Dispute Resolution in Islamic Finance

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Dispute Resolution Islamic Finance

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Dispute Resolution in Islamic Finance

  1. 1. Introduction As the Islamic finance industry is growing annually at a rate of 10% to 15% per year, it is imperative that a unique, independent legal framework is established in order to effectively adjudicate Islamic finance disputes. Currently, Islamic finance disputes are being adjudicated in inadequate civil and common law courts and arbitration centers where the contracts in dispute are being transformed from Islamic to conventional transactions.
  2. 2. Aim The aim of this presentation is to explore the role of the Dubai World Islamic Finance Arbitration Center (“DWIFAC”) and its‟ jurisprudence office (DWIFACJO) as the dispute resolution center of the Islamic finance industry, fitting in with the recent 2013 Sheikh Mohammad „Dubai as the Capital of the Islamic Economy‟ initiative.
  3. 3. Objective The objective of the presentation is to show how using a common law jurisdiction inadvertently transforms Islamic financial transactions into conventional disputes. This is done through analysis of the cases Beximco Pharmaceuticals Ltd, Bangladesh Export Import Co. Ltd., Mr. Ahmad Solail Fasiuhur Rahman, Beximco (Holdings) Ltd. v. Shamil Bank of Bahrain E.C. [2004] EWCA Civ 19 and Investment Dar Co KSCC v Blom Development Bank Sal [2009] EWHC 3545. Through case analysis combined with an exploration of the efficacy of existing arbitration centers, this presentation will seek to reveal that the Islamic finance industry currently lacks an adequate dispute resolution mechanism and facility to adjudicate disputes arising from Islamic finance contracts.
  4. 4. Should Courts Be Used? Asutay and Hasan (2011:64) state that due to the common law, interpretational approach used to resolve Islamic finance cases in UK/common law courts, Shari’ah is denied as a valid source of law for governing a commercial dispute or Islamic finance transaction. When English/common law is designated as the governing jurisdiction of an Islamic finance contract, courts tend to sever any association with Shari’ah by recognizing conflict of laws and asserting that only a national law can govern the contract.
  5. 5. Should Courts Be Used? Judges then strictly apply English law to the commercial dispute, further disassociating the Islamic aspects of the transaction from the adjudication process. Islamic finance dispute resolution must contain recourse to Shari’ah in order to preserve Shari’ah compliance and the Islamic component of the financial transaction.
  6. 6. Beximco In Beximco, the defendant/borrower entered into a murabahah agreement with the plaintiff. The defendant defaulted and after a series of various termination events under the agreements, the plaintiff finally brought the case to court and made an application for summary judgment. The defendant argued that the murabahah agreements were invalid and unenforceable because they were in actuality disguised loans charging interest (Asutay and Hasan, 2011: 56).
  7. 7. Beximco English law was confirmed as the governing law and it was further confirmed that English law does not recognize Shari’ah law as a valid source of law to govern a commercial contract. Furthermore, even if Shari’ah law were recognized under English law, under the conflict of law rules applicable in England and Wales, according to this judgment and the new Rome I, English law would prevail as the governing law must be the law of a State.
  8. 8. Beximco Colon (2011:425) points out that according to Beximco, under English law a murabahah agreement may be treated the same as an interest-bearing loan, which ironically was part of the initial claim that based on the governing law clause, the murabahah agreements were invalid and unenforceable because they were in truth disguised loans charging interest (Asutay and Hasan, 2011: 56). In fact, the adjudication of the dispute by an English court guarantees turning the murabahah agreements into loans charging interest.
  9. 9. Beximco Beximco interpreted the contract in light of the commercial goals that it served to accomplish, as English law requires (Colon 2011:426) and in line with the common law, interpretational approach as explained by Asutay and Hasan. This strict approach decimated the Islamic finance transaction (2011:431).
  10. 10. Blom Bank In Blom Bank, the Investment Dar (TID) was an investment company registered in Kuwait and the Blom Development Bank (BDB) was a bank incorporated in Lebanon. A wakalah investment agreement was entered into between the two parties governed by English law (Asutay and Hasan, 2011: 57). The agreement provided that Blom deposit a certain amount of money with TID, appointing TID as its wakil (agent) to manage the money as an investment (ISRA, 2012:758).
  11. 11. Blom Bank When TID defaulted on payments under the wakalah agreement, BDB sued TID in the High Court of England and applied for summary judgment on the grounds of default in payment (claim in contract) and the deposits held in trust (claim in equity) (Asutay and Hasan, 2011: 57). The master found that there was an arguable defense to the contractual claim, but not to the trust claim due to a misunderstanding of Shari’ah and the application of common law to an Islamic finance transaction.
  12. 12. Blom Bank TID raised the defense of ultra vires (Asutay and Hasan, 2011: 57). TID argued that the wakalah agreement, which was approved by its own Shari’ah board, did not comply with the Shari’ah and was therefore void and against TID‟s constitutional documents (Asutay and Hasan, 2011: 57 and ISRA 2012:758). Although within the wakalah arrangement some issues of Shari’ah non-compliancy arose, since the contract was approved by the TID Shari’ah Board and constituted a binding contract in both common and Islamic law with valid offer and acceptance. Thus, TID should have been held to the terms of the contract.
  13. 13. Blom Bank The judge ignored the valid and binding contract and the original contractual intent of the parties, applied western trust law to the wakalah arrangement and unjustly ruled that TID was only liable to pay Blom the principle amount. In the concerned wakalah arrangement, at the end of every wakalah period, TID was obligated to pay 5% profit to Blom. The issue arose when TID defaulted on payments of Blom‟s principal and the agreed profits. Blom claimed that TID should pay it the principal deposits plus the contractually agreed 5% profit. However, TID argued that the agreement was not Shari’ah compliant, being an agreement for deposit taking with interest, and therefore null, being ultra vires and beyond its legal capacity to conform.
  14. 14. Blom Bank According to the AAOIFI Shari’ah Standard No. 5(2/2/2) on Guarantees, „it is not permissible to combine agency and personal guarantees in one contract at the same time (i.e. the same party acting as agent on the one hand and acting as guarantor on the other hand), because such a combination conflicts with the nature of these contracts. In addition, a guarantee given by a party acting as an agent in respect of an investment, turns the transaction into an interest-based loan since the capital of the investment is guaranteed in addition to the proceeds of the investment (i.e. as though the investment agent had taken a loan and repaid it with an additional sum, which is tantamount to riba).‟ In this case, TID, as agent, also guaranteed Blom a 5% return.
  15. 15. Blom Bank However, even if the wakalah agreement in question really was a loan with interest in disguise or a similar contraption, due to the fact that this agreement was approved by the TID Shari’ah board, TID should be held to the terms of the contract. TID should not be allowed to suddenly claim that the transaction is non-Shari’ah compliant in order to evade its contractual obligations to Blom Bank.
  16. 16. Blom Bank Jurists agree that an agent‟s possession is one of trust, analogous to deposits and similar to possessions (Zuhayli 2007: 675). This ruling follows from the fact that the agent would possess goods as a legal representative of the principal (who is the owner). Thus, his possession is similar (but not the same) to that of a depository, following its rules for trust and guarantee (Zuhayli 2007: 675). Under Shari’ah, TID was holding the 5% profit on trust for Blom as agent for principal even if the guarantee combined with agency is thought by some to have turned the wakalah into a deposit taking with interest or to have simulated an interest-bearing loan.
  17. 17. Blom Bank Although under Shari’ah, TID was technically only supposed to receive an agency fee, in this wakalah arrangement, TID was contractually to receive an agency fee plus all return above 5%, thus bearing risk of loss. In a proper wakalah arrangement, the principal bears all risk of loss and profit, while the agent only receives an agency fee. According to the AAOIFI Shari’ah Standard No. 21(4/2/c), „…the amount payable as remuneration for agency should be known, whether in lump sum or as a share of a specific amount of income. It may also be defined in terms of an amount of income to be known in the future, as when remuneration is linked to an indicator that may be quoted at the beginnings of different intervals of time.
  18. 18. Blom Bank However, it is not permissible to leave remuneration for agency undetermined and allow the agent to take an unspecified share from the entitlements of principal‟ (2004: 415). In this arrangement, the agent was to take an unspecified share from the entitlements of the principal, being any amount of return above 5%. These Shari’ah issues were totally ignored by the judge. In this transaction, the judge misapplied Shari’ah law, ignored the reality of the Islamic finance and banking industry, and then judged the contracts in relation to Western trust law, unfairly ruling that Blom was only entitled to the principal amount.
  19. 19. Blom Bank The judge ordered an interim payment to be paid to Blom based on the fact that the contract was null and void (no trust) and that the transaction was ultra vires (non- Shari’ah compliant). The judge should have ruled that Blom was entitled to the deposit amount plus any profit made up to a limit of 5% (if profit was made) rather than just the deposit amount.
  20. 20. Beximco and Blom Bank Beximco illustrates how selecting English law as the governing law of an Islamic finance contract may invalidate the application of Shari’ah to the dispute as Shari’ah is not recognized as a valid source of law for governing commercial transactions in the UK and is not seen as a national law in relation to Rome I. Blom Bank reveals how the misapplication of Shari’ah by a UK judge may be detrimental to the effective adjudication of the Islamic finance dispute.
  21. 21. Benefits of Arbitration Why Arbitration?  Permissible in Islam;  Time and Cost Effective;  Ability to apply Shari’ah and commercial business practice to the dispute;  Parties may select arbitrators;  Parties may structure the process to the needs of the dispute;  ADR preserves the relationship of the disputing parties.
  22. 22. Arbitration in Islamic Finance Currently, Islamic finance disputes may be submitted to the arbitration institutions around the world. However, Lawrence and Khan called The Qatar International Center for Commercial Arbitration (“QICCA”), the Qatar Financial Center (“QFC”), the Cairo Regional Center for International Commercial Arbitration (“CRCICA”), the International Islamic Mediation and Arbitration Center (“IMAC”) based in Hong Kong, and the Singapore International Arbitration Center (“SIAC”) and Lawrence and Khan were told that very few Islamic finance cases had been brought to them for adjudication as of yet. Yakoob, Smolo, and Muhammad (2011:18) state that the reality is that most of the institutions have not heard of any arbitration or mediation cases based on Islamic finance. Despite the establishment of the centers, especially the KLRCA, none has been substantially involved in Islamic finance cases.
  23. 23. Arbitration in Islamic Finance When Oseni and Ahmed approached KLRCA arbitrators, one arbitrator revealed to them that not more than two cases had been arbitrated (Oseni and Ahmad 2011:11). Agha (2009:29) says that none of these institutions are globally recognized centers for Islamic finance dispute resolution. Even though the International Islamic Center for Reconciliation and Arbitration (“IICRCA”) in Dubai was established by the Islamic Development Bank (“IDB”) and has arbitration rules, that give priority to Shari’ah in the event of a conflict of laws, the IICRCA is not a globally recognized dispute resolution center for Islamic finance and is rarely used.
  24. 24. DWIFAC and DWIFACJO It is clear that state courts in common and civil law jurisdictions are inadequate to adjudicate Islamic finance disputes due to the lack of recognition of Shari’ah law, lack of independent Shari’ah advisory committees, and/or the inability of court staff to effectively apply Islamic finance and Shari’ah concepts in dispute resolution. In addition, the currently existing arbitration centers are insufficient to handle Islamic finance matters due to lack of properly trained staff; inadequate procedure and rules; misapplication and non-application of Shari’ah and preference for national law; legal uncertainty; and lack of popularity as a mode of dispute resolution.
  25. 25. DWIFAC The Dubai World Islamic Finance Arbitration Center or (“DWIFAC”) may offer the Islamic finance industry a globally recognized arbitration center complete with the DWIFAC jurisprudence office, which may issue a uniform Islamic banking law and a standardized DWIFAC dispute resolution contract, creating harmony, legal certainty, and investor confidence in and across the Islamic finance industry. The DWIFAC standardized dispute resolution contract contains a built-in dispute resolution mechanism, facilitating early dispute settlement and completion of contract.
  26. 26. DWIFAC This contract may be attached to all Islamic finance contracts industry-wide, making DWIFAC the central dispute resolution authority for the industry.
  27. 27. DWIFAC As it stands now, the `UAE does not have an Islamic Banking law, however, it has a law allowing Islamic Banks to exist, UAE Federal Law No. 6 of 1985 Regarding Islamic Banks, Financial Institutions, and Investment Companies. There had previously been a proposed law for governing Islamic banks in 1985, but it had not been backed up by a decree and therefore, that is why the law is not in existence now. However, Federal Law No. 6 of 1985 was promulgated to legalize Islamic banking in the UAE.
  28. 28. Supreme Shari’ah Council Article 5 provides that a Supreme Shari’ah Council should be established and approved through a cabinet decision, but it never materialized. The Supreme Shari’ah Council would oversee Islamic banks, financial institutions, and investment companies and its‟ opinion would be binding.
  29. 29. Supreme Shari’ah Council However, Article 6 was implemented, which requires that each Islamic firm establish its own Shari’ah Supervisory Authority (“SSA”) consisting of three members, to be approved by the Shari’ah Supervisory Council (ISRA 2013:656) and inserted into the articles of association (ISRA 2013: 656). The SSA is obligated to apply Shari’ah to the company operations and contracts (Thani, Abdullah, Hasan 2004: 256).
  30. 30. DWIFAC DWIFACJO may take the opportunity to formulate and issue a Uniform Islamic Banking Law based upon the draft of the UAE 1985 Islamic Banking Law, UAE Federal Law No. 6 of 1985 Regarding Islamic Banks, Financial Institutions and Investment Companies, the Law Regulating Islamic Financial Business DIFC Law No. 13 of 2004, and AAOIFI standards. The new law may then be utilized as the substantive law in DWIFAC arbitrations and submitted to the UAE government for approval and gazetting as this law would be necessary for the UAE in order to fulfill its mandate of becoming the capital of the Islamic economy.
  31. 31. Supreme Shari’ah Council In addition, DWIFAC may establish a central Shari’ah Supervisory Authority or Supreme Shari’ah Council for the UAE, which may be utilized by all existing UAE dispute resolution bodies, including the Central Bank of the UAE, the Dubai Courts, and the DIFC/DFSA, which lacks such a board. The Supreme Shari’ah Council may fulfill its original purpose of approving the Shari’ah boards of all Islamic financial institutions in the UAE, including in the DIFC.
  32. 32. DWIFAC A special component of the DWIFAC dispute resolution mechanism is the special relationship between DWIFAC, the Central Bank of the UAE, the Dubai Courts, the DIFC, DIFC-LCIA, and DIAC. The Central Bank of the UAE (“CBUAE”) was formed in 1980 and is primarily responsible for overseeing banks in the UAE, except in the DIFC, where the regulatory authority is the Dubai Financial Services Authority or (“DFSA”). The DFSA is a Shari’ah Systems Regulator, requiring that any Islamic firm must have a Shari’ah Supervisory Board (“SSB”).
  33. 33. DIFC The DFSA is unfortunately not itself a Shari’ah regulator and has not constituted its‟ own Shari’ah Board to oversee the regimes in Islamic firms (DFSA: 2010). There appears to be a substantial amount of Islamic finance business being conducted in the DIFC, under the regulation of the DFSA, however, the DIFC lacks an adequate Islamic finance dispute resolution mechanism and centralized Shari’ah authority.
  34. 34. DWIFAC DWIFAC, which shall be funded by Sheikh Mohammed bin Rashid Al Maktoum, may act as the independent central dispute resolution authority and Shari’ah regulator connecting all of the adjudication apparatus‟s of Dubai, the UAE, and the DIFC into one consolidated framework for the adjudication of Islamic finance disputes with a centralized Shari’ah authority in the form of the Shari’ah Supreme Council. The decisions of the Shari’ah Supreme Council shall be binding and available to the public for review, thereby giving certainty to legal decisions and promoting confidence amongst investors.
  35. 35. DWIFAC The DIFC, Dubai Courts, Central Bank of the UAE, and the IICRCA may refer arbitration to DWIFAC and/or utilize the DWIFAC Ambassador‟s List and facilities. In addition, DWIFAC may utilize the expert determination, mediation, and other services of the Dubai and DIFC Courts and the arbitrators of the IICRCA, DIFC-LCIA, DIAC, and the Central Bank of the UAE governance unit. DWIFAC awards may be enforceable in the Dubai and DIFC Courts through a special protocol.
  36. 36. DWIFACJO Standardized Dispute Resolution Contract I propose that DWIFACJO issue a standardized dispute resolution contract, which may be attached to the main contract. The DWIFACJO standardized dispute resolution contract may contain a similar built-in dispute resolution mechanism as the FIDIC contract containing three stages including (1) the Dispute Resolution Board (DAB), (2) amicable settlement, and (3) final referral to DWIFAC arbitration.
  37. 37. DWIFACJO Standardized Dispute Resolution Contract Within thirty days of the occurrence of the subject-matter of a dispute, any party to the contract may submit a claim to the DAB, addressed to the chairman of the DAB and with a copy to all parties of the contract.
  38. 38. DWIFACJO Standardized Dispute Resolution Contract However, if any of the parties to the contract considers that there are circumstances, which justify the late submission, she may submit the details to the DAB for a ruling. If the DAB considers that it, in all the circumstances, is fair and reasonable that the late submission be accepted, the DAB shall have the authority to override the relevant thirty day limit and if it so decides, it shall advise both the parties accordingly.
  39. 39. DWIFACJO Standardized Dispute Resolution Contract The DAB shall have sixty days to issue a binding ruling, which must be implemented immediately. If either party is not satisfied with the DAB ruling, either party can give notice of dissatisfaction to the other before the thirty days after the day on which she received the decision on or before the thirty days after the day on which the said period of sixty days expired.
  40. 40. DWIFACJO Standardized Dispute Resolution Contract If there is no dissatisfaction within thirty days after the day on which she received the decision, the DAB‟s decision shall become final and binding upon both parties. The DAB‟s decision may then only be overturned by settlement or arbitration.
  41. 41. DWIFACJO Standardized Dispute Resolution Contract The DAB shall consist of three people who must be suitably qualified in law, Islamic finance, and Shari’ah. Each party shall nominate one member for the approval of the other party. The parties shall consult both these members and shall agree upon the third member, who shall be appointed to act as chairman.
  42. 42. DWIFACJO Standardized Dispute Resolution Contract However, if a list of potential members is included in the contract, the members shall be selected from those on the list, other than anyone who is unable or unwilling to accept appointment to the DAB.
  43. 43. DWIFACJO Standardized Dispute Resolution Contract The agreement between the parties and either a sole member (adjudicator) or each of the three members shall incorporate by reference the General Conditions as written by DWIFACJO, with such amendments as agreed between them. The composition of the DAB shall be by nomination and then jointselection. DAB members are to be re-numerated jointly by the parties with each paying half of any fees. DAB members may only be replaced by mutual agreement.
  44. 44. DWIFACJO Standardized Dispute Resolution Contract The appointment of any member may be terminated by mutual agreement of both parties, but not by any party acting alone. Unless otherwise agreed by both parties, the appointment of the DAB shall expire when the discharge of the matter shall have become effective. Where the parties fail or are otherwise unable to agree upon the appointment, nomination or replacement of any member of the DAB, then the appointing official so named in the contract shall make the appointment.
  45. 45. DWIFACJO Standardized Dispute Resolution Contract DWIFAC may establish an Ambassador‟s List similar to the FIDIC President‟s List, from which arbitrators and DAB members may be selected, if not specified in the contract. Persons who have successfully completed a DWIFAC Adjudication Assessment Workshop and International Arbitrator‟s Islamic Finance Contracts Course and applied for entry to the DWIFAC Ambassador's List of Approved Dispute Adjudicators are entered on the List for five years.
  46. 46. DWIFACJO Standardized Dispute Resolution Contract Successful attendees at an Adjudication Assessment Workshop are required to be fluent in English and to be thoroughly familiar with Islamic finance, law, and Shari’ah. There may be situations where a party fails to comply with a DAB decision. In such cases, the other party may refer the failure to DWIFAC arbitration.
  47. 47. DWIFACJO Standardized Dispute Resolution Contract Where notice of dissatisfaction has been given, both Parties shall attempt to settle the dispute amicably before the commencement of arbitration. However, unless both Parties agree otherwise, arbitration may be commenced on or after the fiftieth day after the day on which notice of dissatisfaction was given. The attempt to obtain an amicable settlement during this prescribed period of fifty days is a condition precedent to a referral to arbitration.
  48. 48. DWIFACJO Standardized Dispute Resolution Contract There is no given time frame to refer a dispute to arbitration, however, it should be without undue delay. Once the arbitration procedure has been initiated, the arbitration shall commence according to the DWIFAC arbitration rules. The arbitrator(s) shall have full power to open up, review, and revise any decision of the DAB relevant to the dispute. Neither party shall be limited in the proceedings before the arbitrator(s) to the evidence or arguments previously put before the DAB to obtain its decision or to the reasons for dissatisfaction given in its notice of dissatisfaction.
  49. 49. DWIFACJO Standardized Dispute Resolution Contract Any decision of the DAB shall be admissible in evidence in the arbitration. Arbitration may be commenced prior to or after completion of the contract. The obligations of the Parties and the DAB shall not be altered by reason of any arbitration being conducted during the progress of the contract.
  50. 50. DWIFACJO Standardized Dispute Resolution Contract The arbitration shall be conducted in the English language and any arbitral decision shall be final and binding. All of the DWIFAC decisions (see Appendix B) are to be published in English, French, and Arabic and the arbitration itself to be conducted in English. In the event of a conflict of laws, the Shari’ah shall prevail. A valid arbitration decision should lead to a verdict that conforms to the rules of the Shari’ah (AAOIFI 2004:559).
  51. 51. Shari’ah The Shari’ah and legal basis of the arbitration decision shall be mentioned in the decision (AAOIFI 2004:559).
  52. 52. DWIFACJO Standardized Dispute Resolution Contract In the context of DWIFAC, the center may make arrangements with the Dubai and DIFC courts for enforceability of DWIFAC arbitration awards. However, parties to the dispute must realize that the arbitration award issued by DWIFAC may be overturned or enforced in other jurisdictions (International Bechtel Co. Ltd. v. Department of Civil Aviation of the Government of Dubai 300 F. Supp. 2d 112 (DDC. 2004)) or challenged in UAE courts based on Article 216 of the Civil Procedure Law.
  53. 53. Shari’ah Supreme Council Shari’ah Supreme Council decisions shall act as a source of precedent and shall be binding, thus providing legal certainty to Islamic finance dispute adjudication. The Shari’ah Supreme Council established by DWIFAC shall act as the highest Shari’ah authority for DWIFAC arbitration, the UAE, and the DIFC.
  54. 54. Conclusion It is not efficient for the Islamic finance industry to use domestic common and civil law litigation, which does not recognize Shari’ah, gives priority to secular national laws, or relies on a controversial Shari’ah Advisory Committee (“SAC”) to adjudicate Shari’ah issues. It is clear that international arbitration is more beneficial than mediation and expert determination and the best alternative dispute resolution mechanism available for Islamic finance.
  55. 55. Conclusion However, it is also evident that none of the existing arbitration centers can provide an adequate mechanism for adjudication of disputes for the international Islamic finance industry.
  56. 56. Conclusion The DWIFAC arbitration center along with the DWIFAC jurisprudence office (DWIFACJO) provides the best solution of the dispute resolution conundrum of the Islamic finance industry, providing a globally recognized center for dispute resolution located in one of the world‟s major financial centers, which adjudicates disputes using arbitration incorporating lex mercatoria and Shari’ah, the DWIFACJO uniform banking law, the DWIFAC arbitration rules, and the procedural law of Dubai as well as uses highly qualified Shari’ah and Islamic finance/law arbitrators.
  57. 57. Conclusion DWIFAC may also organize and utilize the existing dispute resolution framework in Dubai, the DIFC, and the UAE, consolidating the centers into one hierarchical system, which includes the Shari’ah Supreme Council for the efficient adjudication and regulation of Islamic finance disputes. In addition, the DWIFACJO standardized dispute resolution contract contains a built-in dispute resolution mechanism, encouraging early dispute settlement and completion of contract.
  58. 58. Conclusion We should take this opportunity in the creation of the Dubai World Islamic Finance Arbitration Center (DWIFAC) and DWIFACJO to encourage practitioners in the Islamic finance industry, which promotes Shari’ah based rather than Shari’ah compliant products, and to pursue Holy Book Banking based on the concept of Risalah, recognizing the teaching of all of God‟s prophets.

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