [62]-[63]; Halpern outside the RC: Art 1(2)(d). A tribunal can willing to apply Sharia principles, for v Halpern [2007] EWCA Civ 291; now apply Sharia principles and other non- example in assessing whether an instrument [2008] QB 195 [20]-[29]; Musawi v RE national rules, where they are designated is void as having been beyond the International (UK) Ltd [2007] EWHC by the above choice of law rule. The CA constitutional powers of, or ultra vires, one 2981 (Ch) [17]-[23]. The conventional recognised in Halpern that, if parties wish of its parties insofar as it is ribawi or Sharia explanation for this principle is that laws non-national systems of law to apply to non-compliant (SNC). cannot exist “in a vacuum”, in other words their agreement, then they can do so by the without being enforceable in the courts of inclusion of a provision for the arbitration of No direct application of any jurisdiction. any dispute: Halpern [37]-[38]. Sharia principles by the courts DIFC law similarly requires the DIFC The equivalent DIFC statute, Law The position under English conflicts of courts to determine civil matters in No 1 of 2008 (“the Arbitration Law”) is laws principles, both at common law and accordance with the laws of a jurisdiction equally clear in providing, in Art 35(1), that under the Contracts (Applicable Law) chosen from a “cascade” of connected the tribunal shall decide the dispute “in Act 1990, which implements the Rome jurisdictions: DIFC Law No 3 of 2004 accordance with such rules of law as are chosen Convention on the Law Applicable to (the Law on the Application of Civil and by the parties as applicable to the substance of Contractual Obligations (RC), is that, Commercial Laws (LACCL)), Art 8. the dispute”.
Butterworths Journal of International Banking and Financial Law October 2014 573 Feature
Both the English and DIFC courts a similarly diffident approach to issues of approved the contract. will therefore recognise agreements to Sharia compliance in Shamil Bank [2003] Certain IF instruments, notably arbitrate governed by Sharia law, both EWHC 2118 (Comm); [2004] EWCA Civ mudaraba and wikala agreements, are in staying actions brought in breach of 19; [2004] 1 WLR 1784. Although the issue often compared with appointments under those agreements and in enforcing awards in that case was whether the enforceability English law of trustees and agents. It should made in applying the agreed Sharia of a contract governed by English law, therefore come as little surprise that it was a “considerations”: Halpern [37]. subject to Sharia law, was conditional upon judge of the Chancery Division of the English its Sharia compliance, both the judge and High Court, with its equitable specialism, Indirect application of the Court of Appeal approached that issue who first engaged with Sharia principles in Sharia principles from the perspective that Sharia law raised finding it to be arguable that the relevant While the English and DIFC courts will complex philosophical issues from another agreement was not SNC under those not directly apply Sharia principles, there period on which there was little or no firm principles. are ways in which they can indirectly apply authority. them. In particular: they can apply Sharia However, in the later case of The Incorporation of Sharia principles that are incorporated in an Investment Dar Company KSCC v Blom principles agreement; they can apply a national law Development Bank SAL [2009] EWHC The English CA has further reminded us that itself applies Sharia principles; they can 3545 (Ch), a judge of the Chancery that provisions of foreign law can not only use Islamic law as an aid to construction; Division took a very different approach. be “applied to” the contract, but can also and/or they can decide a justiciable issue of The defendant sought to resist summary be “incorporated into” the contract, which IF principle on which the rights of a party judgment by reliance on an ultra vires exists as a form of private legislation: Shamil are conditional. defence in arguing that the wikala contract [49]-[51]; Halpern [30]-[33]. The foreign law In practice, the most common indirect was SNC and therefore ultra vires the becomes a source of rules and principles to be application of Sharia principles occurs claimant as a matter of Kuwaiti law, and so applied by the governing law. where a party seeks to avoid its obligations invalid as a matter of English law. The judge An example given in Shamil is the
THE APPLICATION OF ISLAMIC FINANCE PRINCIPLES UNDER ENGLISH AND DIFC LAW under an IF instrument on the basis of an found that the ultra vires defence had been incorporation of particular provisions ultra vires defence. By this, it contends that “dredged up” late by the defendant’s lawyers, from the French Civil Code, so that the the instrument is SNC, therefore beyond and thus gave the claimant both permission relevant articles are incorporated as if the capacity of, or ultra vires, either party to amend to plead a restitutionary claim and terms of an English contract. The parties under the law of its place of incorporation, summary judgment on that claim. However, may accordingly choose one law to apply and therefore void and unenforceable as a he also found that there was an arguable rules of another law incorporated in their matter of English law. However, the English defence to the existing contractual claim to agreement. The limits of such incorporation courts, and in particular the English repayment of the USD 10.7m of principal, arise from a requirement of certainty, so Commercial Court, have historically so that he would not have given summary that it will operate where the court can seemed uninterested in IF and Sharia judgment on that claim. sufficiently identify the relevant rules to compliance issues, and more concerned The judge inBlom did not dismiss be incorporated. Where doubt remains, with enforcing IF instruments as if they Sharia law as medieval religious philosophy. expert evidence can be used as an aid to the were conventional finance. Instead, he considered carefully the evidence interpretation by the English court of the In Islamic Investment Company of the Gulf of the parties’ experts and their exhibited rules and principles incorporated. (Bahamas) Ltd v Symphony Gems NV & Ors, texts. He started with a standard inquiry In Shamil, this led to the suggestion that Unreported, 13 February 2002, Tomlinson as to whether the “profit” payable to the the relevant “provisions of foreign law or an J summarily rejected all of the various IF principal could be characterised as interest international code or set of rules” should be defences put up by the defendant, namely an paid “indirectly”. However, in doing so, specific “black letter” provisions, impliedly ultra vires defence, an illegality defence and he identified the key ingredient that was rules rather than principles, that may not a defence based on misrepresentation. He missing from the wikala contract in that give sufficient certainty [51]. The CA found did so even though the murabaha finance case. There was norisk to the principal, that no terms had been identified as a contract in that case presented obvious who received payments of “profit” in pre- “corpus” of terms apt to be implied as terms symptoms of artificiality, with the bank determined amounts even if the value of the of the finance contract in that case [74]. In failing to acquire the goods and assuming investments made by the agent had in fact this regard, an English or DIFC court may no business risk, and with the purchaser dropped. The judge was willing to consider be more willing to apply as incorporated assuming the entire risk, being liable to pay the Sharia compliance of the contract even terms provisions from such codifications of even if the goods were never shipped. in circumstances where the defendant’s own Islamic law as exist, most notably the Sharia The Commercial Court and CA took Sharia committee of Islamic scholars had Standards published by the Accounting and
574 October 2014 Butterworths Journal of International Banking and Financial Law THE APPLICATION OF ISLAMIC FINANCE PRINCIPLES UNDER ENGLISH AND DIFC LAW DIFC AND ENGLISH UNDER PRINCIPLES FINANCE ISLAMIC OF APPLICATION THE Feature
Auditing Organisation for Islamic Financial law (Art 7), and that the courts shall apply the CA recognised that, although Jewish Institutions (AAOIFI), or the Majala, the the rules of Sharia according to the Qur’an law, as a non-national system of law, could Ottoman civil code based on Sharia law of and Sunna (Art 48) as the source of judicial not be the proper law of a compromise the Hanafi school offiqh . decisions (Art 45), which are not subject to agreement, it could still be relied upon as Clearly, the more specific the reference any other authority (Art 46). Sharia tends part of the contractual context as an aid to to rules to be incorporated, for example to a in practice to prevail even over the modern interpretation [34]-[35]. To that extent, the particular school of jurisprudence, the more statutes of the KSA said to “supplement” court recognised the relevance of religious likely it is that the court will apply them. Sharia where necessary. In general, the law in that case. However, the court in Halpern appeared to KSA courts will apply the Hanbali school In English law, the process of interpreting accept that “Jewish law” would be sufficiently of fiqh, and so that gives some basis for legal the parties’ words is one of assessing “the certain to be relied on as part of the certainty. meaning which the document would convey to contractual framework [33]. The implication Similarly, the constitutions of the a reasonable person having all the background in that analysis, and in the proposed distinction with Shamil, is that Sharia law Clearly, the more specific the reference to rules to be would similarly be sufficiently certain, as long as the relevant school of fiqh were identified. incorporated, for example to a particular school of Moreover, if the proposed incorporation jurisprudence, the more likely it is that the court will was of Sharia in general, the court may well take the view that this was an improper apply them attempt to make Sharia the applicable law of the contract, with the proper law being no UAE and Oman make Sharia the main knowledge which would reasonably have been more than a “shell” for the incorporation of source and the source of legislation, while available to the parties in the situation in which Sharia: Halpern [32]. those of the remaining GCC countries they were at the time of the contract”: Investors (Kuwait, Bahrain and Qatar) describe it “a Compensation Scheme v West Bromwich Application of foreign main source” of legislation. Many of these Building Society [1998] 1 WLR 896, 912. In law incorporating Sharia countries now have significant numbers of Halpern, the agreement in issue purported principles resident commercial lawyers from common to be the compromise of an arbitration In Al Midani v Al Midani [1999] 1 Lloyd’s law jurisdictions and of dual-qualified local before religious judges to which Jewish law Rep 923, Rix J found it likely that the lawyers so that experts in the laws of the had applied, and so it could reasonably be applicable law in that case was “either Sharia KSA and other GCC countries can readily assumed that the parties would not have law or such law as modified by Saudi law”, be found to give evidence and otherwise intended to depart from Jewish law in noting that he regarded Sharia law to be “a assist in English or DIFC proceedings in compromising that arbitral dispute. Similarly, branch of foreign law”. In Halpern at [24], relation to agreements that are expressly in the case of a financial instrument said to be the CA found this to be consistent with or impliedly subject to the law of those Sharia compliant, the context would include conventional conflict of laws principles on countries, and thereby Sharia. the core principles of IF. the basis that the agreement being construed The risk inherent in entering a contract Further, where there are two possible in that case was an agreement to arbitrate. under Saudi law is of course that issues as to constructions of a relevant document, However, Rix J’s words remind us that its validity and enforceability will fall to be the court may prefer that which is more Sharia law is a significant source of law determined in accordance with that law, even consistent with business common sense: in a number of jurisdictions in which it is if by an English or DIFC court. Under Saudi Rainy Sky SA v Kookmin Bank [2011] UKSC directly enforced by civil courts, so that no law, a contract that is SNC will be void and 50; [2011] 1 WLR 2900 [15]-[21]. In the “vacuum” exists. unenforceable without more. This invalidity subsequent case of LB Re Financing No 3 It follows that if clients are keen for will result without any intervening reference Ltd v Excalibur Funding No 2 plc [2011] Sharia principles to be applied to their to issues of the capacity of the company or EWHC 2111 (Ch), Briggs J made clear agreement, one option is to apply the law the authority of its purported agents. that the greater the ambiguity, the more of a country whose laws are or incorporate persuasive may be any argument as to the the desired Sharia principles. The Kingdom Aid to construction business common sense of a particular of Saudi Arabia (KSA) would be an It is clear that the English and DIFC courts construction. Business common sense can obvious example, with its Basic Rule of may have regard to Sharia principles as an itself be understood in the context of Islamic Governance (A/90) providing that the KSA’s aid to the construction of an IF instrument, finance to include compliance with Sharia constitution is the Qur’an and Sunna and that the English courts do not see such principles, not least given the further canon (Art 1), which are the ultimate sources of use as being contrary to the RC. In Halpern, of construction that the court should prefer
Butterworths Journal of International Banking and Financial Law October 2014 575 Feature
a meaning which validates an instrument declines to pay the bank or principal on cases, the validity of the act taken on behalf rather than one which renders it void. grounds that the instrument is SNC and of the association or company is dependent Similarly, the courts will depart from therefore void as being ultra vires one or upon its consistency with the tenets and the ordinary meaning of the words used both of the relevant parties or beyond the practices of the relevant religion. There was where it is clear, again in the relevant factual authority of the directors or other agents of no suggestion in that case that the tenets context, that there has been some linguistic those parties. of Nirmal Kutia Sikhism were particularly mistake: Chartbook Ltd v Persimmon Homes susceptible to objective ascertainment, or [2009] UKHL 38; [2009] 1 AC 1101. Justiciability indeed more so than those of any school of This is sometimes referred to as “corrective There was until recently real concern as to Islamic jurisprudence. construction”. There may be circumstances whether issues of Sharia law were justiciable As yet, there is no DIFC authority on where particular wording as drafted makes by the English and DIFC courts. In Shergill the issue of the justiciability of points of an IF instrument potentially SNC, but v Khaira [2012] EWCA Civ 983; [2012] Islamic law. It can, however, be assumed where the court could in effect correct the PTSR 1697, the Court of Appeal, in a that justiciability would be decided on drafting to ensure the Sharia compliance dispute as to the trusteeship of certain Sikh principles of English law as found in the parties plainly intended. Applying temples, found that an issue as to whether Shergill, on the basis of the final default the logic of Excalibur, the more obvious a claimant was the true spiritual successor application of English law under the the drafting error, the more persuasive an to a saint venerated within a particular “cascade” of jurisdictions found in Art argument that it should be corrected and Sikh sect, was not justiciable. That issue 8 LACCL. That application of English the less ambiguity that will be required. was neither appropriate for, not capable of, law was described by Justice Sir Anthony Evidence of Sharia may therefore serve decision by judicial method, and the court Colman in CFI 8/2007 Ithmar Capital v all of the purposes for which arguments should abstain from adjudicating on the 8 Investments Inc (24.11.08) in terms of of construction are advanced before the truth or merits of differences in religious the use of English and other Common law English courts, not least to support the belief or doctrine. authorities “to add flesh to the concise bones of validity of the instrument, to ensure its Fortunately, the Supreme Court took [the codified] provisions” of DIFC law [112].
THE APPLICATION OF ISLAMIC FINANCE PRINCIPLES UNDER ENGLISH AND DIFC LAW compliance with the presumed intentions a different view, finding that the primary There are, however, a number of and reasonable understanding of the issues in the case were of the English law indicators that the DIFC courts would be parties, and to correct errors that may result of trusts and of the construction of the unlikely to find issues of Islamic law and in its being SNC. relevant deed. The court explained that it Sharia compliance to be non-justiciable. would address questions of religious belief First, the DIFC courts have a number Rights of party conditional where necessary to enforce private rights of UAE-qualified judges, willing to apply upon IF issue and obligations. directly their own knowledge of UAE law: There are other cases where the relief The court considered the issues arising CFI 012/2012 Allianz Risk Transfer v Al sought is not a determination of an issue on claims that the governing bodies of Ain Ahlia Ince (24.4.13). of IF principle, but the rights of a party are unincorporated religious communities Secondly, issues of UAE law, and the conditional upon a prior determination of had acted ultra vires, for example in Civil Code in particular, arise commonly such an issue. In English and Scots law, seeking a union with another religious in DIFC cases, and the DIFC courts have the necessity has arisen principally in cases community or in their dealing with expressed some comfort in dealing with of religious schism where there have been members or employees. Where the vires those issues, in the first procedural instance issues as to who is entitled to trust property in question arise from the civil contract in on paper and without expert evidence: CFI that have required the courts to ascertain the constitution of the community or by 014/2010 Taaleem PJSC v National Bonds the conformity of a purported trustee to statute, the courts may need to decide issues Corporation PJSC (14.1.13). religious tenets. The rule that, on a division of religious belief and practice, insofar as Thirdly, the DIFC courts have recently in a religious body, the property held on capable of objective ascertainment, on the shown greater respect for IF structures. For trust for its purposes will go to the party basis of expert evidence. example, in the recent case of CFI 032/2012 that adheres to its fundamental religious Although the court did not refer to cases Beydoun v Daman (10.7.14), the court principles is sometimes called the rule in in which it was alleged that a corporation found, after detailed consideration of an IF Craigdallie v Aikman (1813) 1 Dow 1. had acted ultra vires by transacting in a ijara facility that an assignment of the right The issue of conformity with Sharia way that is inconsistent with the tenets of a to purchase an apartment would have been principles as a necessary prior issue in particular religion and therefore in breach effective as such to deprive the assignor determining a matter of civil right arises of the contract between members and the of its cause of action if executed after the most commonly where the ultimate company existing in its Articles, there are relevant purchase. It was not merely the purchaser or agent under an IF instrument no obvious grounds for distinction. In both creation of a security interest.
576 October 2014 Butterworths Journal of International Banking and Financial Law THE APPLICATION OF ISLAMIC FINANCE PRINCIPLES UNDER ENGLISH AND DIFC LAW DIFC AND ENGLISH UNDER PRINCIPLES FINANCE ISLAMIC OF APPLICATION THE Biog box Rupert Reed QC is a barrister practising from Wilberforce Chambers, 8 New Square, Feature London. Email: [email protected]
Issues as to capacity and doctrine has in effect been abolished for the arises regardless of whether the point is authority of parties purpose of invalidating an instrument, and an taken by any party: Freeman & Lockyer v The court inBlom clearly accepted that an excess of authority will invalidate only where Buckhurst Park Properties [1964] 2 QB 480. IF instrument could be void as being ultra the third party has acted in bad faith. Secondly, it may be argued, under Sharia vires one of the parties under the law of its The position under DIFC law is more principles, to which recognition may be given place of incorporation. Sadly, the defendant complex. Theultra vires doctrine was under the law of a company’s seat, that such a obtained a stay under the Kuwaiti Financial excluded under Art 24(2) of DIFC Law warranty or undertaking may itself be SNC Stability Law before the claimant’s cross- No 2 of 2009 (“the Companies Law”). and void or unenforceable on that ground. appeal of the judge’s decision on the contract This exclusion eliminates the risk of an Other methods to mitigate SNC risk claim could be heard. The case assumed ultra vires defence where the relevant party may be to require the certification of the particular interest because the defendant’s is incorporated in the DIFC, and gives a contract as being Sharia compliant by the own supervisory board publicly criticised the powerful argument for dealing with and/ Sharia supervisory board of each party, or defendant’s raising of IF arguments without or through such parties. However, there is the inclusion of an arbitration provision for consulting it. If the case had proceeded to no specific statutory protection for third the appointment of an arbitrator with Sharia trial in the Chancery Division, there would parties where the directors were acting in expertise capable of giving a prompt interim have been a very interesting debate, on the excess of their authority, although that award on any issue of Sharia compliance that expert Sharia evidence, as to whether the authority can be drawn widely by reference may be raised against payment. To the extent hybrid elements of the contract in question, to their apparent or “incidental” authority that an arbitration clause is discriminatory which, although a wikala, included a sale under DIFC Law No 6 of 2004. in requiring the appointment of an arbitrator and re-purchase of goods as between the Insofar as English or DIFC law requires from a particular religious or racial group, principal and agent, would have saved the issues of capacity to be decided in accordance such discrimination is not prohibited under contract from being SNC. with the law of the place of incorporation of the Employment Act 2010 as an arbitral When the judgment in Blom was first the relevant company, the company laws of appointment is not “employment”, and such delivered, there was controversy as to most Arab countries have a clear requirement discrimination would satisfy a genuine whether it had damaged IF by creating that a company’s memorandum should occupational requirement under Sch 9 to that significant SNC risk which would be specify, among other things, the objects Act: Hashwani v Jivraj [2011] UKSC 40. required to be priced into IF contracts. or purposes of the company. Often these However, there is now some sense that the are required to be legitimate and to be in Conclusions engagement of secular courts in issues of accordance with such licences as the company There are a number of ways in which IF may in fact have assisted in deterring needs to hold under policies intended to Sharia principles can be applied indirectly more extreme cases of artificiality and maintain uniformity and specialisation, as by the English and DIFC courts. In many in ensuring that banks continue to write under Art 13 of the UAE Companies Law. instances, the parties may wish to provide IF business that is properly within their It is implicit that SNC business, likely to be for such application. There is, however, risk powers. It is no longer unusual to see parties outside those purposes, or illegitimate or that those courts will find IF transactions plead in their defence that an IF contract outside the scope of relevant licences, will be to be void by indirect application of Sharia was void as having been ultra vires one or void or unenforceable. principles by the laws of countries in both of the relevant parties and/or outside which the parties are incorporated. There the authority of the Board or officers who Mitigatory steps are limited ways in which that risk can be executed it. There are clearly a number of ways in which managed. n the risk of a contract being found ultra vires Statutory intervention in can be prospectively mitigated. The most England and the DIFC common is the taking of warranties that Under English principles as to the conflict of the agreement is Sharia compliant and/or laws, issues as to the capacity of a company intra vires the relevant counterparty, and/or are determined under the law of the country a requirement of express undertakings that Further reading where the company is incorporated. If that it will not seek to argue that the agreement The challenge of Islamic banking is England, then s 39 of the Companies Act is SNC or ultra vires any party. While such disputes in the English courts: the 2006 protects third parties, just as under s 40 warranties and undertakings are effective in applied law [2009] 6 JIBFL 350 the authority of the directors is deemed free English law, they face two difficulties. First, Lexis PSL: Dispute Resolution: of limitation in favour of a person dealing or under English law, a party cannot estop itself Applicable Law presumed to be dealing with the company in from asserting the invalidity of a contract Lexisnexis Loan Ranger: Sukuk good faith. The result is that theultra vires which is invalid, so that an issue of capacity reaches western markets
Butterworths Journal of International Banking and Financial Law October 2014 577