UK: Sharia Law: Non-Compliance and Enforceability of Contracts Governed by English Law

Last Updated: 20 April 2010
Article by Peter Measures

The Investment Dar Company KSCC v. Blom Developments Bank SAL [2009] EWHC 3545 (Ch)

Few cases involving Islamic Finance contracts have come before the English Courts, but where they have the Courts have traditionally been reluctant to examine issues of Sharia compliance when looking at the enforceability of an English law contract. However, in a recent High Court decision, it was held that there was an arguable case that a Wakala (agency) agreement did not comply with Sharia law and was therefore void.

Summary judgment was denied to the Claimant bank on this issue and the Islamic Investment Company in question will be able to run this argument at trial. Discussed in this article are the implications of this decision.

Previous Authorities

In Islamic Investment Company of the Gulf v. Symphony Gems NV & Others [2002] WL 346969 (QBD (Comm Ct), the Islamic investment company, IICG (the Islamic Investment Company of the Gulf), entered into a Murabaha Agreement with Symphony Gems. Under a Murabaha Agreement, the Islamic financial institution ("IFI") purchases an asset identified by its customer from the seller/manufacturer and then immediately sells the asset to the customer on deferred terms at a mark-up to the original purchase price. The mark-up is regarded as profit earned by the IFI. The payment to the IFI by its customer may be made as a single payment or by instalments. Most such instruments have a 6 - 12 month maturity.

The Agreement in that case was expressly subject to English law and jurisdiction. In addition the Agreement stated "the purchaser wishes to deal with the seller for the purposes of purchasing supplies under this agreement in accordance with Islamic Shariah". A dispute arose as to who took the risk of a failure to deliver. Under Sharia law (and according to the principles of a Murabaha), the risk of a failure to deliver falls on the IFI (IICG in that case) as it receives a profit for accepting that risk. However, the wording of the Agreement did not support that position and the judge held that "...it is a contract governed by English law. I must simply construe it according to its terms as an English law contract". He rejected the arguments that it was not in compliance with Sharia law, did not bear the hallmarks of a Murabaha Agreement and was therefore illegal because (a) the parties had chosen English law as the governing law without any restriction or limitation and (b) the Agreement was not to be applied in a jurisdiction where Sharia law was the law of the land.

In that case, it was also argued that the terms of the Murabaha Agreement contradicted IICG's constitutional documents which required that IICG carry out its business in a "manner which is consistent with Islamic laws, rules, principles and traditions". The Agreement was therefore ultra vires or beyond the powers/capacity of IICG to enter into. In the UK, statute intervened many years ago to bring to an end the external operation of the ultra vires doctrine in invalidating transactions entered into by a company beyond its objects and powers as a protection for third parties who, when contracting in good faith, are entitled to assume that their counterparty has the requisite power/capacity to enter into the contract concerned. The Bahamas, where IICG was incorporated, has enacted a similar law. In any event, English Courts have shown some reluctance to apply the doctrine (described as a "technical" rule in another case) to enable a party top avoid its contractual obligations.

Shamil Bank of Bahrain v. Beximco Pharmaceuticals Limited and Others [2004] 2 Lloyd's Rep 1 also involved a Murabaha Agreement. In that case, there was a payment default by the defendants. The Agreement contained the following wording regarding the choice of law – "Subject to the principles of Glorious Shariah, this agreement shall be governed by and constructed in accordance with the laws of England." The Appeal Court held that "there could not be two separate systems of law governing the contract". Statute in the UK only contemplates the choice of the law of a country to govern contractual obligations. Whilst it is possible to incorporate specific provisions of foreign law into an English law contract (subject to certain limited restrictions), this Agreement referred to Sharia law in general and not to any specific provision that was intended to be incorporated. Principles of Sharia, it was pointed out, are not simply principles of law but relate to other aspects of life and behaviour and, in any event, are susceptible to differing interpretation depending upon the strictness with which they are interpreted or applied. Furthermore, it was said that it was highly unlikely that the parties had intended that an English Court should determine any dispute as to the nature or application of religious principles. English Courts, in other words, determine disputes on the basis of English law (although there may be occasions where they also accept expert evidence of foreign law, this will be the law of a country and not religious law).

Latest Developments

In the latest case, the question of capacity arose again. Blom made deposits with Investment Dar Company KSCC ("TID") under a Master Wakala Agreement. In essence TID, as Wakeel (agent), would accept deposits from investors such as Blom and would pool the deposits, using the Wakala capital in Wakala assets of a prescribed type. TID would invest the deposits as agent for the investors including Blom.

The Master Wakala Agreement was expressed to be governed by English law and precluded TID from taking any point on non-compliance with the Sharia. In this case TID was a Kuwaiti company whose constitutional documents stated that the "objectives for which the company is established shall be Sharia compliant. None of the objectives shall be construed and interpreted as permitting the company to practice directly or indirectly any usury or non-Sharia compliant activities." One such objective specifically stated that the company was to "carry out all financial transactions in a Sharia compliant manner".

Despite the terms of the agreement, TID argued that the contract with Blom was non-compliant because TID was taking deposits at interest. Blom pointed to the Sharia Committee approval and said the argument being advanced by TID was nonsense. On an application by Blom for summary judgment, the judge said there was an arguable case that the transactions entered into by TID were ultra vires TID. As, moreover, questions of capacity of a corporate entity are governed by the law of the place of incorporation, the fact that the Master Wakala Agreement was governed by English law was irrelevant. On appeal to the High Court, this view was not challenged.

It seems clear that the TID/Blom case is distinguishable from the Shamil Bank/Beximco case, although the issue of capacity/power to enter into a transaction was referred to in the IICG/Symphony case and was rejected primarily it seems on the basis that Bahamian law (like English law) had enacted statutory protection for third parties and in any event English Courts were reluctant to allow parties to invoke ultra vires as a means to avoid contractual obligations. TID is a Kuwaiti company where no similar statutory protection is available and when this comes back to court, evidence will need to be produced as to what Kuwaiti law says about Sharia compliance in the light of TID's constitutional documents. However, weight will also have to be given to the fact that (a) the Sharia Committee in this case appears to have approved transactions which it is now alleged are non-compliant and (b) TID has stated in the Agreement that it would not at any time assert the arrangements made under the Agreement contravene the Sharia.

Comment

There is no suggestion in this recent case that the English Courts will do anything other than look at English law when construing the terms of an English law document (the decision in Shamil Bank v. Beximco will therefore be followed) and they will not, therefore, say that a document is unenforceable because it does not comply with some aspect of Sharia law (particularly since this is open to differing views). However, they might entertain an ultra vires argument if evidence is adduced that this is relevant as a matter of the law of incorporation of the Defendant.

In the writer's view, the way that the capacity issue can be addressed is to express the financing obligation or investment to be conditional upon the production of an opinion (or fatwa) as to Sharia compliance. This could be issued by the Sharia Committee of the obligor or by the Bank's Sharia Committee and should in any event be coupled with representations as to Sharia compliance and to the effect that there is no conflict with the entity's constitutional documents, together with the insertion of a waiver of defences based on Sharia law issues (as was the case in the Master Wakala Agreement). If one wanted to go further one might consider bolstering the representations by obtaining a legal opinion as to the capacity of the contracting party from a local lawyer.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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