Dispute Resolution in Islamic Financial Contracts of Islamic Financial Institutions Issues

DISPUTE RESOLUTION IN ISLAMIC FINANCIAL DISPUTE RESOLUTION IN ISLAMIC FINANCIAL CONTRACTS OF ISLAMIC FINANCIAL INSTITUTIONS---ISSUES* By Mr. Justice (R) Khalil-ur-Rehman Khan Formerly Judge, Supreme Court of Pakistan Abstract: Bank entering into Islamic Financing agreements with Construction Contractors, Governing Law Clause of the contract providing for English Law subject to principles of Shariah. Contractor defaulting on agreements: Whether agreements governed by English Law alone or English Law subject to Shariah Law and principles are to be applied? Conflict of Laws: Principles examined Arbitration way out to apply principles of Shariah for determining rights and liabilities. Factual Background of the Dispute: The Bank was incorporated under the laws of Bahrain, a country which encourages Islamic Banking practices as national policy and the Bank holds itself out as applying Islamic Banking principles and uses Shariah-compliant financial products. The Bank extended finances to the Contractor on the basis of Murabaha mode of financing, and the documents executed contained a governing law clause as follows:- "Subject to the principles of glorious Shariah, the agreements should be governed and construed in accordance with English Law." Murabaha - Mode of Financing: This is a sale transaction wherein the commodity is sold for a deferred price which includes an agreed profit added to the cost. It is not a loan given on interest. The Bank provides fund for purchase of goods, machinery, and equipment on the basis of Murabaha. If the funds are required for other purposes e.g. paying price of goods already purchased, bills of electricity, salaries of the staff or cash for payment for utilities and services, Murabaha cannot be effected. There has to be real sale of some commodities and not merely advancing a loan he financer must own the commodity before he sells to his client. So the Bank purchases the commodity itself or through Agent and takes possession of the commodity physically or constructively and thereafter sells it to the client. Originally Murabaha is a particular type of sale and not a mode of financing. The preferred mode of financing according to Shariah is Mudarabah, Mu sharkah, Diminishing Musharakah, Ijarah (Leasing), Salam, (Advance payment, deferred delivery of goods), Istisna (Order to manufacture goods). Governing Law and Jurisdiction Clause: Whatever may be the mode of Islamic Finance, the transaction documents contain the jurisdiction and the law which is to govern the contract. In the case of Shamil Bank of Bahrain v Beximo Pharmaceutical and others (2004) 4, All England Reports 1072, the principal defence plea was that on a true construction of the governing law clause, the Murabaha agreements were only enforceable in so far as they were valid and enforceable both (i) in accordance with the principles of Shariah i.e. rules and law of Islam; and (ii) in accordance with the English Law; and (b) in fact the agreements were unlawful, invalid and unenforceable under the principles of Shariah in that despite their form as Murabah agreements, the transactions were in truth disguised loan at interest. As such they amounted unlawful agreement to pay Riba, and were thus void and unenforceable. The governing law clause in the agreement reads "subject to the principles of glorious Shariah, the agreement should be governed and construed in accordance with English Law." The contention on behalf of the client Company was that though the governing law was English law alone but this does not preclude the possibility that the principles of Shariah have relevance. It was argued that all the parties have done, is to choose English Law as the governing law but at the same time to stipulate as a condition precedent that the contract is only to be enforceable in so far as it is consistent with the principles of Shariah. It was, however, agreed that there could not be two separate systems of law governing the contract. Moreover, the Rome Convention on the Law Applicable to Contractual Obligations, 1980 as set out in Schedule-I to the Contract (Applicable Law) Act, 1990, Article 1(i) only makes provision for the choice of the law of a country and did not provide for the choice or application of a non-national system of law such as Shariah. So the words "subject to glorious Shariah" were no more than a reference to the fact that the Bank purported to conduct its affairs according to the principles of Shariah. The wording of Article 1 (i) of the Rome Convention may be quoted:- "The rules of this convention shall apply to contractual obligation in any situation involving a choice between the laws of different countries is not on the face of it applicable to a choice between the law of a country and non-national system of law. The argument that the governing law clause should read as incorporating simply those specific rules of Shariah which relate to interest and to the nature of Murabaha and Ijarah contract, thus, qualifying the choice of English Law as the Governing Law only to that extent. The other plea urged was that the construction of the governing law clause as pleaded, produces a result no different from the incorporation by a reference of codified system of rules, such as Hague Rules or the Warsaw Convention 1921 (as set out in Schedule 1 to the Carriage by Air Act 1961) into a contract governed by English Law. The argument was that by that method English Law is applied as the governing law to a contract into which the foreign rules have been incorporated. Reliance was placed on Nea Agrex SA v. Baltic Shipping Co. (Ltd.) (1976) 2 All ER 842." The finding of the court of appeal is reflected in the following Para: "The general reference to principles of Sharia'a in this case affords no reference to, or identification of, those aspects of Sharia'a law which are intended to be incorporated into the contract, let alone the terms in which they are framed. It is plainly insufficient for the defendants to contend that the basic rules of the Sharia'a applicable in this case are not controversial. Such 'basic rules' are neither referred to nor identified. Thus the reference to the principles of Sharia'a stands unqualified as a reference to the body of Sharia'a law generally. As such, they are inevitably repugnant to the choice self-contradictory and therefore meaningless." The approach of the honourable English Judges is reflected from the following observations as well:- "Finally, so far as the 'principles of Sharia'a are concerned, it was the evidence of both experts that there are indeed areas of considerable controversy and difficulty arising not only from the need to translate into propositions of modern law texts which centuries ago were set out as religious and moral codes, but because of the existence of a variety of schools of thought with which the court may have to concern itself in any given case before reaching a conclusion upon the principle or rule in dispute. The fact that there may be general consensus upon the proscription of Riba and the essentials of a valid Morabaha agreement does no more than indicate that, if the Sharia'a law proviso were sufficient to incorporate the principles of Sharia'a law into the parties' agreements, the defendants would have been likely to succeed. However, since I would hold that the proviso is plainly inadequate for that purpose, the validity of the contract and the defendants' obligations there under fall to be decided according to English law." The Court of Appeal in its ruling further said:- "It was clear that the intention of the parties was not to ask a secular court to derive answers to their legal issues from religious writings. There would be grave controversy otherwise since secular English Court was not suited to determining principles of disputed religious law. " "While the Court could be used to settle disputes of foreign law that was not the same as attempting to determine English Law principles through religious law and it was improbable that the parties would ask the Court to judge matters of Islamic orthodoxy, considering that as far the Bank was concerned, passing the activities by a special Board was sufficient." To appreciate the full impact of Shariah on business law, a visit to business centers like Clifford Chance, where Islamic finance is an important activity, would show that doing dealings that are Shariah-compliant, is a standard part of their activity. The scores of lawyers and Islamic Finance Firms are practicing Shariah. The transactions conceived in London by U.K, lawyers are being reviewed by Shariah Scholars in the Middle and Far East to judge whether or not they comply with Islamic Law if they do not, they do not go ahead, so in practice the jurisdiction of Shariah is now well established in Britain. Dr. Williams, the Bishop of Canterbury recognizing the prevalence of Shariah in business and financial dealings urged the English Judicial System to recognize Shariah as applicable law for determination of the rights and obligations of the parties. The Olswang Article mentions that the UK Court of Appeal "refused to deem Shariah law incorporated into the contract as a contractual term, primarily on the basis that the evidence of the experts for both parties was that there is not a single, easily identifiable body of law which is Shariah law and that there are areas of considerable controversy and difficulty arising from the existence of a variety of schools of thought, both in respect of Islamic law in general and Islamic banking law in particular. The general reference in the financing agreements to Shariah law was therefore incapable of incorporating Shariah law into the contracts. It appears that incorporation may have been successful if the parties had stipulated specific "black letter" provisions of Shariah law." (http: / /www. olswang. de / newsarticle, asp?sid=858&aid= 715&de=&mid=) The objection that the rules of Shariah which are applicable in this case, are controversial and even these basic rules have not been identified, can be met by inserting a reference of the rules of Shariah adopted by the AAOIFI, Bahrain in the Accounting and Auditing Standards of Islamic Financial Institutions and also the Shariah Standards of AAOIFI. A specific reference of these Standards in the governing law clause in a contract would thus meet this objection, as it will be sufficient answer to the objection as to the existence, of divergent views of various schools of thought and of uncertainty as to applicable rules. The doctrine of incorporation can also be relied upon as now the terms of their contract would sufficiently identify these specific "Black Letter" provisions of foreign law, that is Shariah principles to be incorporated as terms of the relevant contract, such as a reference is made to French Civil Code or the Hague Rules. The governing law clause in an Islamic Financial' Transaction (Takaful Treaty) may be worded as under:- "This Takaful Treaty has been framed and structured according to the established principles of Shariah as recognized in the Shariah Standards approved by the riA0IFI, Bahrain, therefore, all questions arising in respect of construction, interpretation, meaning of the terms, exclusions, limitations and conditions of this Takaful Treaty shall be resolved and determined in accordance with the principles of Shariah and as the English text appearing in this Takaful Treaty." At this stage, a few words may be said about the scope of legislation in an Islamic State. Legislation in its present Western sense is something new to the Islamic legal traditions. If legislation means "laying down of legal rules by a sovereign or subordinate legislator" as Salmond has put it, then in that sense there has been no legislation in the history of Islam before Majallah of the Ottomans, that too, was not a piece of legislation in the sense that it laid down some new rules of law, what the Majallah did, was not more than the rephrasing or redrafting of the already existing legal rules and arranging them in appropriate order after reformulating them into the form of sections and subsections. The vast development and expansion in Islamic Law throughout the ages was never the result of any legislative exercise in the modern sense. The nature of this development and expansion in Islamic Law is essentially different from the development and expansion of Anglo-Saxon or any other contemporary legal and judicial system. Islamic law is basically a part of a holistic system based primarily on a religious message contained in the Qur'an and the Sunnah -the two basic and original sources for all guidance. The principles laid down in the Qur'an and the Sunnah are, in fact, guiding signs or 'limits') within which human beings have to work out practical details and solution for given problems. The development of law after the Holy Prophet (peace be upon him) gave rise to principles of Ijtiha-a principle which was approved by the Holy Prophet (peace be upon him) himself towards the close of his life, Ijma a principle discovered by the companions of the Prophet (peace be upon him), Qiyas, Maslahah, Istislah etc.-principles later developed by the early Muslim jurists. But the point which becomes crystal clear even by a cursory glance over the history of Islamic law that its entire development and expansion took place at the hands of non-official and private individual-at times collective -efforts. Before the Majallah there is no example in the whole legal history of Islam that a rule of law was ever laid down by a sovereign, a ruler or by an official of the State or by a person or persons appointed by a ruler or even elected by the people for that purpose. The entire exercise of law-making has been taking place at purely private level without intervention by the State or the masses. The interpretation of the Qur'an and the Sunnah and discovery of new rules of law in response to new situations and requirements was the job of the scholars, teachers, academicians and the jurists while the application of that store of legal rules to day-to-day problems was the province of the judiciary and its allied agencies such as Ifta' and Hisbah etc. Whenever a new situation arose, scholars and jurists of the Ummah addressed themselves to the task and discovered the rule of law in regard to that situation applying the principles of Ijtihad, Qiyas, Istihsan and Istislah and giving arguments in favour and in defence of their conclusions. It was then upto the Judge to accept the most sound and most rational of all such conclusions and to apply that conclusion to the question in issue. In some cases - especially in the early days of Islam - where the Judge was himself a recognized, established and trustworthy scholar of the divine law he also participated in that process of law-making. It was in this way that the law continued to develop and expand without interference or pressure from the rulers. It was an open workshop in which everyone possessing the required qualification could freely partake and advance his arguments which, if sound and based on original sources, were accepted both at popular and judicial levels. It was in this very manner that all major legal schools came into existence. It is not a mere coincidence that the founders of such major schools were private individuals enjoying no official position or authority. Some of the jurists whose legal opinions are still followed by large number of Muslims and applied - though on a limited scale - by some contemporary courts were even persecuted by their contemporary, rulers. In this respect the example of Imam Ahmad ibn Hanbal and Imam Zaid ibn :Ali can be cited; these two celebrities were personae non grantee in the eyes of the rulers of their respective times and were persecuted for one reason or the other; yet the legal opinions expressed by them and the legal rules framed by them had their value not only in their own life-time but also centuries after their death. This tradition in the development of Islamic law which originated during the early days of Khulafa-i-Rashidin continued for about twelve hundred and eighty-five years. All the development of the law which is undoubtedly one of the richest treasuries of legal thought ever produced by any people or civilization took place according to this tradition, i.e. with purely private and non-official efforts without any interference or pressure from the governments. Some rulers did try to influence the development of law for one reason or the other, but Muslim jurists never allowed such influence to be effective. Here, the example of Harun al-Rashid can be cited who tried to persuade Imam Malik to let the government adopt his Muwatta as the guide book for the courts. But it goes to the unrivalled credit of the great Imam that he preferred the freedom and supremacy of law to his personal acclaim and recognition. He refused to agree to the idea and saved the right of the jurists and scholars to exercise Ijtihad freely and independently according to their sincere and genuine understanding of the Qur'an and the Sunnah and the strength and soundness of their arguments without being influenced by any other force except their own conscience and fear of God. The first outward departure from this tradition took place in 1287 A.H. 1869 A.D. when the Ottoman Sultan promulgated the first-ever codified piece of law in the history of Islam i.e. the second chapter of the Majallah. Although this was a departure from the tradition only in form and appearance and not in essence and reality, yet it paved the way for a real departure which the Muslims first tolerated and then accepted under the powerful influence of the western legal traditions. (State and Legislation in Islam by Dr. Mahmood Ahmed Ghazi [Pages 112-1131-published by Shariah Academy International Islamic University, Islamabad). Thus Ijtihad has been postulated as the function of scholars and jurists who possess required qualifications and they were under an obligation to exercise Ijtihad in matters not covered by the Qur'an, the Sunnah or the consensus of the Ummah. It has never been considered to be the job of the ruler or holder of an office or a Body or an Organization. The role of the rulers in the process of legislation in the sense of law making was restricted to issuing of administrative orders. In case there is a valid and genuine difference of opinion among the jurists based on sound arguments, the Executive Authority may, in view of the expediency and public weal, order the court to follow one of such conflicting views provided it pertains to the province of Ijtihad, Masalih-i-Mursalah, Istihsan etc. In that case, the opinion preferred by the Executive Authority will be the law of the land and will hold the field. This has been an accepted rule of Islamic law. The compilers of Majallah have put it in these words: "When the head of the Muslims orders (the courts) to act according to one of the views in respect of the problems open to Ijtihad, then that particular view becomes the only accepted view and it becomes incumbent (upon the courts) to act accordingly." (Section 1801 of the Majallah). In view of the uncertainty as to the ability to incorporate non-national laws as contractual terms to aid the interpretation of a contract and till the time that the English Courts accord Shariah the status of laws applicable, the way out for the parties to have certainty for having their disputes resolved in accordance with the principles chosen by them (e.g. principles of Shariah) is for them to submit their disputes to arbitration under the 1996 Act. It was confirmed in Halpern v. Halpern that an English court would give effect to the arbitrating parties' choice of non-national law and would for example enforce an award made by arbitrators applying any considerations agreed between the parties. It is, therefore, suggested that Islamic Financial document (the Takaful Treaty) may contain choice of law and jurisdiction clause as follows:- "Any difference arising out of this treaty for concerning its validity shall be submitted to the decision of a panel of arbitration as per the provisions of the Arbitration Clause. The panel of arbitration is required to decide primarily in accordance with the established principles of Shariah and International Takaful custom as adopted in the Shariah Standards issued by AAOIFI. Notwithstanding the foregoing, each party agrees to submit to the exclusive jurisdiction of the courts of England and Wales in the enforcement of the award made by the Arbitrators (or any other country of choice where award is sought to be enforced)." This paper was presented in the International Conference held at Istambul from 14th to 16th May, 2010 by Dispute Resolution Foundation, USA (Research Centre Punjab Judicial Academy).